On the one hand, they represent the needs of the poor population's access to loans and, in this sense, their operations seem selfless and focused on social well-being. On the other hand however, these entities are for-profit economic agents which need to register revenues, to generate funds and to be financially self-sustainable. This need is obvious at the level of all institutions, but even more so at the level of the entities which have share owners for whom they have to increase the value of the equity investments. In this order of ideas, emphasis is often placed on the recuperation of the costs incurred.
The efficiency of the managerial act at microfinance institutions is generally measured with the aid of the operational self-sufficiency ratio, which indicates that lenders are generally able to cover their costs. Some of them are however only able to cover 60 per cent of the incurred expenditure. The means in which companies manage this problem vary across firm, but the trend is that of reducing the costs associated per each borrower and those incurred with the management of the overdues (de Aghion, Armendariz and Morduch).
14. Group vs. individual lending
Group lending is characterized by the fact the members of the group -- generally between three to fifty women, depending on the case -- seldom possess any collateral, and share the risks of repayment problems. The success of the groups is based on regular meetings of the group members and the sense of responsibility embedded in the group members (de Aghion, Armendariz and Morduch, 2007).
Group lending can however be perceived in a different manner -- that in which the money is offered by a microfinance institution to a group of individuals, who then use the money and repay it. Individual lending occurs when the institution will grant the loan to a single person. Maria Lehner (2009) found that microfinance institutions generally prefer individual loans, but will offer group loans in specific circumstances, namely:
The size of the loan is increased
The competition between microfinance institutions is low and the refinancing costs are high.
In the future context in which the microfinance institutions gain increased access to capital markets, and if the competition in the field continues to intensify, Lehner expects individual loans to become more popular.
At the level of sustainability, it has to be noted that the scope of the microfinance institutions is not that of profit registration, but it is that of supporting the development of the poor population through an enhancement of their access to financial resources. The sustainability of such efforts has often been debated. De Aghion, Armendariz and Morduch (2007) find that the sustainability is increased among the most efficient microfinance lenders, but this sustainability does not overcome 64 per cent of the selected leading MFIs. At the overall level of the industry, the sustainability levels, generally difficult to assess, are expected to be lower.
16. Microfinance and the web
The advent of technology, with emphasis on the revolution of the internet, has reshaped the modern day society. And the field of microfinance has not been excluded from this evolution. In the era of the internet then, access to the funds in the microfinance system is eased through an enhanced availability of information. At Kiva for instance, "the Internet-based lending platform has allowed over 60,000 people around the world to channel nearly 6 million dollars in loans to small businesses in developing countries" (Flannery, 2007).
In spite of the benefits it generates for the poor, for the communities as well as for the institutions which offer the resources, microfinancing is also confronted with a wide array of disadvantages. Thomas W. Ditcher and Malcolm Harper (2007) for instance argue that a main problem is that it generates too high and unrealistic expectations. The two authors also mention that important problems of microfinancing arise from improper design of the processes, the mismanagement of the resources or the improper policies set at the basis of the processes.
Ditcher and Harper also raise the questions regarding the actual benefit of microfinance. In essence, they imply that lending to the poor and helping them enter debt is not a sustainable solution to alleviate poverty. And this is also linked to the fact that the funds lent to the poor would only be helping them on the short-term, forcing them to make the future effort of repaying the loans. The most relevant example of useless microfinance is represented by the case of Africa, where, after billions of dollars were sent in the form of aid, the poverty levels in the region continue to increase (Mayo and Ferguson, 2010).
Tazul Islam (2007) argues that the final success of microfinance operations is also prone to failure as a result of corruption. On the one hand, this corruption can be present at the level of the policy makers, and it could result in legislations which do not promote the right causes of microfinance. On the other hand, corruption can be obvious at an internal level of the microfinance institutions and could materialize in fraud, inside trading and so on (Helms, 2006).
18. Challenges for the U.S. MFIs
At a general level, microfinance operations are subjected to the following challenges:
The need to increase the product and service palette in order to serve the needs of larger populations
The need to reach poorer people in more remote locations
The need to reduce the costs of the financial operations and loans for both the customers as well as the microfinance institutions.
At a more specific level nevertheless, the challenges include the following:
The need to use optimized technology in order to support the efficiency and superior results of microfinance operations
The need to leverage cross-border remittances and other transfers and use the large financial funds to improve the quality of life for the poor people
The expansion of high quality financial services in order to reach farmers and other people in remote locations and in need of loans
The need to measure the social performance and return of the investments in the meaning of assessing the actual means in which the loans support increasing living standards for the low income category of population, and finally
The need to adequately regulate the microfinance operations and services in order to ensure that the poor individuals are protected and that they "do not fall prey to predatory lenders and other unscrupulous practices" (Helms, 2006).
19. Microfinance to reduce economic inequality
Overall, the microfinance operations, products and services are aimed at supporting the poor population in gaining an increased access to borrowed funds. The most important argument against the efficiency of such measures is represented by the fact that increasing debt for the poor population is seldom an economically effective means of reducing poverty. Through increased debt, the poor become even poorer.
In turn, when using their money to fund microfinance services, the wealthy investors benefit from a return on their investment. This subsequently means that the wealthy investors gain financial resources and as such become wealthier. In essence, as it represents a process by which the poor get poorer and the rich get richer, it could well be argued that microfinance enhances economic inequality, rather than reducing it.
On the other hand, when the money collected through microfinance loans are used to improve the quality of life and to start up operations which would also generate revenues, it can be argued that the money has supported the poor population in improving their living standards. Also, with the investment of the money, they would be better able to repay the debt and would not as such be negatively impacted by the loan. In such a context, it would be safe to conclude that microfinance does indeed manage to generate a reduction of the income gap.
Ultimately, the impact of microfinance within the societies and the economies is yet unclear and it can be both positive as well as negative. The final outcome is based on situation specifics, such as the quality of the lender, the means in which the money is used and repaid, national specifics and so on. The uncertainties which still occur in both the practice as well as the theory of microfinance reveal the need for further research and analysis.
Clark, B.S., Political economy: a comparative approach, 2nd edition, Greenwood Publishing Group, 1998
De Aghion, B.A., Armendariz, B., Morduch, J., the economics of microfinance, MIT Press, 2007
Dichter, T.W., Harper, M., What's wrong with microfinance? Practical Action Publishing
Flannery, J.J., Redefining microfinance in the internet era, Social Innovation Conversations, 2007, http://sic.conversationsnetwork.org/shows/detail3252.html last accessed on April 6, 2011
Helms, B., Access for all: building inclusive financial systems, World Bank Publications, 2006
Johnson, S., Rogaly, B., Microfinance and poverty reduction, Oxfam, 1997
Kai, H., Microfinance and inequality, Research in Applied Economics, Vol. 1, No. 1, 2009