The Impact of Global Recession on Microfinance in Asia - Assignment Example

?An analysis of microfinance and the effect of the financial crisis Inserts His/Her Inserts Grade Inserts ’s Name 5/1/2011 Introduction: Microfinance is providing financial services to poor and low income individuals that do not qualify for regular banking services. Microfinance has gained popularity in recent years as an effective measure to eradicate poverty in third world countries. Although, it is not the only tool for the alleviation of poverty, it follows the concept of self help, that instead of giving the poor man a fish a day, teach him how to fish and he will never go hungry. Thus, micro finance narrowly deals with the provision of small loans to low income individuals to help them start small business ventures. Microfinance does not involve large loans as poor people seldom need large loans or want to start big business ventures. Microfinance advocates believe that providing access to finance can help poor people in getting the resources to help themselves out of poverty. Poor people are usually avid savers but they save in kind rather than in cash. Jewelry, gold, animals and building materials are examples of things that they save which might not always be turned into cash easily. If they require finance, they borrow from relatives or landlords and other informal mechanisms which are often exploitative. (Micro finance, 2008) The modern microfinance mechanism is accredited to Dr. Muhammad Yunus of Bangladesh, the founder of Grameen Bank. He experimented with lending to poor women in rural areas and achieved great success due to high repayment rate and interest rates. Although, bankers were unwilling to assume the risks and costs associated with micro lending, micro finance institutions succeeded in focusing on women and charging high interest rates that the poor were willing to pay. Although micro credit institutions have existed since the 1700’s, it wasn’t till Grameen Bank in 1983 that the approach to micro finance changed. Currently, it is considered a vital element in the eradication of poverty as it enables the poor to lift themselves out of their situation. (The history of Microfinance, 2006) The report covers the role and limitations of microfinance as well as the effect that the recession has had on this sector. It further takes Kazakhastan’s microfinance sector into account and the implications the downturn has had on it. The importance of microfinance: According to a study by Robinson (2002); 90% of the citizens in developing countries lack access to financial services from established institutions whether it is for credit or savings (Vincent, 2004). The impact of the financial sector on the economy and growth of the country is great and this unavailability of finance leads to the vicious poverty cycle of low investment, low productivity and thus low growth. Microfinance is a tool to empower the power, to provide them resources to invest in venture that will increase productivity and lead to economic growth. Although there are conflicting views to microfinance’s real contribution to economic growth and poverty alleviation it is a vital socio-economic tool. The importance of microfinance is that it focuses on the grass roots rather than on dev elopement from top. It focuses on the basics likes a woman getting a loan to set up a PCO and not on setting up industries; thus microfinance is within the grasp of the poor and does not require grand visions but rather baby steps. The investment of credit in an enterprise that leads to the generation of income increases economic growth and development. It not only leads to higher productivity but rather a higher standard of life. It expands income sources and increase aggregate demand thus has a multiplied positive effect on the economy and the lives of the poor. It is important to realize the importance of microfinance in providing income that is sustainable, the ventures that microfinance should focus on should be economically and environmentally sustainable to be successful so they help in eradicating poverty. A real example of a Bangladeshi woman illustrates the way microfinance helps eradicate poverty individually if not necessarily in numbers. Joygon Begum was a poor mat weaver whose family often went hungry and had no money for medicine. A $65 loan from Grameen Bank for a sewing machine changed her life and now her family eats three healthy meals a day, her children attend school and she has savings. More importantly, microfinance enables the poor into deciding for themselves what venture to invest in and create their own ideas. (Vincent, 2004) Microfinance leads to entrepreneurship which is necessary for economic and social development. In poor countries, financial markets are under developed and funds are often short. Governments with large borrowings often crowd out private investment and commercial banks do not consider small investors as good borrowers. Thus microfinance is an instrument which encourages entrepreneurship. Microfinance institutions (MFI’s) can develop infrastructure, provide training and assistance to new entrepreneurs that are starting on s small scale. Critics of microfinance often cite payment defaults and higher costs as weaknesses of microfinance however; women in poor countries have proven to be excellent borrowers with higher repayment rates than in most developed countries. Also, poor people are willing to pay high interest rates as well. Women in lower developed countries have stronger family ties and are more committed to providing for their families. (World Bank, 2004) Microfinance institutions can provide micro loans in a sustainable and efficient manner if the number of clients reaches a large range and thus are commercially viable as well. Microfinance has gained recognition due to its role in poverty alleviation and economic development. Grameen bank founder Muhammad Yunus was awarded the Nobel Prize in 2006 for his accomplishments in microfinance and the bank now serves more than 4 million customers (The history of Microfinance). In the 2005 World Summit, world leaders reaffirmed the importance of microfinance in enhancing economic and social development. The presidents of Benin and Spain among other world and business leaders spoke on the importance of microfinance in helping poor people meet their basic needs such as nutrition, health and education. (International year of microfinance 2005) Consultative Group to Assist the Poor provides statistics that point to microfinance’s effectiveness; BRAC clients increased expenditure by 28% and their assets rose by 112%, also in Bangladesh, 57% of Grameen’s clients were not considered poor. In Indonesia, the average income of BRI clients rose by 112%. Thus statistics show that poverty can be reduced by empowering the poor through microfinance. (Politics, 2009) Limitations of microfinance: Microfinance has encountered many critics in recent years who believe that it is not an effective tool in poverty reduction. Critics argue that funding from donors has gone to wasteful microfinance ventures that are unsuccessful instead of going into health and education. The Department of International Development in a Research and Impact study claimed the microfinance was not the solution to chronic poverty. (Vincent, 2004) Another major criticism of microfinance is that it does not reach the poorest of the poor and thus is not reducing poverty. However, most MFI’s aim to reach communities that banks do not cater rather than the poor and the poorest of the poor do not just require finance but education, skills and healthcare. MFI’s are not charities but aim to be commercially viable entities and thus to redirect aid to MFI’s from charities and NGO’s that work on infrastructure and development does not contribute positively to poverty alleviation. (Ruben, 2007) According to various studies, it has been found that it is a common practice among MFI’s to ignore the poorest and opt for those that are less poor, have some background or credit ratings. This defeats the acclaimed purpose of micro lending. Another criticism relates to its catering towards women which has often led to women being exploited by the men in their households in order to get loans. Women are often forced to transfer their loans to their husbands or other males in the household. As MFI’s lean towards lending to women they are often asked to join by their husbands in order to get the loans. Although, they might not use the loans but they are the ones responsible for repayment. According to Ross Mallick, in Bangladesh women have been subjected to greater abuse and gender conflict. However, Ware Nawaz in his research found that microcredit enabled Bangladeshi women to fulfill their needs and offered them a social support system and prestige (Hossain, 2002). Another factor in this issue is that some women that invested the loan did not make enough to repay the interest even though they were committed to repayment and thus resorted to borrowing from family members to pay off the loan. (Ruben) When these women or other borrowers cannot repay the loans, or do not earn enough to make a profit they become poorer as a result. These criticisms paint the picture that microfinance institutions now resemble commercial banks rather than charitable institutions as they focus on charging market interest rates and turning profits by focusing on the poor but not the poorest. According to a study, microcredit benefits those above the poverty line more than those living below the poverty line. This also occurs due to the fact that poor borrowers usually invest in low return and less risky investments than borrowers with already stable income (Khawari, 2004). In Bangladesh, for example studies claim that poverty levels have remained unchanged since the 1970’s (Hossain, 2002). However, it cannot be refuted that microfinance has had some successes and has been successful in reducing poverty in some areas and for many households although MFI’s need to restructure their programs better to cater to the poor. (Politics, 2009) A microfinance client is an entrepreneur who arranges everything on his own; the finance, management, production and so on. Poor people seldom have the vision to innovate and venture into new things and stick to ventures that seem easy and feasible. Thus, many microenterprises are small and are not built on fresh, new ideas and thus fail. (Karnani, 2007) A comparison of micro credit entrepreneurship and the creation of jobs by higher level skilled entrepreneurship also provide a unique view. An institution that lends small amounts of money to various women to buy sewing machines would lead to increase income for all of them. But, they will have to repay at high interest rates, their skills might not be sufficient, income will be variable and they might not be able to reach and sell in a favorable market. However, if the same amount is invested in one venture of an educated, skilled entrepreneur who wants to set up a garment factory, it will increase the number of jobs available in not just sewing but engineering, designing, construction, maintenance and so on. The factory will be able to achieve economies of scale and reach better markets. The employees will be provided a stable income with no costs associated to it. Thus the creation of jobs seems to be a better alternative for poverty alleviation. (Karnani, 2007) The effect of the current economic downturn on microfinance The impact and importance of microfinance is debated by advocates and critics fervently, however microfinance is a relevant tool that is being implemented in many LDC’s and thus it is important to analyze how the current recession affects the microfinance sector and in turn the poor of the developing countries. Microfinance survived the 1990’s market crash in Asia due to its independence from global markets, however in the recent recession this has not been the case for most MFI’s. MFI’s from Indonesia and other countries have attracted great international interest after the 2006 Nobel Prize for Bangladesh’s Dr. Yunus; this has resulted in investment from international agencies and commercial banks. Large commercial banks such as Citibank have also entered the microfinance sector thus the recession has had a direct impact on the microfinance sector and the very poor. By 2007, $5 billion worth of investments had been invested in MFI’s from the developed world. (Microfinance Insights. 2006) Although to a great extent microfinance has survived the recession blow due to its localization and segmentation; its integration into the mainstream financial market has caused the vulnerability to the recession. According to Elizabeth Littlefield, director and CEO of CGAP; microfinance institutions have been hit in different ways depending on their funding structure, location, clients and financial status. Deposit taking MFI’s were relatively secure as compared to non-deposit taking MFI’s as they are protected from foreign exchange risks and third party financing. Debt-based MFI’s with international sources for funds suffered the most as their funding decreased. Thus, the isolated MFI’s that are dependent on local savings have been protected due to their independence from the foreign market. This includes most MFI’s in Bangladesh including Grameen Bank. Microfinance institutions can obtain funding from three sources according to David Morrison, the executive director of the United Nations Capital Development Fund. They can obtain international funds through local banks or directly, get foreign assistance or local savings. The source of the funds determines the MFI’s vulnerability to the credit crises. Thus the local savings MFI is found to be the safest. Most MFI’s in Bangladesh are self-sufficient and thus are unaffected; however in Cambodia they have been hit so hard that they have suspended credit programs. In West Africa , MFI’s were dependent on local savings and have survived whereas in East Africa there was a greater level on international integration and thus the MFI’s are more exposed to risk. MFI’s dependent on charities and foreign assistance have not been hit as bad and although there funding has decreased they are still viable. The recession has enabled the microfinance sector to return to the savings-lending model proposed by Grameen Bank and is so far the most successful. The financial downturn has hurt MFI’s considered good investments and not affected those that were deemed not profitable enough. (Slothower, 2009) Case Study: Bereke in Kazakhstan Bereke is a nongovernmental organization in Kazakhstan that was founded in 2003 by the former employees of UNDP. It is a microfinance institution that focuses on serving the poor and specifically caters to women. Its major funding comes from grants and shareholders capital. Bereke is a socially active organization that serves over 6000 clients in three regions. It supports human rights, has set up a water project t and has established a refugee rehabilitation centre. (Triodos Bank, N.D.) Microfinance in Kazakhstan is a young sector and has a lot of potential. Only 2% of poor people have access to microcredit in the country and demand largely outstrips supply. Many MFI’s including Bereke are dependent on donor support and are not yet self sufficient. Due to rampant poverty levels the demand for microcredit is high. According the Kazakhstan’s national poverty line 18% of the population is below the poverty line and although there is high literacy and employment, life expectancy is low and GDP per capita is average. The biggest obstacle to growth considered by firms in the country is cost of financing. Many individuals and institutions opted for micro financing when the economy moved to market economy and the market for microfinance is approximately $812 million. The MFI’s are not allowed to accept deposits and this is a big drawback for the sector as many MFI’s are small and segmented and do not provide international investment opportunities. MFI’s in the country have been badly hit by the recession as commercial banks were there largest source of funding. Until 2007 commercial banks borrowed heavily from foreign sources thus the economy has been hity drastically by the recession. Thus MFI’s are facing shortage of funds as demand is high and have turned to international lenders, wholesale funders and government donors. Since Bereke does not have deposits like other MFI’s in Kazakhstan it has not been immune to the finance crunch but it has been able to obtain funding from Hivos-Triodos Fund in 2007. It has also been involved in ACDI/VOCA’s community action program. Bereke is a relatively small MFI compared to other MFI’s such as Grameen bank, however it does have similarities with Grameen as it also focuses on women clients as 98% of its clients are women and it searches out poor borrowers and takes the bank to them. It is involved in training, human rights and other activities for the betterment of society. Unlike Grameen which takes deposits, Bereke is not allowed by law to take deposits and is thus funded by grants and shareholders. Bereke was affected to a certain extent by the downturn due to this source of funding although operational self sufficiency is 100%. The negative effect was largely due to the effect on the economy and the financial constraints faced by the banking sector. Berke does not have any international presence and thus lacks the means to garner funding which is necessary due to the credit crunch commercial banks locally are facing. It also lacks a good MIS system which hinders plans for growth. Bereke has great opportunities to exploit provided it can obtain the grants it requires and increase efficiency. Microfinance demand in the country is greater than the supply and the time is ripe to expand. Although the country’s financial institutions have been affected greatly by the recession due to their dependence on commercial banks and their dependence in turn on foreign loans, Bereke has been successful in finding an international donor and maintaining its self sufficiency. Although poverty alleviation through micro financing has not been achieved in Kazakhstan or any other country, individuals and small companies are willing to borrow and start up their enterprise which is a good sign for the economy. Conclusion: The term microfinance had been hailed as the solution to poverty only six years ago however; the microfinance framework needs many adjustments to become an effective tool for poverty alleviation. The case of Grameen Bank and its success in empowering power women and increasing their incomes has not led into major changes in poverty levels in Bangladesh. Many issues crop up regarding the abuse of women, the failure of ventures and the investment of funds into unproductive and unprofitable ventures. Microfinance yields many positives due to its stance of empowering the poor and enabling them to help themselves however, the creation of industries and jobs is also a necessity and not every individual is an entrepreneur. Microfinance should not be a substitute for spending on infrastructure, health and education which are necessary for poverty alleviation nor should it be a substitute for factories and industries. The conflict on the effectiveness of microfinance intensified due to the recession. The international investments in microfinance institutions harmed them rather than proved beneficial. MFI’s that were self sufficient and deposit based survived without a scratch. However, the debt-based MFI’s suffered to a great extent and funding based MFI’s were also hurt. Thus the recession proved there was a need for restructuring and that MFI’s should focus on local savings to help poor people rather than foreign aid or investment. The same scenario was present in Kazakhstan, which has great demand for microfinance. MFI’s are not allowed to accept deposits and are dependent on financing from commercial banks that are in turn dependent on massive foreign borrowing. The recession hit the entire financial sector of Kazakhstan hard even though many financial reforms had been implemented in the country. The demand for microfinance is still high but the supply is inadequate. MFI’s including Bereke is focusing on garnering foreign grants that are difficult to come by. Recommendations Microfinance is not the answer to poverty although it may assist poor people in improving their financial condition it still leaves the very poor behind. The microfinance system, like any system has its advantages and its disadvantages and countries that encourage it as a poverty alleviation tool should keep those in mind. Thus expenditure on infrastructure, health and education as well as industries and other sectors should remain the top priority as the creation of jobs is a more stable indicator of economic development. After assessing the impact of the financial crisis MFI’s should aim to be deposit oriented and self sufficient rather than dependent on outside sources. This will insulate them from financial crises in the future. They should increase reserves and focus on the quality of their portfolio. MFI’s should truly aim to eradicate poverty and thus reach out to the very poor as well instead of aiming for profitability. MFI’s should also be involved in providing guidance and training to entrepreneurs rather than just finance to increase the profitability and success of the ventures. Bibliography Bank, World. "Afghanistan: Pioneering Donor Coordination for Microfinance." 4 2 2004. . [Retrieved 3 1 Dec 2011] "Bereke." 2010. Mixmarkets. 3 01 2011 . [Retrieved 3 1 Dec 2011] Dr. Dragon Loncar, Christian Novak, Dr Svetlana Cicmil. "GLOBAL RECESSION AND SUSTAINABLE DEVELOPMENT:." 2009. . [Retrieved 3 1 Dec 2011] Fehmeen. "Microfinance and the Global Economic Crisis." 20 2 2010. Microfinance Hub. . [Retrieved 3 1 Dec 2011] Hossain, Farhad. 2002."Small Loans, Big Claims." Development in Practice . IFC. "Kazhakstan: Microfinance and Financial sector Study." 2008. MIFA. 3 1 2011 . [Retrieved 3 1 Dec 2011] "International year of microfinance 2005." 16 9 2005. Microfinance Matters. . [Retrieved 3 1 Dec 2010] Jump, Triple. 2009."Triple Jump: Annual Review ." Karnani, Aneel. "Microfinance Misses Its Mark." 2 6 2007. Stanford Social Innovation Review. . [Retrieved 3 1 Dec 2010] Khawari, Aliya. "Microfinance: Does It Hold Its Promises? .2004." Hamburg Institute of International Economics 2004. "Micro finance." Kiva. 4 1 2011 . "Microfinance and beyond..." 2 12 2008. . [Retrieved 3 1 Dec 2011] Mohammed, Aqiyla. "Hivos-Triodos Fund Invests $232,904 in the Microfinance Institution, Bereke." 23 3 2007. MicroCapital. . [Retrieved 3 1 Dec 2010] Politics, Compassion in. "Evaluating the Criticism of Microfinance, Microloans, and Microlending." 7 2 2009. . [Retrieved 3 1 Dec 2010] "Poverty Reduction in Europe & CIS." . [Retrieved 3 1 Dec 2010] Report, Star business. "Microcredit one bright spot in recession." 14 5 2009. The Daily star. . [Retrieved 3 1 Dec 2010] Ruben, Mathew. "The Promise of Microfinance for Poverty Relief in the Developing World." 5 2007. . [Retrieved 3 1 Dec 2010] Slothower, Molly. "Savings-based microfinance institutions emerge as most recession-resistant." 2 5 2009. MediaGlobal. . [Retrieved 3 1 Dec 2010] "Successor organizations." ACDI/VOCA. . [Retrieved 3 1 Dec 2010] "The history of Microfinance." 14 4 2006. Global Envision. 3 1 2011 . "Triodos Bank." 3 1 2011 . UNDP. "Kazhakstan." 2005. 3 1 2010 . Vincent, Guy. "Sustainable Microentrepreneurship:." 2004. 3 1 2011 . Visconti, Roberto Moro. "The Impact Of Global Recession On Microfinance Governance." 4 6 2010. Microfinance Focus. 3 1 2011 . Vishal Sehgal. "The Business of Microfinance." 2 2008. 3 1 2011 . Read More