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The Role of Micro-finance in Poverty Reduction

Nowadays, micro finance is a vital tool in poverty reduction in every country most especially in the developing countries like India, Bangladesh, Nigeria, and Mali and so on. Micro finance has been a source of loans (over decades say forty seven years ago) since its creation. Many people with no financial resources with dreams of making money have had the opportunity to get money for their start up through micro financing. It suffices me to say that having this type of opportunity is a means of creating a new world full of riches and living by one’s self. Studies have shown that, microfinance has been a great source of empowering the poor most especially those in rural areas of the world.

 However, microfinance institutions require that borrowers be of a certain financial strength in order to be able to repay their loans. In this case, many people still find it difficult to borrow money from these institutions on the first side. These make things difficult on the borrower’s side as well as on the microfinance institutes side because giving out such small loans to numerous individuals with no financial means or strength to repay their loans seems difficult and time consuming. In certain countries such as in Bangladesh and India, especially in rural areas, many strategies have been put in place to overcome this problem through the means of forming groups of around five to ten persons per group. We get to know how forming groups can help the repayment of the loan later.

However, what is microfinance and all that it pertains such as microfinance institutes, Microfinance Company and so on?

What is Microfinance

Microfinance has been defined by many people in many different ways with most of the authors of the definitions focused on their local perspectives. The truth is told that microfinance is a local or general and a global type of banking. I will go like this;

Talking of what microfinance is in a general piece of mind, I would say it is a banking system or banking service with the aim of providing financial resources to the unemployed, groups of people who do not have access to some other financial services as well as those who are low income earners. It is important to note that there are many different providers under micro finance. These providers usually identify themselves under microfinance through microfinance institutes. Generally speaking, Microfinance has a goal to making people becoming financially self-sufficient through their provision of loans, saving of money as well as helping such low class people or organizations save money and hence getting insurance.

From my global point of view, microfinance can be defined as an organization in which an envisioned world with low income household is giving a permanent access to a range of affordable and quality financial services offered by some retail providers. Some microfinance institutes activities includes producing financial incomes, build assets as well as stabilizing and protecting themselves against risk.

Microfinance is a very broad term we ought to break it down into smaller compartments in order to understand it.

 Micro financing seeks to adopt a technique of providing their customers with some limited resources thereby helping them to actively participate in production activities and also helping small businesses grow. Also it is important to understand that while microfinance institutions are specialize in lending to their customers, other microfinance institutions or companies are concern with the provision of additional services such as bank accounts, insurances and stabilizing risk as was discussed above.

Even though, microfinance is considered a new system, on the other hand it is not the first of its kind. Looking back to the 18th century, the Irish man Jonathan Swift had introduce a micro-lending system in the Irish loan fund system to fight against poverty in the Irish land.

In the terms of any microfinance loans, not every applicant or borrower is usually guaranteed the loan base on the terms of the loans and the default risk associated with the loans. In other sense, if one is granted a loan upon application, like any other conventional system of banking, microfinance lending bodies usually charge interest on loans as well as instituting specific plans on how to repay the loan at regular intervals. All microfinance institutions usually measure and disclose their performances over a period of time both financially and socially.

Also, because the interest rate provided by microfinance intuitions is usually lower than that provided by other conventional or normal banks which make the microfinance banks make even greater profits, concerns are usually raised from their opponents that they make profit from the poor and thereby rendering them poorer. However, it is important to note that not all funds raised through micro financing is usually used for productive activities as suggested by their opponents. Some of the funds are also usually used to cover the needs of the poor such as food and shelter.

There is an agreement by microfinance that women be the main or primary source of their services with expectations that women have a high possibility of repaying their loans or are less likely to default their loans than men do. As a result of this, many women are able to live independently from their husbands as well as supporting their families. We shall discuss more about this later.

The areas with the highest operations in micro financing are located mostly in the developing countries some of which include; Uganda, Honduras, Serbia and Indonesia. Statistic have shown that in most of these countries, due to the poor nature of many people, their applications are usually granted, but at a higher rate of repayment than the average rate. In some cases even higher than the average rate of repayment in conventional banks.

Microfinance Institutions

With many countries stricken by poverty due to unemployment, financial institutions have been created under the so call microfinance. Microfinance institutions alleviate poverty in low income populations through the lending of financial services as well as many other services such as insurance, deposits, risk stabilization and some other.

Microfinance institutes are thus regarded as one of the greatest organizations that offer financial services to the certain representatives of poor populations.

Microfinance through microfinance institutes is therefore an effective tools of reducing poverty in the world bridging the gap between the formal financial institution and the poor in rural areas coupled with the fact that they access financial resources from the banks as well as the mainstream financial institutes.

Microfinance institutions are the global providers of direct microcredit loans to their customers which are mainly the poor: micro entrepreneurs, impoverished women, villagers as well as poor families. This means that microfinance institutes have made it their responsibility to providing loan to the economically marginalized citizens or population. This therefore tells us that microfinance institutions are self-sufficient to their operations and hence they are proven worth of high rate of success.

It is important to note that there exist different types of institutions offered by microfinance some of which include credit unions, cooperatives, Non-Governmental Organizations and so on. Usually microfinance institutions can also change their legal status from their original status being unregulated non-profit or non-governmental organization in to a regulated and for profit organization. This process of a change in legal status by microfinance institutes is called commercialization process.  After which a microfinance institute has been transformed, it is usually supervised by a financial authority which is mostly the central bank of that country and they are usually held at certain standards of performance as well as capital adequacy standards all because they are registered. Also every commercialized microfinance institution has the likely hood of attracting investors as every investor would want to see the value of his investment maintained or even enhance so as to elect board members who have the same vision on how they can move as one and make profit whether In a short run or long run.

Also, microfinance institutions focus on the poor and what they can do to satisfy the poor with regards to delivering their services with respect to the poor’s requirements. Microfinance institutes however are developing new and effective means of referring their services to the poor. One of which involves automated system operations which is heavily improving the efficiency of the institution and hence the growth rate of the finance sector. As was earlier said, microfinance seek to render their services to the poor but not to the too poor as they will turn to default the loan being offered to them. As a result in some countries like in India and Bangladesh, microfinance requires that the too poor form groups of about five to ten persons in order to be guaranteed a loan. Doing so, each member of the group should always be present in their meetings which are usually held weekly followed by contributing small amount of money so as to be preparing on how to repay their loan. On the other hand, anyone who is not present without sending any form of information about what his situation (health) could be sanctioned.

Microfinance Company 

There are many microfinance companies all around the world today with many already very big while some are still small. The main aim of microfinance companies is to provide small loans as was earlier discussed above. The loans being small are usually called microloans or microcredit. There is really no difference between microfinance companies and microfinance institutions. Some of the largest microfinance companies in the world include;

 

  • 51Give; a microfinance company found in Beijing and founded in 2007 which helps to provide microfinance solutions to other microfinance institutions. With its beautiful e-commerce platform, it offers a means of connecting other microfinance companies, institutions as well as organizations and hence facilitating the save delivery of microfinance services, investments as well as donations.
  • Bank Raykat Indonesia; which is one of the oldest type of banking in Indonesia concern with providing small scale services through microfinance lenders.
  • BRAC; found in Bangladesh since the 1972 and is concern with the provision of services mostly for education, human rights, health as well as for economic development.
  • Kiva Micro-funds; which was founded in 2005 with the headquarters of San Francisco in the United States  and currently operating in about eighty countries around the world. This microfinance operates by lending funds through their platform which allows peer-to-peer as well as crowd funding enabling individuals to interact with other individuals and hence being able to lend directly to their peers.

How does microfinance help in eradicating poverty?

Since the introduction of the world submits for social development, there has been a priority well stated on poverty eradication. As a result, microfinance through its institutions saw it as a means of laying a helping hand to fight against poverty. As a result of the increase growth in this struggle, microcredit has assumed it to a certain degree of prominence with regards to improving the entrepreneurial talents of the poor.

Talking of how microfinance can eradicate poverty, I will rather classify it into two:the past methods and present method of eradicating poverty.

Past Methods of Eradicating poverty by Microfinance

In the past, poverty was mainly seen as the consequences of the poor not being able to earn enough money and so could not afford their daily needs such as food, clothing and so on. So did microfinance thereafter came in with poverty alleviation methods by creating jobs, developing skills as well as sharing income from the rich to the poor which was mainly focused on providing loans and which also was a limited means. But by so doing, many poor people could benefit from some of their daily needs such as increases consumption, increase production and many others thereby reducing poverty.

Many governments such as the Indians have used the direct credit approach for both rural and agricultural finances and this thereafter led to an expansion in banks in rural areas. These banks therefore created policies for lending quotas at lower interest rates which was lower than the market in the priority sector. Thereby permitting many waivers of the loan principles. This therefore has led to increase access to financial services in rural areas and hence eradicating poverty.

Also, in other countries, for example in India, the government through the banking system had encouraged the creation of an integration development program focused on providing loans for the poor at well subsidized rates in which subsidies where provided along with the loans and hence recovery rate fell to as low as 31%. As a result the government started to distant itself from this sector which led to the introduction of a new microfinance institutions which brought in strong rates of recovery as well as self-sustainability as a potential source of poverty eradication. 

Present Methods of Eradicating poverty by Microfinance

Recently, microfinance has brought in innovative ways through which they can provide their clients with credit and savings to the poor entrepreneurs. In this domain, two approaches have been applied; there is one on income generation where their supporters provide credit mainly to the poor entrepreneurs with objective of helping them generate or increase the revenue through income generating activities. The second approach is the minimalist approach where their supporters argue that credit be giving to any poor who is capable of and willing to repay the loan without any dictatorship on how the loan should be used. As pointed out by the minimalist approach, it suffices to say that, using the loans offered to the poor in an unproductive manner may only lead to defaulting as such the income generating approached is best acceptable in alleviating poverty.

Also, with new strategies being devised by microfinance institutes, they have been capable of reaching many poor hands. This is focused on providing small loans mostly to rural individuals with a full cost rate as well as without any collateral which could be repaid in frequent installments. Since borrowers are organized into groups to avoid default risk. Highly praising, microfinance have recently been targeting large group of really poor people such as women who live in households with little or no assets, as such providing them with means of self-employment. All these go a long way to eradicate poverty.

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