Microfinance - Dissertation Example

?Microfinance Table of Contents Introduction 3 Definition and Brief History 3 Significance in developing economies 3 The situation in Saudi Arabia 4 Literature Review 4 Concept and importance of microfinance 4 Significance of Microfinance Institutions in Developing Economies 6 Summary 11 Research Methodology 12 Timescale for the dissertation 14 References 14 Introduction Definition and Brief History Microfinance institutions advance credit at lenient terms to encourage entrepreneurial ventures by the poorer section of the society. The history of modern microfinance institutions could be traced back to the 1970s when Bangladesh introduced financial units like the Grameen Bank under the tutelage of Nobel Laureate, Mohammad Yunus, who supported lending programs to poor women. These institutions shielded the poor households from risks of exogenous shocks, powerful enough to adversely affect their consumption levels and thus, falling victims to the exploitative schemes of moneylenders (Patibandla, 2006). The concept gradually gained popularity across the globe in nations rife with social vices such as poverty, widespread unemployment and inequality in the distribution of wealth, after it tasted success in Bangladesh. In fact, the impact had especially been stark in cases of transition economies. The present paper attempts to evaluate the truthfulness of this fact in context of Saudi Arabia that too is characterised by all the aforementioned economic vices preventing a nation from economic ascension. Significance in developing economies The foremost significance of microfinance institutions lies in their pro-poor feature Most of the developing nations are characterised by a majority of the population dwelling in poverty-stricken rural areas. Hence, microfinance institutions help to bail them out of dire situations arising out of low investment potentials and opportunities mirrored through a poor economic growth rate. Secondly, the fragile financial systems of developing economies are too poor to confront the risk of lending out to the rural poor; rather, they tend to advance their services to the more organised or formalised sector. Hence, investment lending is indeed negligible for the rural areas in developing economies (Organisation for Economic Development, 2004, p. 105). Lastly, the rural poor in developing economies often are discouraged to avail lending options in commercial banks, where they need to deposit collateral while taking credit unlike in microfinance institutions, where they are allowed to accept loans collectively that does not expose any single individual to huge liability stakes. In addition to alleviating poverty, reducing inequality of income and generating employment, microfinance institutions also help to boost up economic growths through increased production and reduced dependence on externally produced items (Woller & Parsons, 2008). The situation in Saudi Arabia Saudi Arabia could be distinguished exclusively as an oil-producing giant that draws almost all of its income from exporting the fuel around the world. However, the rise in economic growth rates has been recorded as 1.25 percent between 1981 and 2000 in contrast to a fall of 2.5 percent in GDP per capita, implying a rising inequality in the distribution of income (Raphaeli, 2003, p. 1). The nation is also characterised by an extremely skewed tax structures favourable mostly for the richer section, while the same cannot be said for the poorer population who derive their incomes out of primary activities such as farming or fishery. The modestly developed financial sector of Saudi Arabia cannot is quite unfavourable for the rural poor who have to strive hard for loans. Furthermore, the national government exhibits little effort in development of infrastructure in these regions (Islamic Development Bank, 2010, p. 3). These loans could prove to be foundations for setting up of small scale industries conducive for the economic growth and employment generation in the nation. In addition, microfinance institutions could also bail the Saudi women who are highly biased against. Literature Review Concept and importance of microfinance An extensive research conducted in the area of the economic anthropology demonstrates that the economic action of the people is enabled as well as constrained by cultural practices, social relations, economic and political development. As per Firth and Yamey (1964) this is also a central message that emerged from the sociological and anthropological studies conducted as early as 1960s on insignificant capital accumulation, savings and credit. These essentially comprise the studies in the area of microfinance (Lont & Hospes, 2004). Consequent to the emergence of the formal financial organizations the existence of the microfinance has mostly remained unseen and unnoticed by the observers. It is only in the last few decades that there have been serious international efforts to formalize the provision of financial services to the poor. This process initiated towards the beginning of 1980s and has gained tremendous momentum over the years. According to Christen et al (1995) in the current scenario there are a number of MFIs which offer financial assistance to roughly 100 to 200 million of the underprivileged population across the world. This shows how a movement that originated at the grass-root level has transformed into worldwide industry. In the historical context the growth of microfinance industry is a significant achievement. As per Mutua et al (1996) this has upended the established belief that the poor section of the society is merely consumers of financial aids, put to rest the belief that the poor people are not bankable, and generated a wide variety of the methodologies of lending establishing the idea that it is very much possible to provide gainful financial services to the needy and generate social investment in millions for the purpose of helping the poor in financial terms. Besides this the concept of microfinance enabled the upliftment of the poor with the latter contributing in the initiative thereby ensuring the profitability of this social initiative commonly expressed as “doing well by doing good”. It is by virtue of this potential that the microfinance industry has emerged on a global scale (Brau & Woller, 2004). Sehgal (2008) refers microfinance “as an umbrella” that encompasses the extension of banking services by the institutions working for poverty alleviation to the poor section of the masses that are left out of the realm of the mainstream financial banking. These are essentially small loans granted to meet the financial requirements of the poor workers. In the beginning the rural population remained at the centre of the microfinance lending but with time even the urban poor are being included within the domain of microfinance lending. According to a research conducted by Deutsche Bank (December 2007) the total volume of microfinance loans has been estimated as approximately USD 25 billion in the year 2006. The rise in the microfinance lending has been stupendous as compared to an estimated lending of USD 4 billion in 2001. As per Dr Akula of SKS Microfinance (India) the microfinance market in India is estimated at nearly USD 2 billion. Microfinance is based on the premise that even the working poor can take upon entrepreneurial work and can in principle comprise the creditworthy class. According to Dr Akula the rapid growth of the microfinance industry is reflected from the fact that the people are interested in carrying on their business and in this endeavor they are willing to pat interest. The significance of the microfinance industry is evident from the fact that it is based on a development model of ‘Bottoms up’. Besides promoting entrepreneurship it provides the people with the means of fighting or alleviating poverty. The growing popularity of this industry has now reached out to the global audiences. The United Nations (UN) heralded 2005 as “a year of microcredit” with the aim of a global promotion of the potential and benefits of microfinance. It has also been acknowledged by the UN that contrary to the development model of top down approach like waiving of debts, grant of international aids, microfinance is reputed for its model of bottom up development. It operates at the local level and facilitates an improvement in the situation of the micro-borrowers by way of self-effort rather than depending on the strategies of external development. On a collective basis the micro-credit has fostered economic development on a large scale and led to the growth and well-being of the target nations (Sehgal, 2008). Yuenger (2009), states that towards the end of 1990s the microfinance industry contributed significantly to the financial sector by raising the profits and widening the accessibility of the financial services in the public domain. This was the time when these microfinance institutions reorganized themselves as ‘microfinance banks’. After years of experimentation it is now amply clear that recovery of cost remains the key element in the success of the microfinance institutions which functions with the dual focus on the social as well as commercial principles simultaneously working towards the growing its client base. Therefore, ensuring a disciplined cost management at various levels would bring about a financial viability of the microfinance institution (Yuenger, 2009). Significance of Microfinance Institutions in Developing Economies Microfinance institutions attained popularity in developing economies following a massive withdrawal of financial benefits to the rural poor throughout the world during 1980s. Their localized knowledge, proximity to rural households and less stringent terms and conditions, are welcomed by the rural poor of developing economies (Holden & Prokopenko, 2001). These institutions are believed to have every capability of abolishing poverty from the heart of the society. In fact, in situations when other sectors of the economy are undergoing a feeble growth phase, microfinance institutions could help to boost them up through assisting the poor in developing new assets, lower the rates of interest in order to encourage flow of money within the economy, improve market competition, etc. (Barr, 2005). One of the most pestering aspects of domestic financial systems of developing economies is that they cannot effectively mobilize the resources of these nations which deprive a huge section of the needy. However, microfinance institutions play the role of accumulating these savings and mobilizing them in the neediest of channels (Robinson, 2001). Microfinance institutions could be useful in shielding poor households from the risks of falling victims to exogenous shocks which could compel them to compromise on their consumption front. These institutions come of great help in insuring these poor households against such risks. Moreover, due to the availability of such financing, production activities could continue smoothly in developing economies (Lustig, 2001). In cases where facilities of microfinance institutions are absent in an economy, the poorer households often attempt to reduce their plight through adopting various measures such as selling their labor in greater amounts. Such activities could also include marketing the labor of children which could take a toll on their education and health. Hence, absence of microfinance institutions in developing or low-income economies could induce the poorer section to compromise upon the health and education of their children and ultimately shove them to an underprivileged life filled with poverty (Jutting, 2005). Simultaneously, these institutions provide investment opportunities to these households even despite their involvement in least yielding economic activities. In addition, these institutions also have recognized the need of women in alleviating poverty in their households. They encourage credit advancement to the rural women in addition to accepting their savings in the form of financial assets which ensure a secure future for them (OECD, 2004). Thus, microfinance institutions also play a robust role behind enhancing social welfare. In fact, there are 7000 Microfinance Institutions around the world serving 16 million people across developing economies of the world. These institutions have earned a gross cash turnover of $2.5 billion, which has ample room for growth (Alsayrafi, 2010). Apart from being conducive for economic growth and social welfare, microfinance institutions also assist in boosting psychological factors such as ability to take effective decisions, rising awareness about primary education and healthcare, good networking practices among different members of the society are some of the social positivism being nurtured by a precedence of microfinance institutions in an economy (Foschi, 2008). Developing economies are largely characterized by a highly fragile financial system. The commercial financial houses are especially found to be less friendly for the rural poor and rather, tend to advance their services to the more organized or formalized sector. Hence, investment lending is indeed negligible for the rural areas in developing economies (Organisation for Economic Development, 2004). Microfinance institutions open up avenues for the poor households, forming part of developing economies, to directly access financial institutions. These people, living below the line of poverty, no longer need to fear of exogenous shocks affecting their levels of consumption as they are insulated by undemanding credits from an organized sector unlike those of the unorganized but exploitative moneylenders. Secondly as they are insured against severe risks by financial institutions, the rural poor are more encouraged to participate in varied economic activities which involve a higher risk but are also featured by higher potentials of returns. Thus, such steps might be regarded as progressive towards an egalitarian society devoid of poverty and hence, conducive to economic growth and development. Thirdly, as the interest payments are no longer the sole responsibility of an individual, the opportunity cost that each of them have to bear while accepting a loan gets sharply reduced (Honoman, 2004). On the other hand, these institutions are also characterized by certain limitations such as inability to finance the needs of budding entrepreneurs who require funds to support their business, but have do not have the credit worthiness to appeal the same from commercial banks. Moreover, these institutions charge high rates of interest on loans to cover the risk of default payments. Default payments on the other hand are quite frequent owing to poor management efficiencies. Hence ultimately, they might not actually contribute as much economic growth as possible for developing economies as predicted (Holden & Prokopenko, 2001). Empirically too, the worse angle of these institutions became prominent in Bolivia where excessive competition in the industry led to a malfunctioned atmosphere restraining the economic growth rate. In a bid to enhance their respective market shares, the institutions aggravated their lending rates to people with the least credibility so that the final outcome had pushed the nation towards inflation. People had a huge sum of money bestowed in their hands even though they were not being spent in significant economic activities (Matthaus-Maier & Pischke, 2004). Despite these drawbacks however, microfinance institutions are believed to have every potential to prop up the economic growth rates of microfinance institutions. The Impact of microfinance on the developing economies According to Rodrick and Rosenzweig (2009), Dutt and Ros, (2008) Zaidan and Jensen, (2008) Sundaresan, (2008), Narasaiah, (2008) and Islam (2007) micro finance have been an eye opener for a number of small business persons in the developing economies like Saudi Arabia. Some have even sprung up to access the normal credit facilities in formal bank. The issue of microfinance has much significant benefit in the society. For instance several women groups have done very well following the introduction of such facilities (Islam 2007). In this they have been empowered, therefore the issue of gender equality can actually be addressed. In many developing economies the micro finance has helped not only in boosting the existing businesses but also in starting businesses. The microfinance agencies that provide micro credits are sometime responsible for organizing training sessions for those who are in need of skills which are required to run the money generating activities (Sundaresan, 2008). As mentioned earlier, if the focus is clear as why the microfinance are available, and the right people who are also willing to make use of these facilities wisely are there then there can be a realization of making a difference in the economy and the lives of the recipients of the facilities (Sundaresan, 2008). However if they cannot work hard to put the finances in good investments then the project will be pointless. A number of researchers have found out a few impact of the microfinance in the economy of various countries, most of which addressed the elevation in the economic status of the countries yet so much still needs to be done when it comes to establishing the difference in the status of these families before and after they accesss the funding (Sedzroet al 2010). So much has been done about this topic bust it has emerged that none of the studies have actually pointed out the feasible present challenges as well as the future problems that these institutions might face. Although Fernando, (2006) has looked at this particular issues on the geographical and cultural perspective it is also important to view it in long term economic gain just as Sundaresan, (2008) regarded as elevating the social and economic status of the poor. At the same time this study hypothesize that it is for the poor and families of low income needs revision especially in these economic time. Saudi Arabia, just like any other country at present has been hit by inflation and therefore the micro finance institutions in my opinion should be widened to include those who have found themselves in a temporary recession situation without necessarily singling out that the funds are for the poor families hence this study will also shed light in some of the challenges that the institutions face or are likely to face. For instance, getting the exact feedback about the status of the people who are benefiting from these micro credits and carefully establishing whether they have actually improve as far as their poverty line is concerned. The other anticipated challenge is the assessment which the institutions face in establishing whether ones needs the micro finance or not, is also a challenge therefore there need to a statistical study about how to deal with such circumstances. It is imperative to include the findings that have been established to identify the families daily needs and also to check whether the people that need the help are also capable of making use of these microfinance in fruitful and fulfilling way. This is because is possible to access these fund by the virtue of the availability to those in the rural areas but as mentioned by Fernando, (2006), it is very crucial to find out the skills that the people have before being given these finance. Also it is important to train these personnel on how to handle the finances and also giving various business opportunities that they can venture in. Also, the best idea is to identify what the microfinance providers themselves encounter at also the challenges of the entrepreneurs (Sundaresan, 2008). Although from the studies done earlier on the same topic it is evident that these facilities are helpful to some people yet in other regions in the Saudi Arabia people still do not know the existence of such institution and some still have to travel far to access these institution. This is one of there reason why it is important to set many of these institutions. It is evident that when these institutions are locally then it will make it easy for the people living in the rural areas to access them at the same time remove the transportation barrier of going to get such as distance (UNDP, 2008) if these people are considered to be poor then it does not make sense concentrating the institutions in the capital cities which will the require the needy people to travel and get them when the means is in the first place a bizarre these are some of the gaps that needs to be addressed. One of the problems that the institutions have been facing and have not been addressed is how to determine the interest rate on such loans when the people who are targeted are already poor with no or negligible assets and at the same time have no previous history (Ault and Spicer 2009). It is also very interesting the way authors such as Ault and Spicer, (2009), Dayananda (2002), White, (2006) Churchill and Frankiewicz, (2006) and Robinson, (2001) have given the issue of Capital budgeting a passage mention, yet these are key issues for the financing bodies like IMF. Therefore it is important to analyze their long term availability and how such financial projects can be managed. There should be tools which need to be employed to examine ways of making these projects sustainable. Summary The above sections show the extent to which microfinance institutions are able to boost economic progress in developing economies despite feeble domestic financial systems. These institutions with their evolution history dating back to 1970s in the developing economy of Bangladesh are often regarded as pro-poor due to their relaxed financial terms and conditions. Neither do these institutions ask for high credit-worthiness on part of their lenders and nor are they required to be already involved in significant economic activities. However, these institutions help in boosting up the investment potentials of rural households in addition to investing them against exogenous shocks such as those arising from crop failure or untimely climatic changes. Moreover, as loans could be taken on a cooperative basis, they exert little pressure upon any single individual of the group, unlike the case of moneylenders. However, these institutions tend to charge high rates of interest on their loans as they stand at high risks of being victims of loan defaults. Furthermore, these institutions have little incentive to make profits as they generally operate in high tax generating environments. Despite these facts, the role that they are supposed to play behind the economic development of low-income nations could be justified from a number of grounds. Research Aims The present paper aims at assessing the extent to which microfinance institutions are needed to prop up the rural economy of Saudi Arabia. The most pestering of all facts is that the economy is fast losing in the frontier of income inequality and unemployment which are likely to take a toll over the long run future of the nation. The high rates of unemployment that the economy faces at any point of the year could easily be solved through the development of microfinance institutions in the nation which assist in improving the economic growth rates. Thus, the paper actually aims to: 1- Investigate the popularity of microfinance institutions in Saudi Arabia and to evaluate their roles in economic ascension of the nation 2- Identifying the probable challenges that the industry is likely to face while operating in an economic environment like that of Saudi Arabia. Research Question Given the economy’s present position of high income inequality, poor investment ventures, high unemployment rates and looming poverty, it is important to evaluate the extent to which building up of microfinance institutions could actually alleviate those problems from the economy. The following research questions might be considered as suitable for the present paper: 1- Are microfinance institutions necessary for the economic development of Saudi Arabia? 2- What challenges do these institution faces at present and are likely to confront in future? Research Methodology 1- Secondary data The research methodology to be employed in the present paper is that of secondary research. Secondary data will be used in this case in order to gather up-to-date information and at the same time gather enough information to obtain a rich data. Secondary data involves the use of the information which was collected before hand, Hamilton, (2005). In it also time consuming and tends to be cost effective. The purpose of the present paper will be that of assessing the potentials for success of microfinance institutions in case that they built in Saudi Arabia. In a follow-up, 10 banks based in Saudi Arabia and enlisted in the domestic stock exchange will be examined and their annual reports have to be evaluated. To investigate their success, some financial ratios will be examined along with their individual trends. In line with the objectives of the paper, it will be wise to investigate the degree of profitability and efficiency with which they handle their jobs. In order to examine these factors the following ratios need to be examined. For profitability – Return on Assets = (Net Income)/ (Total Assets) and Return on Equity = (Net Income)/ (Shareholder’s Equity). For efficiency – Accounts Receivable Turnover = Operating Revenue/ Accounts Receivable Asset Turnover = Operating Revenues / Total Assets In addition, the degree of growth in number of loans forwarded by microfinance institutions will also be assessed in order to examine the degree to which these institutions are featured by growth potentials. 2- Primary data Examination of these trends will speak of the robustness of their respective positions as well as their popularity. Primary research has been avoided in this case to curtail cost and time incurred in conducting research. Primary data is that which is collected exclusively by the researcher in order to accommodate the needs of his customised research. In contrast to secondary data, they are acquired by the researcher himself through employing methods such as interviews, surveys, etc. This is the reason why the collection of primary data could consume a substantial amount of time and energy even though it helps to accomplish the exact research objectives. However, there will not be any necessity for using Primary data collection method, because, there are sufficient information on readily available source on the Internet and books that will be used to collect the data. Timescale for the dissertation Following is the timescale of the dissertation - Task Start date Duration (Days) End date Introduction 5/5/2011 3 5/8/2011 Literature Review 5/12/2011 15 5/27/2011 Research Method 5/18/2011 2 5/20/2011 Data Collection 6/10/2011 25 7/5/2011 Analysis 7/6/2011 15 7/21/2011 Conclusion and Recommendations 7/22/2011 4 7/26/2011 Total Number of Days   75   References Alsayrafi, F. H. 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