Microfinance: Theory and Practice

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Microfinance Theory and Practice
Beatriz Armendariz Littauer 323
Lecture 1 Overview
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Microfinance formal financial institutions
delivering credit other financial services to
poor individuals without collateral

• Salient features
• Technology credit delivery often attributed to
  Muhammad Yunus (Peace Nobel Prize 2006)
• Main idea group lending under joint
  responsibility (GLJR) ? High repayment rates at
  affordable interest rates)
• Idea has been widely analyzed theoretically
• GLJR circumvents adverse Selection, moral
  hazard, and enforcement ? lower than usurious
  interest rates

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GLJR rooted in

• ROSCAs
• Informal credit arrangements among individuals
  acting both as lenders and borrowers. Defaults
  averted under the threat of social sanctions
• 19th Century Credit Unions
• Villagers that are linked by a common bond
  and where the threat of stigma or social
  sanctions prevents individuals from defaulting

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Main innovations introduced by Yunus in 1977 and
parallel efforts in Latin America

• 1) Foreign savings mobilized
• a) via donations from charities and
  multilateral organizations,
• b) via private entrepreneurs in recent trends
  pertaining for-profit microfinance institutions,
  and
• c) via social business or socially
  responsible investments

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• 2) Strong biased in favor of women for two
  reasons
• a) Donors standpoint women are the main
  brokers of health and education empowerment
  concerns, and gender equity concerns (in line
  with the millennium development goals (MDGs).
• (Pitt and Khandker (1998 JPE article in your
  syllabus) have helped to reinforce this view
• Consumption increases by 18 taka for every 100
  taka lent to women and only 11 taka for every
  100 taka lent to men
• b) Microfinance enterprises standpoint women
  are more conservative in their investment
  behavior, have no access to other sources of
  credit, among others

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Recent research, however, shows that

• GLJR under the threat of social and bank
  sanctions is not the only way to ensure high
  repayment rates.
• In particular
• Under individual loan contracts, a
  non-refinancing threat may suffice
• All forms of collateral (precious to the
  borrowers more than to the lenders) can be
  equally effective
• Public repayments can be imposed as a way to
  insure that social sanctions are effective
• And this has in turn popularized microfinance in
  sparsely populated areas. Eg., Eastern Europe
  and Latin America
• d) Aside for an under-provision of savings and
  basic insurance, microfinance is not
  under-serving farmers in most developing
  countries, not even now (commodity prices crisis)
  

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Managerial Issues

• Microfinance enterprises struggle to meet a dual
  objective of alleviating poverty on the one hand
  and attaining self-sustainability on the other
• Conflicting objectives have often led a number of
  practitioners to bias their managerial skill
  formation in favor of one
• Managerial skills in microfinance also change
  across regions Asia versus Latin America, for
  example
• Some researchers and practitioners would argue
  that microfinance should move away completely
  from dual objective .
• Some even suggest that the core poor qualify for
  grants not loans. (PROGRESA/OPORTUNIDADES, for
  example
• Over-emphasizing self-sustainability and growth
  has its dangers, however.

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Let us now turn to the issue of subsidies (next
class in greater detail)

• Ever since microfinance was invented, most NGOs
  and for-profit institutions have benefited from
  subsidies because social objectives
• However, critics would argue that such subsidies
  are either detrimental or not needed because
  (among other things)
• Microfinance enterprises can easily attain self
  sustainability and make profits
• Competition among microfinance entrepreneurs will
  prevent for-profit institutions to charge
  astronomical interest rates
• A way to tone-down the anti-subsidy critics is
  the idea of smart subsidies
• Infant industry argument? Skill acquisition?
  Poverty alleviation? ? Next class

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Other exceedingly important challenges

• Based on growth estimates, heavily subsidized
  microfinance remains at its infancy
• Far less than expected households have benefitted
  from microfinance products
• Not necessarily the core poor
• 3) Microsavings and microinsurance still
  exceedingly small
• Potential mismatch between what microfinance
  institutions offer and what the potential clients
  would wish
• 4) Regulation
• Interest rates
• -? Next Class Armendariz Morduch (2005)
  Chapter 1 Rethinking Banking