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Eye on microfinance~II

There has been a growing awareness among microfinance institutions that credit is certainly not transformative. Although certain people will be able to use microfinance to alter their future and build their businesses, that is not the case with the majority who receive a loan. Most are going to use it to smooth out their consumption.

Moin Qazi | New Delhi |

The biggest problem with microfinance is that people who get these small loans usually start or expand a very simple business. The most common business using microfinance is retail selling groceries, where there are often too many players creating fierce competition, and where people don’t really earn enough money to get out of poverty.

They basically compete with each other and drive everyone into the ground.

Not only are borrowers often innumerate, illiterate and unfamiliar with interest rate calculations, but they frequently have little or no awareness of local demand for goods and services. Consequently, they often fail to establish successful income-generating ventures and therefore cannot repay their loans.

There has been a lot of rethinking in the microfinance fraternity. One major premise that has been discredited is that capital is not the only important financial need people have. This seems clear and obvious now, and microfinance organizations are expanding the range of their credit offerings.

While we must still consider the risks and ethical dilemmas as we continue to aggressively push microcredit, the power of an entire range of microfinance services to help us achieve a more equitable world is becoming increasingly clear.

There has been a growing awareness among microfinance institutions that credit is certainly not transformative. Although certain people will be able to use microfinance to alter their future and build their businesses, that is not the case with the majority who receive a loan. Most are going to use it to smooth out their consumption.

Credit can be both an opportunity and a risk for low-income families. It is necessary to open doors, but it can also be a barrier. A person can dig oneself into a lot of debt, preventing the ability to move up financially. Loans can be malignant. Some people shouldn’t take on debt. Some businesses are too risky. And the temptation is always present to take these costly loans and scrimp on groceries. When they miss loan payments because a lingering illness keeps them away from their business, they get into the regular default cycle. That’s acute over-indebtedness.

Should there be bailouts for unscrupulous debtors who invested unwisely or selfishly, as well as for debtors who genuinely tried to use their loans sensibly but now cannot make repayments, either because of the economic downturn, or because they had no choice in taking on such debt, such as by having to pay for essential medical care? Some form of debt forgiveness and write-offs is sometimes necessary. An alternative (or additional) option would be a moratorium on interest repayments ~ giving borrowers a certain period in which they only have to repay their initial loan, allowing MFIs recoup their money even if not making a profit ~ as well as a much longer delayed period for repayments. One wouldn’t like to resurrect the “deserving poor” versus “undeserving poor” trope, but if the reasons for the individual debt aren’t going to be factored into potential write-offs, then the situation could get messy. Blanket, no-questions-asked write-offs are hardly useful for solving problems of financial illiteracy.

Access to small loans for tiny businesses by itself won’t miraculously enable the poor to take them to a new level. It will not build a steady business because a lot of them face several barriers. A modest cash injection cannot generate a stable income, or create a profitable cycle of trade and income particularly when the dally struggle of most of these people has to do with making a living, feeding their families, educating their children and staving off ill health.

The notion that microfinance has the potential to spark sustained economic growth is misplaced. The direct evidence of microfinance’s impact is less than overwhelming. In several cases, these financial activities can damage the prospects of poor people. Microloans do create opportunities for people to utilise “lumps” of money for augmenting incomes and mitigating vulnerability, but that doesn’t necessarily mean investing in businesses could lead to sustained revenue growth. Not all microloans produce beneficial results, especially for those engaged in low-return activities in saturated markets that are poorly developed and which are prone to regular environmental and economic shocks.

Poor households are not well served by simple loans in isolation. Minimalist microfinance provides a bandage where a major operation is needed, and at worst, it deepens the wounds. While the bulk of microfinance portfolios may be commercially sustainable and attractive to conventional investors, reaching the still-excluded will continue to require innovation and experimentation. More than micro-loans, what the poor need are investments in health, education and the development of sustainable farm and non-farm related productive activities.

Marguerite Robinson, an author and consultant of microfinance, puts it succinctly: “Credit is a powerful tool that is used effectively when it is made available to the creditworthy among the economically active poor participating in at least a partial cash economy ~ people with the ability to use loans and the willingness to repay them. But other tools are required for the very poor who have prior needs, such as food, shelter, medicine, skills training, and employment.”

The present model of microfinance practices ~ minimalist microfinance in which credit is the only intervention ~ is unlike the classic avatar that shows dollops of genuine good.

Socially embedded institutions provide clients with information and handholding, but most microfinance clients have no training, education, or role models in business, and therefore are unlikely to cultivate successful microenterprises on their own. They need a comprehensive suite of financial tools that work in concert to grow savings, mitigate risk, fund investment and move money.

Many microenterprises fail due to lack of local demand, fierce competition, or inadequate technical skills of entrepreneurs. Microfinance actually best serves those who have higher skill levels and better market networks. Its loans, then, are hardly a tool of resilience, especially when widespread shocks threaten not only borrowers but the industry itself.

The hard truism is that microfinance has been saddled with misplaced expectations, and we have lost a sense of its more modest, even though critical, potential. It is actually only one instrument in a broader development toolbox, but in certain conditions, it happens to be the most powerful. It can make the poor a little more resilient, but it is not the answer on its own. It all has to do with how we are using it and how we are defining the outcomes.

The writer is the author of Village Diary of a Heretic Banker. He can be reached at [email protected]