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Main Content
Micro-financing - Combating Poverty through Business
Micro-financing has emerged in recent years as the fairytale success story of the financial world.
Institutions such as Grameen Bank in Bangladesh and non-profit organisations such as Kiva have helped millions in developing countries to secure small loans and build business’ freeing themselves from abstract poverty.
Micro-financing is considered the lending of credit of up to $100 USD to borrowers who would not otherwise qualify for traditional bank credit. The initiative began in 1976 by Professor Muhammad Yunus. A Bangladeshi economist, Professor Yunus, established the Grameen Bank (village bank) offering small loans with low interest to Bangladesh’s impoverished populace in the midst of the countries devastating famine of the 1970s. The loans, unlike traditional aid, are intended to support borrowers in building businesses and empower them to pull themselves out of poverty. Today the Bank has almost 7 million borrowers, 97% of which are women. The Bank offers stepped lending, whereby after the repayment of an initial small loan, borrowers may apply for larger loans. For his work Professor Yunus was, in 2006, awarded the Nobel Peace Prize. From the initial success of Grameen Bank numerous other organisations and financial institutions have begun their own lending programs such as Kiva, a San Francisco-based NGO founded in 2005.
Kiva allows web-based lenders to fund as little as $25 per loan, with the choice of lending with or without interest. After a loan is repaid it may be re-loaned or withdrawn by lenders. The NGO boasts a 98% loan repayment rate and has offered some $205 million USD in loans. Donations can also be made to the administration costs of Kiva. This measure frees the organisation from hidden administration costs as with many other NGOs where for every euro that is donated to say save a child from hunger in Africa up to 50% may be eaten away in administration costs. The system of micro-financing has had tangible success in developing economies where basic education, numeracy and literacy exist, yet has proved more problematic in war-torn regions where recovery of loans is difficult.
The Wicked Witch of the East…
The fairytale of micro-financing does have its darker side. Abuses of the new microfinance market have arisen as fast as the market itself. While lending amounts are very low, often in the range of just a few hundred dollars, the interest rates imposed by some profit driven lenders border on usury. The desperation of borrowers often leads them to accept interest rates exceeding 100%. Further exacerbating their plight if they are unable to make the loan profitable. The repayment of loans has been linked to suicides in India and many other countries. Mexican banks have been some of the largest documented culprits of usury in the micro-financing sector.
Many corporate banks have also tapped into the profitable opportunities of micro-lending. In a book by C. K. Prahalad, The Fortune at the Bottom of the Pyramid, he notes that the market for traditional borrowers is approximately 1.7 billion people whereas that for micro-lending nears 4 billion – those earning $360-1500 USD per year. With substantial prospects for financial institutions it is no wonder many commercial banks and credit unions are diversifying their portfolios into the micro-financing sector. While this could indeed be a force for good, the pace at which the sector has taken off means there is insufficient global regulation. When it is added that borrowers are often uneducated of the risks involved, it can be assumed serious problems may plague the sector in the future.
Today, Mohammad Yunus himself is facing highly disputed charges of corruption and has been dismissed from his position at Grameen Bank. The Nobel prize-winner attempted to establish a political party to challenge the incumbent in 2007. The Prime Minister last year urged Grameen Bank to dismiss their founder and managing director, a call which they finally succumbed to in early April. The US has stated that any conviction of Professor Yunus could harm relations between the two countries. The saga appears to have pitted political power against the financial institution that carries such influence in the country. A turn of events that displays just one of the hurdles for rise of powerful micro-lenders in developing countries.
While micro-financing has been a fairytale success story of recent decades lifting millions of people out of poverty there is a sordid underbelly that is bulging below the good banker’s belt. The enormous potential for micro-lending to take advantage of unsuspecting borrowers should be of future concern and regulation needs to be swiftly implemented to weed out the good from the bad. If such regulation is sufficiently enacted, micro-financing may just begin to live up to the hype as a panacea of the world’s ills.