Impact of Microfinance on Developing Countries - Literature review Example

?Impact of Microfinance on Developing Countries Literature Review In a good number of countries, poor people continue to be excluded from formal financial institutions and other formal financial systems. This may range from partial exclusion as in most developed countries, to full exclusion in developing and poor countries (Idowu, 2008). With no access to financial systems, the poor have to define new informal ways through which they have to guarantee their financial survival while at the same time obtaining seed capital for development. Such informal community based institutions are meant to meet their daily and long-term financial needs, a gap that is perfectly filled by the micro financial institutions (Jegede, Kehinde & Hamed, 2011). Consequently, micro financial institutions are organizations developed towards promoting economic activities among the poor and low-income earners, where formal financial institutions have not offered similar services. To these people, banking services are impossible or almost impossible and they have to get a new way of bridging the gap left by the banks, which makes micro financial institutions prominent in poor countries particularly in the African continent. Micro financial institutions will lend small amounts of capital to members and other poor individuals in the locality towards poverty eradication, in addition to providing the poor communities the same services that are available in banks, and which are enjoyed by the rich (Jegede Kehinde & Hamed, 2011). In fact, microfinance institutions do not only provide capital for the poor but will go an extra mile to alleviate poverty from the basic individual level and at the community level (Anyanwu, 2004). Consequently, as Anyanu asserts, in Africa and other developing countries, microfinance institutions are considered the main source of funding for the poor towards creating projects that alleviate poverty and educate the poor on wealth creation. Due to the important role played by these institutions in poverty eradication, the government of Nigeria adopted micro financial institutions as the main route towards poverty eradication with the central Bank of Nigeria developing the necessary policies to facilitate operations of these institutions. This is despite the fact that the number of people benefiting from these institutions is still lower than required, with more people targeted through expansion of microfinancial institutions throughout the rural areas in the country. More than 70% of Nigerians live below the poverty line with microfinance banks serving about one million clients across the country that has a population of more than 140 million people (Irobi, 2008). Considering these facts, it is important to investigate how microfinance institutions affect the poor in developing countries with a close focus on Nigeria. Microfinance institutions have a role to correct an imperfect market in answering the various shortcomings of imperfections in the credit market (Armendariz & Murdoch, 2010). Making it easy for people to obtain capital has been shown as the best way to increase output, profits and net income among the poor, which improves their individual and communal welfare. However, the borrowing capacity is mostly dependent on the amount of information in the market, the vulnerability of the business being funded and the amounts of uncertainties in the business setup (Duvendack et al, 2011). Moreover, credit facilities continue to be used for gender empowerment among the poor where microfinance institutions targeting women have continued to sprout. Such credit facilities and education on members are aimed at promoting the status of women in the society and empowering them to handle more roles in the society and their families in general (Duvendack et al, 2011). There is a general simplified assumption that credit is an exogenous mode of treatment on borrowers that represent the wellbeing of the affected individuals through changing their livelihoods and other relations between individuals (Duvendack et al, 2011). This is further complicated by the fact that most evaluations in the effects of micro financial institutions in most studies do not provide actual results due to lack of rich and quality data sets. Such poor results are blamed on poor design in studies or due to the lack of factual data about the number of people affected by microfinance institutions (Caliendo & Hujer, 2005). For instance, though it is widely believed that microfinance institutions in developing countries empower more in the society (Armendariz & Murdoch, 2010) a meta-analysis of 29 studies found only 5 studies with discussions to that effect (Duvendack et al, 2011). For the benefit of this analysis, these assumptions require detailed investigation on their influence in the way microfinance institutions affect communities and individuals in poor and developing countries. Currently, there are various major micro financial institutions spread throughout African countries. These include the Rural Developments Programs in Kenya to the operation feed yourself in Ghana, all which have the main purpose of improving the social-economic status of the rural poor population. Consequently, micro financial institutions are perceived as unique approaches towards reducing the vulnerability of people in rural communities and facilitating achievement of millennium development goals (MDG) across these countries (Adam, 2007). These institutions allow the poor to diversify their economic welfare by increasing their incomes, which is the ideal path towards alleviating hunger and other poverty related effects. In other words, when people have diversified, they become resistant and able to withstand external shocks. In most cases, a person is considered poor when their daily consumption falls below one dollar, which is considered the lowest level for an individual to meet their basic daily needs reliably. For instance, In Nigeria, poverty is considered as a state where an individual cannot meet their daily essential needs adequately. These are food, shelter and clothing; the individual should also have limited or no access to social infrastructure that include education, assets, self-worth, health, water and sanitation among others, and the individual has no or limited chances of advancing in their lives towards attaining their capabilities (Jegede, Kehinde & Hamed ,2011). Consequently, microfinance is defined as the supply of loans and savings among other basic financial services to the poor, as an economic development that targets to benefit the lower income earners in the society, both men and women being beneficiaries (Irobi, 2008). World Bank (2007) defines microfinance as availing financial services both savings and credit to the poor and low-income earners. These institutions can be governmental and non-governmental institutions. Studies have reported positive correlation between poverty reduction and microfinance institutions in Nigeria (Adam, 2007 & Irobi, 2008). Therefore, most studies have affirmed the belief that microfinance institutions are the right way through which to achieve poverty eradication in poor communities. This is mainly due to the ability of these institutions to reach deeper into the poor communities and the willingness of these institutions to serve those below and above the poverty line all together. In some cases, poor people continue to learn from those above the poverty line through learning programs organized and coordinated by such institutions towards educating the rural flock on self-empowerment. Various studies have indicated that microfinance institutions on the global scale have helped in reducing poverty levels particularly in developing countries. Shahid (2001) in a survey on how to fight poverty with micro-credits in Bangladesh observed that between two studies, one in 91/92 and the second one in 98/99, poverty levels decreased by between 5 -10 % in this period. Poverty among the participating households using micro-credit facilities was found to be significantly lower than those who did not participate. Studies have also indicated that significantly promoting the woman’s credit facilities through microcredit facilities had a considerable impact on the measures of health of both the girl and boy children, compared to credit provided to men. In other words, the study indicated that when more women are allowed access credit facilities, such women have a greater impact on the family setting than wealth created by empowering men (Murdoch & Haley, 2002). Moreover, studies have indicated that the greater the micro financial institutions become to serve more clients in the poor communities, the most sustainable and cost effect the institutions become. In other words, in initiating developments among the communities, the more people the institutions serve, the less the cost becomes unlike in other cases where serving such great numbers of people increases the costs (Murdoch & Harley, 2002). Consequently, most financial institutions in developing countries work on the principle of cost-effectiveness and sustainability as the main approach in programming their funds, despite dwindling budgets. In this unique advantage, microfinance institutions have been found to have much better platform on which to offer their services compared to other financial institutions, whose costs increases with the number of people served. This fact was further supported by Robinson (2001) who observed that the poor can benefit from social and economic fronts continuously without having a negative impact on the financial sustainability of micro financial institutions. A study in Bangladesh revealed that for every 100 taka of credit advanced to women, their household expenditure increased by about 20 takas, which is overwhelming evidence on the impact of micro financial institutions in decreasing vulnerability of the poor through economic empowerment and increasing consumption in the economy (Jegede, Kehinde & Hamed, 2011). However, despite the advantages that have been linked to these institutions, in Nigeria, most people continue to miss the services of microfinance institutions due to major hurdles that crumble the effectiveness of these institutions. These include lack of proper awareness among the people, communication gap, lack of enough government support, poor funding from donors limiting the operations and expansion of the institution and lack of proper attention in ensuring the sustainability of these institutions. Others include lack of equity capital to increase loans to the community, poor human and institutional capacity building, increasing number of illegal NGOs that fleece communities soiling the reputation of micro financial institutions and lack of monitoring efforts in standardising the operations of these institutions (Irobi, 2008). With these drawbacks, many people are either not aware of the operations of these institutions or shy away from their operations in fear of unscrupulous NGOs that pretend to offer such services only to fleece their members. All the same, Jegede, Kehinde & Hamed (2011) in a quantitative study on the impacts of micro financial institutions in Nigeria observed that there was a significant effect of the institutions in promoting sustainable development among the poor rural communities across Nigeria. Consequently, the study observed that the use of micro financial institutions had the potentials to reduce poverty particularly through increasing the level of income among the members. This reduces people’s vulnerability resulting from high poverty levels. It is through such increased income that communities will have better economic capacities, which as a result will lead to sustainable development in the community. Therefore, to attain these benefits, Jedege et al (2011) recommends the need to put more efforts towards expanding such institutions to all rural areas and creating more awareness and ability of these institutions to cater for other services that are important in poverty eradication for them to function as envisaged in the case of Nigeria. Moreover, the study indicates that the government has a role to play in creating a favourable environment for these institutions to operate through creating a stable political environment, stabilizing the economy in ensuring low inflationary rates and promoting a stable macro-environment for these institutions to operate. Jegede, Kehinde & Hamed in the study noted that the government has to assist these institutions to cater for all the poor in the country and in providing the right infrastructure to link the poor villages to the upmarket areas mainly to induce movement of capital in these areas and trigger growth and development. Through such improvements on infrastructure, the local communities would participate in developments using credit facilities from the microcredit institutions. The government also has a huge role to play in streamlining the activities of micro financial institutions. More fake NGOs are constituted aimed at fleecing the poor in the rural areas by pretending to offer the required services. Consequently, the government of Nigeria had failed in protecting the poor through prosecuting erring staff in micro financial institutions or in dealing with the fake NGOs to ensure only the genuine and credible institutions operate towards benefiting the poor (Jegede, Kehinde & Hamed, 2011). Ayanwu (2004) supports this allegation in remarking that in Nigeria, the services provided by micro financial institutions are not offered the required publicity and are not covered in detail in financial statistics. Anyanwu in addition reiterates on the need to have a detailed policy framework to regulate and standardise operations of micro financial institutions across the country. The issue of micro financial institutions has been relatively new to Nigeria with 266 MFI registered by 1993 though the number increased five times to 1,193 by 2003 (Anyanwu, 2004). However, these institutions by 2003 had only employed about 777 people. The MFI sector increased from total assets of about 54 million in 1993 to about 348 million Nairas by 2003, which indicates the industry was still young and had not managed to reach a good number of people, considering the country had over 130million people by 2003 (Anyanwu, 2004). However, despite their small numbers, the effect was significant in sensitising people and in poverty eradication. In 1993, only about 6,013 borrowers had actually obtained credit from these facilities compared to about 405,915 by 2003. The figure indicates the low penetration of MFI in Nigeria by 2003. However, Anyanu (2004) observed that most MFIs in Nigeria had relatively much higher interest rates that discouraged the poor from borrowing and using their services. In 2003, most of the MFIs were charging a repayment of as high as 92.5%, though the repayment rate in MFIs was impressive with two leading firms obtaining a 100% repayment rate, with the lowest realizing 80% repayment rate. This was much higher compared to the banking sector that had an average repayment rate of 79% in 2002, with some having a much lower distress rate of about 58.6% particularly between 1990 and 1995 (Majeha & Nwachukwu, 2008). These figures indicate that despite the high repayment rate, most poor people have confidence in MFI and when given the chance are willing to repay such loans. This is an indication of positive development; as such, clients will have created some wealth before repaying the loans. Therefore, considering that two thirds of Nigeria fall below the poverty line ; Nigeria is the third largest country in the number of poor people globally (Majeha & Nwachukwu, 2008) such MFIs would be critical in the society in supporting small scale farms and other small investments to spur growth and wealth creation in the society. The fact that most Nigerians have portrayed interest in borrowing from MFIs despite the high interests rates compared to commercial banks creates an impression of Nigerians being industrious. Such borrowers can be more effective given the right conditions to invest. However, most MFI in Nigeria are hampering wealth creation and redistribution through unequal interest rates. For instance, interest rates in borrowing may range between 30 % and 100%, while interest rates on savings for members range between 4.5% and 6%, which erodes the benefits, accrued by the poor and redistributes them to the rich, as the owners of these institutions (Majeha & Nwachukwu, 2008). Consequently, most MFIs are blamed for eroding the major gains gained in poverty eradication and empowerment in the society. However, despite the unequal wealth redistribution, MFIs have improved the saving culture in Nigeria, with savings for members increasing steadily, leading to capital acquisition for development. The community banks have much higher loan rates compared to deposit rates with community members increasing their loan application for development projects across the country, which is essential in poverty eradication (Majeha & Nwachukwu, 2008). This is enhanced through strategic cooperation between the Nigerian Central bank and United Nations development Program (UNDP) that has initiated more training programs in communities and to MFIs staff, taking Central bank personnel to countries such as Jordan and Philippines where such institutions are well developed and have worked great in poverty eradication in rural areas (Majeha & Nwachukwu, 2008). Moreover, the two have developed short courses to train Central Bank’s staff on MFI operations and how to ensure risk based supervision in facilitating their sustainability (Majeha & Nwachukwu, 2008). In addition, the government has of late developed policies that have recognised such MFIs as instrumental in achievement of Millennium goals, though there remain a good number of areas not covered by these services. This is portrayed by the increasing number of unemployed people that have turned to their formal sector with more informal sector developments supported by MFI loans to create wealth in communities by employing a number of individuals and in consuming the locally available resources (Idowu, 2008). In encouraging the community and especially the youth to initiate projects and giving small loans towards the same, MFIs in Nigeria have absorbed a good number of youths in gainful employment, which not only creates wealth for such youth and the community, but also significantly reduces crime that is common with such unemployed youths. Therefore, though not completely developed across the country, micro financial institutions have been instrumental in poverty eradication across Nigeria. Considering that the country is among countries with the highest number of people below the poverty line, the government has realised that it is only through such institutions that poverty eradication towards achievement of the millennium development goals would be realised. To supplement the government’s efforts, the UN and other donors have undertaken strategies to improve the micro financial institutions across the country as well as injecting funds in these institutions. This support has proved essential in spurring development across the country by improving the income levels of Nigerian people. References Adam, G. 2007. Role of Microfinance Institutions in Actualization of MDGs. Paper delivered at the induction ceremony of Institute of Chartered Economists of Nigeria (ICEN) in Port Harcourt Anyanwu, C.M. 2004. Microfinance Institutions in Nigeria: Policy, Practice and Potential. Nigeria: Central Bank of Nigeria Research Paper Armendariz de Aghion, B. & Morduch, J. 2005. The economics of Microfinance. Cambridge: MIT Press. Caliendo, M & Hujer, R. 2005. The microeconometric estimation of treatment effects - an overview. Forschungsinstitut zur Zukunft der Arbeit (IZA) Discussion Paper No. 1653, July. Duvendack M, Palmer-Jones R, Copestake JG, Hooper L, Loke Y, & Rao, N. 2011. What is the evidence of the impact of microfinance on the well-being of poor people? London: EPPI-Centre, Social Science Research Unit, University of London. Idowu, F.C. 2008. Impact of Microfinance on Small and Medium-Sized Enterprises in Nigeria. Proceedings of the 7th International Conference on Innovation & Management, 1864-1871. Irobi, N.C. 2008. Microfinance and Poverty Alleviation: A case study of Obazu Progressive Women Association Mbieri, Imo State- Nigeria. Uppsala: Department of Economics Jegede, C.A, Kehinde, J & Hamed, A.B., 2011. “Impact of Microfinance on Poverty Alleviation in Nigeria: An Empirical Investigation.” European Journal of Humanities and Social Sciences. 2(1), pp. 97-111. Majeha, R.O & Nwachukwu, N.I. 2008. Microfinance Institutions in Nigeria. MPRA Paper No. 13711 Murdoch, J. & Haley, B. 2002. Analysis of the Effects of Microfinance on Poverty Reduction. NYU Wagner Working Paper series No 1014. Robinson, M. 2001. The Microfinance Revolution: Sustainable Finance for the Poor. Washington: World Bank. Shahid, K. 2001. Does Micro-finance Really Benefit the Poor? Evidence from Bangladesh. Paper delivered at Asia and Pacific Forum on Poverty: Reforming Policies and Institutions for Poverty Reduction held by the Asian Development Bank. Manila World Bank 2007.Globalization, Growth and Poverty: Building an Inclusive world Economy. World Bank Policy Research Report, New York: Oxford University Press Read More