Bareeq AlBarqawi

October 23, 2012

Case Analysis – Microlending

The concept of Microfinance is relatively young and is still an evolving industry which was outlined in the case readings for the week. Although, microlending solves the issue of providing poor people in the developing world access to money, it still raises many questions. Is the process effective? Could it be profitable? Is this a sustainable model? And most important, where can we go from here?

Microfinancing is a man-power driven model where microlending institutions provide small loans to poor people in the area providing them the financial capital to begin an entrepreneurial venture in order to pay back the lender. Since there are no credit bureaus available to check their credit, lenders implemented a group lending model. This group lending model works best in rural areas because of the closeness in their community, but it is not very efficient and is flawed in theory. It relies on societal pressure which will eventually lead to these individuals in developing credit history with that microfinance institution. Ideally this is an excellent approach, but it does not account for the fact that some individuals in the group will flourish in business while others businesses may fail or grow slower and deters the group lending process. In addition, group members at times felt the need to push away from meeting regularly because they thought it was time wasted while away from their business and eventually they did not feel a need for group lending once they established their own personal credit history. In essence, the idea is a good kick start to microlending for certain communities, but that should rely on a judgment call. Not every community is cut out for this type of approach or is as close as certain communities. Also, it is a good stepping stone for borrowers, but would prove better if there was a second step they could advance to once they’ve completed group lending and succeeded in paying off their loan(s) (Economist, 2005).

Microsavings accounts are not as booming as the microfinance industry, but it is something that should have been considered way in advance of microlending. It was assumed that poor people in developing countries had no interest in saving but in reality, people on the ground attached great value to keeping their money in a safe place than hiding them in the dirt. Instead of “jumping the gun” and pushing the loans and debt process on these people, they should first experience what it’s like to save, how to do it, and why. They should be taught how to manage their money before borrowing it and putting themselves in debt and risk. Baby steps are key here (Economist, 2005).

The whole premise of microlending started with the idea of “doing good.” But has it become exploitive and manipulative? Some microfinance institutions are transitioning from non-profit to for-profit business models and operating as they would in the West. They are drifting away from charitable donations and looking for long-term capital from investors and big banks. With this type of business drive and acumen, it is quite surprising that these investors and microfinance companies did not fill in the gap between the people and microfinance; training and development. People on the ground are in a situation where they borrow money they are not normally accustomed to having and must now begin a business to begin to pay that back, but where do they start and what do they do? They need financial and business experts and incubation centers to develop their critical thinking skills and aid in becoming an entrepreneur.

Having this type of training, along with microlending, seems to remedy the issues that arise on the ground in this field. Companies such as SKS Microfinance are doing exceptionally well following their for-profit model and have the backing of foreign banks and have turned a philanthropic effort into a business/corporate one. Many are now trying to follow suit, but when SKS implemented simple accounting practices given the little electricity India gets and having their borrowers pay a set amount every week with no change involved shows that if you go for the issues or problems directly then you see some real progress. Knowing that, providing the people avenues to succeed with these newfound funds would be ideal and will probably be something we see in the coming years (Bellman, 2006).

Microfinance has economically developed the regions of the developing world but there is still so much more to be done. When you see how SKS Microfinance has a default rate of less then 2% then you know that they are onto something. However, this is still a young industry and many more improvements will come but seeing the direction it is headed reveals that it will eventually play a much larger role in economic development and business ventures while bringing corporate and foreign investors to the region as we have seen with Citigroup. In addition, foreign companies may have limitations in the way they run their businesses in such countries which is why we are now seen starting partnerships with microfinance institutions such as Citigroup and SKS Microfinance (Bellman, 2006).

The impact of foreign capital on microlending effectiveness is that it provides microlending institutions more capital to do business and not relay on charitable donations, but at the same time we question if it’s ethical? Based on the “green model” in the comparison between Wall Street and the borrowers on the ground in developing countries, foreign investors gain a large margin of profit in comparison to those this system is supposed to help. It questions the ethics of working to do good but then pocketing most of the capital rather than reinvesting back into the region. Given that the region still has more growing to do, the question of intent comes into play when foreign investors could re-invest in the region to fix the gaps in the microlending business especially with consideration to small business management education and the lack of it.

Tying it all together, the process of microlending is ethical if viewing it in an ideal circumstance, but ethical people are not always involved. Lenders can manipulate and pressure borrowers to take out loans at interest rates that spike up in the future and now the borrower is unable to repay or foreign investors are making more money off the hard work of those on the ground. We cannot ignore that these things are happening. The ventures that need further advancement are microsavings accounts, credit bureaus, small business management education, and insurance products because these are the gaps missing in the microlending process (Bajaj, 2011). For example, when a rural lender in Indonesia, BRI, was failing, they transitioned into a bank for the poor and introduced a government-guaranteed savings account with no minimum deposits and now they have around 30 million savings accounts (Economist 2005). We hear success stories which makes us believe this is working, however that is not always the norm. Just as SKS Microfinance fixed what they saw wrong in the system, this process needs fine tuning and being that it is a fairly new and young industry, we are in the hopes that this is the direction they will be headed. The four main areas that require attention in this field are “culture, products, funding, and the cost of operations” and with the ventures outlined earlier, once these are addressed is when real social change can take place (Economist, 2005).


One thought on “Microlending

  1. tlhill2012 November 24, 2012 at 5:47 PM Reply

    Bareeq – thanks for this post. You’ve captured the main issues, leaving the question about what to do about each one?

    For example, group lending does indeed seem to work when the culture is right and when there is no good, transparent, informaton about individual credit-worthiness. Is this just a transitional solution, waiting for the day when good information becomes available (as the Economist suggests). Or is it a new way of doing business that might work at large scale, at least in some cultures? While this may seem far-fetched, there is increasing academic interest in what is called relational governance as a complement to, or sometimes a substitute for, more familiar transactional governance (clear information, contracts, collateral).

    Turning to savings, yes it is in demand and does seem critical to effective, ethical and sustainable development. My sense is that just giving credit seems to allow some to succeed, but not the majority. Providing safe savings, with occasional access to credit, seems to have a positive effect on a much wider swath of the population. (Confirming or adjusting this impression would make for a good paper topic…)

    Finally, to the Economist’s list, I might add innovation in organization structure and management, such that those affected have a voice at the board table.

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