Making a Dent in Poverty through Microfinance

With the turn of the new decade, the global agenda of poverty eradication remains just as important a pursuit now as it ever was. The world continues to move towards an age in which the social business model is being reinvented with innovation at regular intervals, and industries are actively encouraged by their governments to make positive contributions to society through their core or ancillary activities. In spite of the prevalence of many new channels dedicated to the alleviation of poverty, the continual importance of Microfinance is undeniable.

Microfinance can be defined as the provision of financial services such as collateral-free loans and short-term credit to individuals or groups who are unable to avail traditional bank loans or similar services for reasons such as not having bank accounts, or having a lack of collaterals.

The origin of this service dates back to the mid-1970s in Bangladesh and parts of Latin America and was introduced as an attempt to meet the various financial needs of the low-income groups, which included but were not limited to asset accumulation and combatting exogenous shocks to their livelihoods.

Bangladesh: A Radiant Example of Microfinance’s Luminescence

The prominence of microfinance in Bangladesh surfaced in the early 2000s and today stands as an integral aspect of the nationwide financial system.

Principally, the providers of microfinance services are NGOs. There are over 500 operational NGOs in Bangladesh with over 19,000 branches between them  providing such services. However, the lion’s share of the branches, jobs created, and disbursed credit belongs to a much smaller number.

Grameen Bank, Association for Social Advancement (ASA) and BRAC alone have 7,671 branches, constituting about 40.03% of the total branches in the sector. The total number of active members of the microfinance sector from the aforementioned NGOs is 22.88 million (58.34% of the sector’s total). However, it is important to note that a number of other NGOs besides these major players, such as Sajida Foundation, Padakhep Manabik Unnayan Kendra (PMUK), Society for Social Service (SSS), and BURO (Basic Unit for Resources and Opportunities) Bangladesh, have shown significant growth trends in both these regards.^[1]

Microfinance on an absolute scale has seen growth in almost all important indicators.

Source: Generated from Bangladesh Microfinance Statistics 2016-2017 ^[1]

Category/Year	2015-2016	2016-2017	Growth (%)
Total Loan Disbursed(million BDT)	955,772.18	1,207,538.08	+26.34
Outstanding Borrowers(Million individuals)	30.61	32.45	+6.01
Outstanding Loans (million BDT)	611,617.68	770,464.77	+25.97
Recovery of Loan(million BDT)	924,225.40	1,171,712.75	+26.78
Members Savings(million BDT)	294,111.38	349,063.74	+18.68

Eligibility for Microfinance

Typically, microfinance serves the interests of individuals unable to avail traditional financial services and allows them to borrow smaller amounts at a typically higher rate of interest.

Individuals generally seek microfinance due to

• A lack of geographical mobility or means to access agents for financial services or banks directly.
• Insufficient accumulated collateral, making it difficult to avail loans.
• Low/insubstantial disposable income to be credible for bank loans.
• A lack of financial portfolios which makes it difficult for commercial banks to evaluate their credit worthiness and thus provide loans.

For these same reasons, the interest rates of microfinance loans are typically higher than those of commercial banks. The higher rate of interest is attributed to higher administrative costs for Microfinance Institutions (MFI) and larger provisions for bad debts and similar reserves. The Microcredit Regulatory Authority(MRA) set the interest rate cap at 27% in 2011 and currently the real effective interest rates for MFIs vary between 24% to 27%.^{[2] [3]}

The Institute of Microfinance (InM) has segmented the target market of microfinance institutions and commercial banks based on their level of income.^[4]

Source: The Institute of Microfinance ^[4]

Market Segment for Credit	Notional Loan(BDT)	MFIs	Non-Bank Govt. Dept.	Banks
Extreme Poor	500-5,000	✔
Moderately Poor	5,000-30,000	✔	✔	✔
Small and Marginal Farmers	10,000-50,000	✔	✔	✔
Microentrepreneurs	30,000-50,000	✔		✔

Microfinance’s Effect on Poverty: Hotly Debated

Despite the continued proliferation of microcredit in Bangladesh, it is often a divisive topic when it comes to its effectiveness in relieving poverty and the skepticism arises from the following issues:

• The high interest rates acting as a deterrent for borrowers
• The inflexibility of loan terms and borrower knowledge, resulting in them unable to pay up their loans and falling further into poverty.^[5]
• The tendency of women, who are the prime beneficiaries of microfinance, to be unable to utilize microfinance loans for their own use due to familial pressures and lack of societal empowerment.
• The lack of education prevalent among rural borrowers, preventing them from using microfinance productively.
• The growing penetration of agent banking into rural areas, as mandated and supported by the Government of Bangladesh has mitigated the problem of geographical immobility for many in rural areas.^[6] As interest rates on loans disbursed from agent bankers are lower than those disbursed by MFI-s, this leads to lower microfinance activity.

Despite this, according to a panel-data based research undertaken by the World Bank which spans the period from 1991/92-2010/11, A positive effect on reduction of extreme poverty and a similar positive increase in farm and non-farm activities have been observed as a result of microfinance growth. The authors have also found the performance of Grameen Bank and BRAC to be comparable with the top MFI-s in India, Indonesia, Mexico, Thailand, and Vietnam.^[7]

Modern microfinance in Bangladesh has become diversified in its reach and now facilitates savings and insurance, microenterprises, and productive employment in addition to disseminating important information to help borrowers. Microfinance helps to smoothen the after-effects of environmental shocks such as flooding, hurricanes and otherwise, to which the poor of Bangladesh in both urban and rural areas are especially susceptible.

The Way Forward

In order to reap the greatest return from microfinance as a poverty-alleviating tool, there are a number of ways it can become more dynamic, effective, and inclusive.

The Digitization of Microfinance: This has the potential to significantly improve microfinance as a whole if implementation is timely and proper. It will allow for mobile and digital access to microfinance, improving efficiency of MFI-s through lower administrative costs and shorter processing times, which may in turn manifest as lower interest rates. It will  allow easier access for borrowers and improve the record-keeping and internal control for MFIs.

Better Policy Framework – Working to remove the daily transaction limit for digital transactions will supplement the effectiveness of the microfinance digitization process. Additionally, solving the conflict between the agendas of Agent Bankers and MFI-s can lead to improved overall societal gains and perhaps symbiosis between the two. It is also essential to have a strong regulatory framework in place to prevent client exploitation.

Discouraging Monopolies: It is also recommended that policies be in place so as to avoid monopolies in the microfinance sector, thus promoting healthy intra-industry competition.

Since its inception, microfinance has grown globally to include over 200 million people as direct or indirect beneficiaries.^[7] Despite there being recent skepticism, microfinance in Bangladesh has historically proven to be a powerful channel for uplifting the poor and holds immense future prospect if it can be made more dynamic and inclusive.

Sartaz Zahir, Trainee Consultant at LightCastle Partners, has prepared the write-up. For further clarifications, contact here: [email protected]