The Impact of For-Profit MFIs during the Global Recession - Term Paper Example

 «The Impact of For-Profit MFIs during the Global Recession» INTRODUCTION In order for the business/organization to be profitable, all of the financial concerns should be managed well so that financial objectives will be attained. In this definition rest the nature of financial management. One of the new branches of financial management that refers to small-scale financial services is microfinance. These financial services are for lower income customers that involves micro target group and small enterprises for trade, agriculture, fishery, services, and etc., which are abundant both in rural and urban areas (Robinsons, 2001, p.9). The mentioned undertakings are usually small volume operation that gives an opportunity to individual or group of people who do not have an access to appropriate formal financial services. According to Johnson and Rogaly (1997), microfinance “is considered as the effective means of poverty reduction...” (p.1). This industry will alleviate poverty and increase economic growth in terms of producing more income and creating employment not just in developing countries but also in the world major economies. Microfinance Institutions (MFIs) are the organizations that will deliver and furnished money-matter services to the mentioned low income groups or individuals. MFIs although vary in legal and regulatory structures, missions and procedures, they share common objectives -- to alleviate poverty and increase economic growth. On the other hand, global recession arrived just like a perfect storm that created an impact on the economy, corporate governance and mechanisms of almost all countries in the world. This had transformed the equilibrium between risk and return, global and local demand and capital inflows in financial management (Rangan & Petkoski, n.d., p.1). Microfinance is of course affected by the impact of this global financial crisis; however, it is taking the positive side that this is the right time to help the poorest of people engaged in business (Mahajan, 2010). The impact of microfinance to some for-profit firms during global recession had set worldwide concerns that consequently made this topic important. The extent of the impact should be detected on how it affects MFIs in developing countries (Visconti & Muzigiti, 2008). AIM / PURPOSE “MFIs started as not-for-profit organizations but they are now organized as for-profit entities because they have license from banking authorities to offer savings services” (Bellman, 2010). Examples of MFIs in different countries are Khushali Bank (Pakistan), SEWA Bank (India), Banco Estado (Chile) and Compartamos Banco (Mexico.) By generating more income and creating employment, microfinance had served its purpose not just a tool for poverty alleviation and a better access to development but also for the whole world economies. Institutions under this industry are encouraged to deliver a positive image suitable for the government not to withhold an idea that these institutions need more regulations for expansion in performing its purpose. However due to global recession, financial institutions had formulated an initiative to tighten its lending practices and credit set-up that basically touched the critical growth of poor households and a restriction of credit access (Ayodele & Sotola, 2010). MFIs are composed of organizations that are not-for-profit and for-profit but both of them are standing on the same side of microfinance. The main purpose is to tackle the impact of microfinance upon some for-profit organizations during the global recession. This purpose will necessarily involve the poor at the front line as they are the important players in fighting war against poverty. They are basically the most common cited reason why microfinance exists. MICROFINANCE INSTITUTIONS (MFIs) One of MFIs for-profit entities is the microfinancing banking whose objective is “to increase access to credit among local entrepreneurs who do not have the collateral to obtain loans in commercial banks” (Ayodele & Sotola, 2010). Unlike the traditional banking sector, microfinancing banking services are poverty-focused that allowed poor people to experience the service of mainstream financial services providers. According to the book of Muhammed Yunus, “Banker to the Poor,” he proved that the poor people are credit worthy and that they always pay back on what they have obtained, making MFIs more confident (as cited in Ayodele & Sotola, 2010). Although this rationale is not a hundred percent assurance to be sustainable in this kind of business, a good customer relation must be present at all times (“Microfinance Focus,” 2010). Figure 1 Source: (Ruben, 2007) Figure 1 illustrates the breakdown of microfinance services available for over 100 million of the world’s poorest families that are extremely high compared to the number of MFI outreach. “Over-funding in poor countries can lead to a temporary surge in liquidity and cause over-indebtedness” (Pouliot, 2007, p.273). There is no presence of equilibrium in the survey, although MFIs are granted that they exist to alleviate poverty, they are still organizations that need to survive that is why they are charging rates amply high to resist risks. LITERATURE REVIEW IN A BROADER CONTEXT It was frequently said that poor people stay poor, and one of the reasons was the insufficiency of finance penetration on the lives of the poor. The microfinance concept was formulated by Muhammed Yunus which was being utilized until today. This concept was developed to correct the failure of the idea that financial services were not for the poor. This short literature review will introduce the role of microfinance on how it influenced the lives of the poor especially during recession. Since then, microfinance organized its purpose into various categories to appropriately deliver the financial demand of different people. The services generally include capital market such as microsaving and microcredit (Burgess & Pande, 2003); however it also comprehends on the categories of insurance, money transfers and payment services (Wrenn, 2005, p.1). With the so many decades of financial crises, MFIs were still unharmed and not directly affected compared to other entities. Way back late 1990s, MFIs were untouched from the currency and banking crises in East Asia and Latin America and performed much better than mainstream banks (Littlefield & Kneiding, 2009). During this recession, India was greatly affected in terms of its collapsed currency and decreased economy that basically reduced investment return (Everett, 2008). Latin America particularly Bolivia, had also been affected by the major economic recession last 1998 in which the MFIs in the country suffered from an over-indebted debtors (Muriel, Muriel, Franco, & Martin, n.d., p.149). This result had been similar to the recent global recession that greatly scathed the MFIs in Eastern Europe (Loncar, Novak, & Cicmil, n.d.). The study explained the negative effects brought by recession such as inflation, slowed GDP growth, currency depreciation and many more. The situation was almost the same in Bangladesh because of price hike, the instinct of family consumption, and the quality of portfolio had been reduced (Alamgir, 2009). MFIs were looking for alternatives on how to solve this crisis such as by providing emergency loans, allowing withdrawals of savings, extending credit limit and many more. The study of Rangan and Petkoski (n.d.) presented almost the same effects of current financial crisis that constituted to the declining GDP growth, weak global demand, declining international trade, unemployment, and the collapsed of foreign capital inflows (p.1). According to Littlefield and Kneiding (2009), “the effects of today’s global crisis are likely to be more complex, deeper, and more difficult to predict than the past.” What is interesting on the effect is that both the poor people and MFIs will experience the punishment of recession. Based on the study conducted by Aportela (1999), the result showed that the expansion of microfinance in savings had contributed an increased of savings rate for the poorest household. Microfinace banking services like rural banks had also been significant in lowering poverty and increased non-agricultural output as to the study of Burgess and Pande (2003). Figure 2 Source: (Narayanaswami, 2009) The above map shows the countries that have microfinance gross loan as of 2009. The top five countries which have high MFI gross loan in terms of percentage are Indonesia (9.80%), Columbia (9.45%), Peru (8.19%), Mexico (7.32%) and Vietnam (6.07%). The countries with low MFI gross loan are Paraguay (1.09%), Romania (1.09%), Ukraine (1.08%) and Philippines (1.05%). THE IMPACT OF MICROFINANCE DURING GLOBAL RECESSION Since the outbreak of global recession, the issue about the impact of microfinance to some for-profits firms has been a debated issue. For-profit organizations are not the authentic organizations when microfinance is developed. Traditionally, the non-profit movement includes NGO, credit unions, financial cooperatives, etc. and the for-profits are organized as banks (specialized or full-service). As MFIs are increasing in number and becoming more popular, the funding capital will also increase that is why the newer for-profit microfinance organizations exist. Non-governmental Organizations (NGO). This innovation in microfinance business is the most recognized and is created to fulfill the financial needs of the poor people (Mohapatra, 2009, p.207). In the evidence of gender empowerment result, it is being stated that NGO borrowers are the poorest people in the distribution and it is being dominated by women: Africa (81), East Asia (98), Latin America (71) and South Asia (100) (Sundaresan, 2008, p.18). Credit Unions. These are semi-formal financial institutions that are mostly and easily reached by customers and dominance than other MFIs. Although credit unions have larger volume of operations in many countries of the world, it is largely regulated and supervised because it is prone to systematic risks (Fisher, 1999, p.106). The structure is based on the kind of MFIs and the status of people in that certain country. Commercial Banks. This institution is a new player of microfinance industry having a new phase of image. Just like other institutions, commercial banks are also heavily regulated largely by central banks; however, the regulations are few and the charged interest rates are generally high (Harper & Arora, 2005, p.288). The two models (not-for-profit and for-profit) which came in different in structure, missions and methodologies but originated in all shapes and sizes have the same purpose, to alleviate poverty especially during financial crisis. The real image of financial crisis is still unclear to MFIs if what is being experienced today would be the last or the worst does not come yet. The only instrument to survive and to thrive from this impact is to possess the right strategy. A significant diagnosis of the impact of this global recession can be achieved through the usage of right segmentation from the most crucial extent. The segmentation could be characterized by: a) Country Location; and b) Capital Structure. A. Country Location This is one of the critical factors that need to be deliberated as one of MFIs formulator of operating environment. The location of the country is needed so that the design of MFIs will not be contradictory to the issues of the operating environment like liquidity, credit and political issues. In other words, country crises need to be considered as well as the degree of recession in that certain country. Before moving into the final decision, all facts must be considered and should be gathered first, and then a methodology for testing will be conducted to know the country’s perspective. The geographical distribution of microfinance market in all countries of the world is having significant differences that vary from country location in terms of micro-loan and distribution of borrowers. The large market of micro-loan portfolio is being constituted to Asia with 38%, followed by Latin America (28%), Eastern Europe (27%) and Africa (7%). “As for the distribution of borrowers, South Asia accounts for 51%, East Asia and Pacific 20%, Latin America and the Caribbean 15%, Africa and Middle East 10%, and Eastern Europe and Central Asia only 2%” (Loncar et al., n.d.). The profitability of microfinance has been enjoyed by Eastern Europe MFIs and clients, and also the impact of economic turmoil. In the previous studies it seems that the poor in rural areas are proven to be faithful payers of microfinance services due to the reason that they did not heavily rely on economic crisis. The poor people constituted the higher population, and if all of these people in every country would give an interest to microfinance either for-profit or not-profit companies, this would be a big asset justification. “In fact, microfinance is growing faster than banking, and would likely reach more individuals than the banking sector” (Beckett, 2010). One of the cited banks that had the same mission with those in microfinance is the World Bank. The World Bank is very eager on how to fight poverty and how to address the needs of the poorest households. The founder of microfinance concept, Muhammed Yunus is suggesting that for the World Bank to fulfill its mission, it should increase its pro-poor investment and make sure that the funds will go to the poorest families below $1 a day (“Microfinance Advocacy,” n.d.). B. Capital Structure This second factor is very relevant in determining the associated risk involved in the segmentation of microfinance. It had been realized by MFIs that getting funds from savings or grant alone would not compensate to be sustainable in market growth and expansion. Thus, it needs to have an access to capital markets such as debt and equity. The debt financing should be raised in a most well-known conception and equity must sound good to continue building loan portfolio and investment income. Deposit Based. There are several MFIs that are highly reliant on deposits, wherein it is considered as the inexpensive source of funding at the lowest risk (Huttenrauch & Schneider, 2007, p.322). This deposit based is independent on a third party funding with a lesser display to financial risks and threats. However, deposit based is also unstable like other sources because of financial crisis for it is being challenged by inflation and the urgent concern of basic needs. Debt Based. In contrast to deposit based funding, the risk involved in debt based is much greater in times of financial crisis because the repayment demand is high but the funds are relatively scarce and expensive. The debt and equity of a certain MFI organization must ensure equilibrium so that the risk cannot greatly penetrate (Ledgerwood, 1999, p.224). Equity Based. As to the rating of risks, this funding is located at the middle range between deposit based and debt based. The first two sources are talking about higher interest rates because of unstable money market brought by recession. Equity based in the form of equity investment is the best choice in market diversification for it will contribute lower rates and strong profit margins in the portfolio (Visconti, 2009, p.413). THE IMPACT INVESTIGATION AMONG AFFECTED PARTIES MFIs are bound to face the impact of global recession which comes in different ways, varying degrees, country location, capital structure and many more (Ayodele & Sotola, 2010). The stability of different microfinance industries are largely affected by this financial threat, like for instance the fact that the profit margins of microbank depends on the economic growth rate (Henion & Ahlin, 2010). The recession in MFIs had “delivered 25% decreased in lending, 20% reduction in staff size, 37% have modified their growth plans downwards and 41% have began charging higher interest rates” (Fariha & Arsalan, n.d.). The impact had been extreme especially in international microfinance industry in the form of higher interest rates and risks, increased of food and fuel prices, reduction in foreign investment and international trade and decreased of remittance flows. In the microfinance sector for-profit firms, the impact is very significant because the decrease of available capital will lead to a deterioration of microfinance clients. Global recession has greatly affects various stakeholders of microfinance sector like equity holders, capital providers, lenders and borrowers. If cash would exceed its limit and borrowers would become delinquent, chaos will take place unto the lenders and microfinance investors (Visconti & Muzigiti, 2008, p.3). CONCLUSION Microfinance is truly an effective tool in alleviating poverty as what is being illustrated in the performance of different countries. By permitting the poor people to have an access to various financial services, the income levels had increased and so with the employment rate. However, the performance of microfinance industry should not be based on the history of crises because microfinance has been modified. It is considered unscathed during the 1990 crisis, but the current economic turmoil had a significant impact on MFIs. Many countries had suffered from serious threats and risks, and it needs to formulate right strategies to fight back and remain sustainable. RECOMMENDATIONS Hope remains to be positive that microfinance industry will outlast the ongoing global recession and see that if they flip the other side, risk will become an opportunity. Some have made an assumption that today’s crises will make the institutions much robust in terms of responding to unpredictable economic environment. By proactively respond on this situation, there should be an appropriate regulatory framework in all MFIs after considering that more regulations are needed to perform the expansion purpose. This framework will serve as a guide that all of MFIs have one purpose, to alleviate poverty. For instance, a training for MFI managers and capital providers for them to be well-informed on the real mission of microfinancing. It is also necessary to focus on portfolio quality and depart from being too much dependence on foreign funding and remittances from abroad to raise funds. The fact that funds during recession are expensive and scarce, MFIs should provide an increased in its capital reserves and adequacy so that selling, savings and withdrawals would not create a chaos to the industry. This would be done by diversifying and expanding all sources of financing just like an increased in deposits as the cheapest source of funding. Once the recession would suddenly hit MFIs, the industry would have time to cope up because it has gravity problem as its protection. The industry could also adopt or enhance the risk-management processes and techniques that will monitor the degree of recession to different stakeholders like borrowers. Particularly, this strategy would focus on the clients’ delinquency on repayment. Everything has space for improvement, and so MFIs can amend its means of repayment as to where the clients are convenient. References Alamgir, D. A. H. (2009). Microfinance in SAARC region: review of microfinance sector of Bangladesh. Retrieved from http://www.inm.org.bd/publication/state_of_micro/Bangladesh_counntry_report.pdf Aportela, F. (1999). Effects of financial access on savings by low-income people. Retrieved from http://www.lacea.org/meeting2000/FernandoAportela.pdf Ayodele, T., & Sotola, O. (2010). Rethinking microfinance strategies. Punch on the Web. 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Retrieved from http://www.procasur.org/microfinanzas-asia/documents/ general/6%20GLOBAL%20RECESSION%20AND%20MICROFINANCE.pdf Wrenn, E. (2005). Micro-finance literature review. Retrieved from http://www.dochas.ie/Shared/Files/2/MicroFinance_literature_review.pdf Read More