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April 10, 2008

microfinace: the way out?

Writing about web page http://cdj.oxfordjournals.org, http://www.econ.yale.edu

The limelight has been focused on microfinance and the promises it offers to lift many out of poverty. Reading through various literature, microfinance has been termed an innovative business idea’, ‘the best route to sustainable growth’ and for many opens a door to the mainstream economy.

Such comments from academics and the wide range of applause that microfinance has received definitely demonstrates that microfinance displays promises and is a means of reducing poverty levels.

However there are those who question microfinance and its institutions. Stefan Klonner (2001) questions why economists in the field have not paid equal attention to other small credit projects in the developing world. This is echoed by Evan Mervyn Davies (2007) who advocates financial inclusion but states that it has been prevalent for many years before the rise of microfinance in Bangladesh.

So are we ‘putting all our eggs in one basket’ by solely focusing on microfinance and not considering other options? Is microfinance so promising that it will be the answer to reducing poverty and be the tool in achieving the Millennium Development Goals? Shouldn’t practitioners and donors also focus on various small credit projects operating in various countries, in addition to microfinance institutions?

One major financial intermediary in many parts of developing countries is Rotate Savings and Credit Association (ROSCA.) It now flourishes in both urban and rural areas especially where financial institutions fail to meet the needs of the majority of the population.

However microfinance institutions also offer a service to clients who have been excluded from the formal banking sector, allowing many borrowers to use this to finance self-employment activities.

ROSCA is a voluntary group of individuals who contribute financially at set dates to create a fund. This is then allotted to each member in turn. Once a member has received a fund they are no longer eligible until the ROSCA ends.

ROSCA is a worldwide phenomenon known under different names such as tanda in Mexico and Chit funds in India. ROSCA has received little attention from economists, however the turnover from registered ROSCAs in India in 2001 was 100 billion rupees, approximately $2.5 billion. (Gang- Rao, 2001)

ROSCAs are used as a source of housing finance for slum dwellers. Often it is also used by members to contribute to children’s education and to escape the vicious circle of debt and the debt trap: loans offered by money lenders with high interest rates.

Moreover it used by small traders and businessmen providing an opportunity to save excess cash on a daily or monthly basis.

ROSCAs are multi-dimensional; the input does not necessarily have to be cash. Building materials can also be pooled and are used directly for construction or stored for later improvement of a house for instance. The storage of building material provides the opportunity that if in urgent need of cash then the individual can sell the materials in part or completely.

An important impact that ROSCA has is to encourage social networking and community involvement through development.

On the other hand ROSCAs are more difficult to maintain in urban areas, as people are more likely to leave the neighbourhood where they live or work after obtaining the ROSCA fund.

It is hard to control whether members pay on time and evidently this affects the rest of the members.

Interestingly, in order to participate in a ROSCA an individual’s shelter usually serves as collateral as this is evidence that individuals are unlikely to leave the community.

ROSCAs are accessible to the poor and can support their practices of incremental building and financing but are not the answer. They can work for some people under certain conditions such as those with a strong social network.

Another form of ROSCA is susu, one of Africa’s most ancient traditional banking systems which have allowed for fund mobilisation for initiation, and sustenance and development of micro and small enterprise business.

In Ghana only 5-6% of the population have access to formal banking facilities and have limited access to deposits and financial services provided by Formal Financial Institutions (FFI)

The Ghanaian economy is largely characterised by micro and small enterprises (MSEs) and the frustration of accessing credit facilities from formal systems compel the poor to resort the non-banking arrangements like susus. It is termed the ‘Ghanaian Micro-Finance’, which extends microfinance to the least affluent.

The theory behind financial inclusion encompasses the various means described above. Evan Mervyn Davies (2007) states that economic growth should be broad based and sustainable. Enforcing financial inclusion is the means of achieving this.

Whatever the method or means of achieving financial inclusion, it allows those who are normally ignored by financial institutions to become financially self-sufficient.

Admittedly microfinance is a strong tool that can be used to realize financial inclusion. Unlike many humanitarian efforts where the cost of reaching every additional person brings the programme closer to its economic limits, microfinance becomes more self-sufficient with scale.

Microfinance has been heralded as not only financially empowering the under privileged, it can also facilitate institutional relations necessary for broad based social change.

Jude L. Fernando (2006) states ‘there are no other viable alternatives to micro-credit credit and for helping the poor. Micro-credit works!’

Whether it is microfinance or chit funds in India, there are both benefits and downsides to each approach, whether they ‘work’ remains to be seen.

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