Micro Finance – Strengths and Weaknesses

Micro Finance – Strengths and Weaknesses

Strengths and Weaknesses of micro finance 

Strengths:

The biggest strength is bringing financial services to the poorest of the poor people and making it financially sustainable by the economies of scalability. In India the National Bank for Agriculture and Rural Development (NABARD) finances more than 500 banks that lend funds to Self-help groups (SHG). SHGs comprise twenty or fewer members, of whom the majority are women from the poorest castes and tribes. Nearly 1.4 million SHGs comprising approximately 20 million women now borrow from banks,  which makes the Indian SHG-Bank Linkage model the largest microfinance program in the world. Similar programs also help in the development of an economy by giving people the chance to establish a sustainable means of income. Eventual increases in disposable income will lead to economic development and growth.

Weaknesses:

There´s not much research done on the actual effectiveness of microfinance as a tool for economic growth. Some argue that there´s too much focus on microfinance which will motivate less spending in other helping assistances like public health, welfare, and education.

Some doubts about microfinance really have that impact on poverty as the MFI’s would submit.  Some microfinance institutions charge excessive interests thereby exploiting the under privileged.

Studies of microcredit programs have found that women often act as collection agents for their husbands and sons, such that the men spend the money themselves while women are saddled with the credit risk. Some borrowers have become dependent on loans for household expenditures rather than capital investments.

Economies of scale:

MFIs need both capital and internal operating efficiency to achieve scale. Since 1970 microfinance has been proven to be one of the most effective and sustainable tools in poverty alleviation. But still 80 percent of the working poor, more than 400 million families,are without the reach of financial services. To be able to serve everyone better the microfinance industry must be even more efficient and improve the scale of operation by a large extent. At today’s growth rates it will take decades for the rest 80 percent to be served according to some studies.

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The most critical problem of today is finding money to lend out to the poor. Existing microcredit programmes are coming to a virtual halt in their expansion programme, and finding it difficult to continue their present programme because of lack of funds.

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Many microfinance institutions are self-sustaining but most of the microfinance institutions still rely on and must get rid of their dependency on donor money in order to reach scale. Large amount of money is required to expand their operational capacity in order to reach economies of scale rapidly. Without sufficient internal operating capacity, growth suddenly stops once a program reaches several thousand clients. They must provide their financial products to a much bigger number of clients. The only possibility to access large amount  of money is on the traditional financial market. The problem for most MFIs to attract this money is the lack of track record and well framed business plans.

The key solution to the right internal operating capacity includes improving for example the information technology, internal controls, new product development and human resources. When MFIs rely too much on donor’s money, it´s very hard to do the necessary investments in the areas that are sustainable and with expandable possibility.  That’s why most MFIs are small and stay small which this figure visualizes. About 73% of all microfinance institutions serves less than 2500 clients.

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Commercialisation:

In order to capitalize on the success of MFI’s in reaching out to rural areas and establishing more transparency in the industry, it is imperative that MFIs move towards financial self-sufficiency through a combination of strategic objectives and business planning and an adoption of cost recovery interest rates.

If MFIs were to continue to function as NGOs, several issues such as lack of good governance, poor transparency, limited funds, and difficulties in achieving sustainability etc., would make it difficult for MFI’s based on that model (NGOs) to function in the industry.

The reason for transforming [MFI’s into commercial operations] is to bring more transparency, increase the confidence of investors and donors, ensure sustainability and get more income for a greater lending capacity which as a result, would expand the reach for providing financial services to rural poor people.

The nature of NGO’s is to seek funding from donors and their capacity to operate micro finance institutions is very limited. The non-profit model might work if the micro credit provider has the ability to do the job otherwise it wouldn’t be sustainable in the long run.

Commercial approach on the other hand ensures sustainability of various products and services and sufficient levels of capital.

More profits, more benefits:

Contrary to common perception that commercialisation will shift MFI’s target market, away from the very poor to the less poor and non-poor, it has not suffered  such a shift in the micro finance industry. In fact the experiences of the industry have shown that commercialisation level and depth of outreach have increased in tandem. Commercialisation of MFI’s has been beneficial at both micro level and the macro level.

From a micro level point of view that MFI’s can have various source of funds, which would be more sustainable due to financial returns and a greater capacity to satisfy their client’s needs due to its capacity to offer several financial services to the poor.

From a macro point of view commercialisation expands operations nationwide as MFI’s can reach a large scope of rural households and generate more jobs as they absorb more employment.

With commercialisation, not only the rate of interest has declined but also the number of borrowers has increased gradually year by year.

The profit oriented perception can attract more local and foreign investors to invest in existing or setting up new MFI’s to serve untouched rural households. More players in the market will create competition which results in lowering of interest rates and other  charges.

Balancing commercial and social vision:

The social value of microfinance has long been taken for granted; the sector’s number one priority has essentially been to scale up. In the mid-1990’s, when attention was driven by growth and sustainability, focus was on the number of clients, profitability, subsidy, dependency, reduction of delinquency, and operational and financial sustainability.  Through the mid-2000s, efforts to assess the contribution of microfinance to development were often denigrated by influential players in the sector, who did not want social concerns to “hijack” MFIs’ focus on financial performance. However, the aforementioned developments in recent years have led microfinance actors to make the social dimension of their activities more visible. The recognition of a double bottom line that marries financial and social performance is poised to become mainstream. This shift has revealed that good social outcomes are indeed compatible with financial performance as they improve client retention, repayment and staff productivity. Some even propose to relax regulatory constraints for institution that have proven their social utility  or credit rating based incentives for institutions that contribute substantially to social objectives.

To be contd.,

(Contents gathered from various websites on the subject)