Wednesday, August 18, 2010

Microfinance: Loan Sharks or Development Agents? The Ethiopian Case

Walking along the street of any low-income settlement in anywhere in the world, one is thumped by the apparent contrast of dwelling and habitat. On one side of the street is a decrepit, single story, windowless house of tin sheets and open drains; across the street is a fine two-storied brick and concrete house with glass windows, paneled doors, and painted walls. While there are many reasons for such disparity, one variable that repeatedly surfaces as a common denominator is the accessibility to different sources and types of credit.

Over the past three decades, microfinance has evolved, mutated, and segmented. Microfinance started as a simple idea--to provide loans to poor entrepreneurs--but today it is a far-ranging and dynamic sector, including institutions that provide savings and remittance services, sell insurance, and offer loans for a wide range of purposes.

The idea of giving small loans to poor people became the darling of the development world, hailed as the long elusive formula to boost even the most destitute into well again lives.

Actors like Natalie Portman and Michael Douglas lent their boldface names to the cause. Muhammad Yunus the Bangali banker and economist who previously was a professor of economics in Chittagong University while a famine raged in Bangladesh in 1974 where he developed the concept of microcredit. These loans were given to entrepreneurs too poor to qualify for traditional bank loans. He initiated the practice by lending small amounts to basket weavers in Bangladesh. Yunus is also the founder of Grameen Bank. In 2006, Yunus and the bank were jointly awarded the Nobel Peace Prize, "for their efforts to create economic and social development from below."

According to a report covering 100 Countries worldwide published by Microfinance Information eXchange (MIX), on August 2007, updated September 2007, there were 77 million borrowers and 2,207 MFIs.

If we take the case in Ethiopia alone, the Association of Ethiopian Microfinance Institutions (AEMFEI) which initially was established by four microfinance institutions (MFIs) namely Dedebit Credit and Saving Institution S. Co. (DECSI), Amhara Credit and Saving Institution S. Co. (ACSI), Oromia Credit and Saving Institution S. Co. (OCSSCO) and Omo Microfinance Institution (OMFI) has grown in to a 27 member MFIs Association. This can be taken as a witness of how this sector is thriving.

In 2009 Forbes Magazine has listed the top 50 Microcredit Institutes worldwide. Accordingly Amhara Credit and Saving Institute (ACSI) and Dedebit Credit and Savings Institution were listed 6th & 31st respectively. However Desta, Asayehgn, (Ph.D), Distinguished Professor of Managerial Economics, Dominican University of California labeled Forbes’s study that listed the Top 50 MFIs as ‘’anecdotal rather than a study based on a rigorous empirical assessment of the repayment rates and it hardly focuses on whether or not microcredit programs have improved the lives of the marginalized participants or beneficiaries’’.

The idea even got its very own United Nations year in 2005.

Though this idea of lending money to the needy grew so popular, some of its biggest proponents are now wringing their hands over the direction it has taken. Drawn by the prospect of hefty profits from even the smallest of loans, a raft of banks and financial institutions now dominate the field, with some charging interest rates of 100 percent or more.

With regard to ‘’loan sharks’’ drawn by the sturdy profits Mr. Yunus said at a gathering of financial officials at the United Nations “We created microcredit to fight the loan sharks; we didn’t create microcredit to encourage new loan sharks, Microcredit should be seen as an opportunity to help people get out of poverty in a business way, but not as an opportunity to make money out of poor people.”

The brawl over safeguarding the field’s saintly aura centers on the question of how much interest and profit is acceptable, and what constitutes exploitation. But still the noisy interest rate might lead one to suspect that microcredit institutions are scamming the poor.

Underlying the issue is a ferocious debate over whether microloans in point of fact haul up people out of poverty, as their promoters so often claim. The recent conclusion of some researchers is that not every poor person is an entrepreneur waiting to be discovered, but that the loans do help cushion some of the worst blows of poverty.

“The lesson is simply that it didn’t save the world,” Dean S. Karlan, a professor of economics at Yale University, said about micro-lending. “It is not the single transformative tool that proponents have been selling it as, but there are positive benefits.”

Though the success stories about MFIs are flooding from all corners of the planet, many are the proponents of the Microfinance concept. Some believe that the question ‘’If microfinance is about serving the poor, why does the provision of financial services need to be profitable?’’ is rebuttable. Some practitioners try to justify why institutions need to be profitable in order to cover the costs of reaching out and meeting the demand of underserved segments of the population over a sustained period of time. In addition, after a series of very small loans, a micro-entrepreneur often wants to expand his/her business; a microfinance institution must keep up with the demand for larger loan amounts so businesses can grow into small enterprises.

Moreover, the interest rate is only a small part of their overall transaction cost of credit, and if microfinance institutions offer credit on a more accessible basis, substantial costs in terms of time, travel, paperwork, etc. can be reduced, thus benefiting the poor.

A long series of studies has shown that many programs that charge subsidized interest rates end up using rationing mechanisms to distribute credit in response to excess demand. These mechanisms cause the borrower to have to “jump through hoops”; increasing the time and money s/he must put out to get the loan. In fact, these transactions costs are frequently higher than the interest costs, which take away the advantage to the borrower of the interest rate subsidy.

However, while increased access to credit for the poor on a long term and sustainable basis can bring significant benefits, MFIs must continue to work to improve efficiency levels, and to increase scale. This will bring down the cost of providing loans, and the benefits transferred to the poor in terms improving loan products, better access to loans, and lower borrowing costs.

The rationale and objective of advancing micro-loans to the ultra poor is to improve their liquidity constraints, create employment opportunities, and induce sustainable incomes by engaging the poor in the reinvention of everything from the bottom-up, with limited top-down directives.

But still, its earliest proponents do not want its reputation tarnished by new investors seeking profits (by making the poor pay a lofty interest and/or transaction costs) on the backs of the poor; though they recognize that the days of just earning enough to cover costs are over.

These proponents also argue the idea of the calculation of Microcredit interest rates set with the aim of providing viable, long-term financial services on a large scale, while subsidized interest rates generally benefit only a small number of borrowers for short period as a pretext.

This approach to breadth of outreach is based on a long-term view of microfinance services and the belief that, in many cases, there is a limit to depth of outreach. This approach thus accepts a trade-off between sustainability and reaching very poor people.

Other practitioners argue that microfinance should make reaching very poor people a priority because credit is a human right in the fight against economic exclusion. This approach requires narrow targeting of very poor people. Both breadth and depth of services are very important for the microfinance industry. What has become apparent, however, is that very poor people are unlikely to be served by microfinance programs unless these programs are intentionally designed to reach them.

There are three kinds of costs the MFIs have to cover when it makes microloans. The first two, the cost of the money that it lends and the cost of loan defaults, are proportional to the amount lent. The third type of cost, transaction costs, is not proportional to the amount lent.

After all the poor is in need of credit facilities. It could be for a new tool, a machine, or a shop in the marketplace—to launch new enterprises, create jobs and help economies to flourish. Poor people have proved time and again that they are able to repay these loans on time, though repayment doesn’t necessarily co notate there are people escaping from the shackles of poverty.

There is an ongoing debate whether credit alone or credit plus is needed for poverty reduction. There are views that credit alone on its own is inadequate to fight poverty. The need for other services is also important in this respect. Such views, although, do not negate the role of credit; fail to appreciate the role of credit on its own merit.

Though the institutes have grown tremendously and profitably is the poor benefiting from their services? This is the question fuming debate by many practitioners.

Currently, no concrete tool for measuring the poverty level of MFI clients exists. Most of the practitioners believe that credit plays a vital role as an instrument of intervention for a poor person to discover his/her potential and to gait for a well again living. Muhammad Yunus advocates that Credit is a human right. Once this right is established, he argued – ‘‘The entitlement to other rights for leading a dignified life becomes easier’’. It empowers to break the vicious cycle of poverty by instantaneously creating self-employment and generating income.

When in the ultimate analysis nothing can be said to be cure-all, by overemphasizing that micro-credit is not a panacea is in a sense overreacting and underestimating the role of credit as an instrument to combat poverty. Micro-credit is itself a very powerful tool. But if it is combined with others, it is definitely more empowering.

According to the Association of Ethiopian Microfinance Institutions (AEMFI), until December 31st 2008 there were 2,220,901 active clients, with an outstanding loan of 4,606,885,776 ETB and a total saving of 1,575,635,740 Birr with in the 27 member MFIs of the association. The total asset of the 26 members of the association has reached 5,462,578,130 Birr and total liability of 4,061,476,516 birr and total capital of 1,401,101,614 birr.

Though this industry is flourishing and access to money is by far becoming near to the poor, the link with Micro and Small Trade and Industry Promotion Agencies, and Local Technical and Vocational Training Centers or even Farmers’ Training Centers (FTCs) and Community Skills Training Centers (CSTCs) is the weak link in the chain.

It is not the amount of money lent by Microfinance institutes that matters most. What matters most is the change in the lives of the poor and in fact the poorest of the poor. The tangible change that is the rise in the number of people above poverty line can rise when the ability of the poor in assessing profitable business opportunities and developing business even literacy and innumeracy is not the case anymore, communication skills, life skills, business skills etc are mastered by the poor. This should have to be and can be inculcated as an add-on component in an integrated manner by the CBOs mentioned above.

Otherwise the role of MFIs is like doling out financial relief to the poor. This is like “the canaries in the mines.” for Governments and other practitioners. Coal miners in England and the United States took these small birds into the mines. The reason was because they would normally sing almost constantly but when poisonous gases began to overwhelm them they would stop singing, thereby warning the miners of danger.

Now that we have MFIs, realizing the ‘’Credit right of the poor’’, but is there any mechanism/s that pledge the credit right has enabled – ‘’the entitlement to other rights for leading a dignified life’’? Breaking the vicious cycle of poverty, instantaneously creating self-employment and generating income?

By Wondwossen W. Mebrat, Amhara Reaching Women Projects Supervisor for Development Expertise Center (DEC-Ethiopia), A local Frontline Office for Edukans Foundation

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