From Bangladesh to Bolivia, the
promise of microfinance has spread across the developing world to society’s
poorest looking to break free from cyclical poverty. The industry is based on
the idea that small amounts of money – even as little as $20 – are enough to
secure a sustainable source of income. Whether it’s agriculture, textiles or livestock,
the Internet is full of microcredit success stories.

In theory, microfinance has the
power to generate economic growth in impoverished communities by creating
business that reinvest locally rather than through large transnationals which carry
profits offshore. Credit opportunities spur investment, leading to a higher
velocity of money throughout the market.

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However, the original vision of
microfinance to fight cyclical poverty seems to have been lost. Rather than lending
to establish local businesses and a focus on borrower benefit over lender
profit, the industry has shifted to predatory lending practices that leave the
world’s poorest worse than they were before. Microfinance has its flaws, but
the solutions lie in investment in borrower resources, corporate responsibility
and government regulation.

Good Microfinance vs.
Bad Microfinance

            Bangladesh’s
Grameen Bank is cited as the first pioneer into the microfinance industry. Founder
Muhammad Yunus saw the devastating impacts of the 1974 famine and mass immigration,
leading him to give small, low-interest loans to families in his rural village
to spark economic activity. Yunus actively avoided predatory lending practices
characteristic of small lenders and instead saw microcredit as a tool to pull
rural Bangladesh out of poverty. It has become a government-subsidized and
operated bank.

                                    (citations
from Wikipedia)

            Since its founding,
Grameen Bank has demonstrated a significant impact on borrowers. After joining
the bank, 91% improved their economic conditions. Those who had taken more than
5 loans had a lower portion below the poverty line than those who had taken one
or less (

            http://www.arabic.microfinancegateway.org/sites/default/files/mfg-en-paper-evidence-on-the-social-and-economic-impact-of-grameen-bank-and-brac-on-the-poor-in-bangladesh-2002_0.pdf).
P7-8 By sticking to its pillars of social business, the bank has promoted lending
as one of the premiere methods of poverty mitigation throughout Bangladesh.
While some have criticized Grameen as another debt trap for the poor, it has since
established a variety of programs and educational initiatives to assist those
who have trouble staying solvent. Grameen focuses on community needs and
responds with tailored policies.

            Though the
success of Grameen Bank has proved itself in Bangladesh, microfinance has spread
to other countries as a largely-unregulated, commercialized industry. Rather
concentrating on social benefit and poverty alleviation, this portion of the
industry focuses on profits.

            Mexico’s
Compartamos Bank scandal demonstrates this trend of over-commercialization. In
its 2007 IPO, the bank’s senior managers and outside investors earned millions
of dollars from a corporation funded by Mexico’s lower classes. Despite the
massive scrutiny faced from microfinance activists, other privatized corporations
have emulated Compartamos’ business model to profit. Corporations founded on
these principles have shown little positive economic impact on their target
demographic: the world’s poor (http://inctpped.ie.ufrj.br/spiderweb/dymsk_4/4-6S%20Bateman-Microfinance%20in%20Latin%20America.pdf
p 4)

            While
commercialized microfinance delivers to key stakeholders, including corporation
management and shareholders, by filling market demand for small loans, the benefit
of this credit is lost through predatory lending tactics. In short, when
borrowers default on their loans, commercialized lenders are more focused on
collateral recovery than social advancement. To resolve the issues associated
with microfinance, it is important to not only ensure that the benefits of microfinance
are passed on to borrowers (the consumers,) but also that the industry remains
profitable for private ventures.

 

Borrower Resources
and Education

            Education
and counseling is key to success in any field, and microfinance is no
different. Creating informed consumers prevents risky borrowing and spending. In
developing, relatively wealthier countries like India and Pakistan, third-party
credit counselors help bridge the gap between lenders and borrowers.

            The Banking Codes and Standards board of India is an
example of such an organization. It ensures that clients of member banks not
only receive simple, easy to understand information before applying for a loan,
but also credit counseling if they encounter financial difficulties. This
involves case-by-case analysis of each borrower’s situation and can bring them
to solvency through debt restructuring or One Time Settlement plans.

http://www.bcsbi.org.in/Codes_MSE_lending.html

            Using third-party organizations removes some of the
vested interest that could be present when working directly with lenders or
banks. They provide tailored help at little or no charge to ensure access to those
who might not be able to afford it otherwise. Both the consumer and the producer
benefit; borrowers face less risk to their assets while lenders have a stronger
promise of repayment. The third party doesn’t have to be a nonprofit
organization, either. It may be established as a government program or funded
through subsidies and operated by banks themselves.

Government
Regulations

            Government intervention
can help ensure the viability of microfinance through macroeconomic fiscal and
monetary policy. Though this applies generally to most businesses, maintaining stability
and keeping inflation rates steady encourages investment by preventing
unpredictable spikes and falls in the economy.

            The World
Bank suggests loose regulations with frameworks to allow a diverse mix of
institutions into the industry to spur innovation and competition. Bank
supervision is a key investment to prevent corruption and ensure financial
institutions play by the rules.  

https://www.cgap.org/sites/default/files/CGAP-Donor-Brief-The-Role-of-Governments-in-Microfinance-Jun-2004.pdf

            While
government intervention should be minimal to encourage competition, regulatory
frameworks controlling

Corporate
Responsibility

            To ensure
solvent clients, lenders too must take steps to mitigate the negative
externalities of microfinance. Social issues including poverty, famine, or war
are inherently tied to the industry; People impacted by these factors are those
who push demand for easy access to credit.

Corporate transparency initiatives
and codes of conduct push corporations towards a social business oriented model,
where firms aim to stretch beyond legal requirements and capital gain to
improve the communities they impact.

 

Conclusion

            Microfinance serves as an
effective tool to alleviate poverty if managed properly. While the free market
has solved the problem of credit access through commercialization, further
steps must be taken to ensure that positive externalities are passed on to the
consumer.