From Udaimicrofin

Revision as of 02:09, 21 November 2006

This is the online collaboration space for the Udai microfinance project. We want to understand the intricacies of microfinance operations, especially in the context of India. There is much controversy surrounding microfinance, and the aim of this project is to scientifically analyze the strengths and weaknesses of microfinance, so that Udai can help MFIs improvise their processes to make a greater impact in reducing poverty and improving efficiencies.

Microfinance: Pros and Cons

Pros

Poverty is modeled as a vicious cycle: A poor person or family remains poor because their poverty itself makes it difficult for them to avail the basic means of breaking out of this cycle. For example, education is one such means through which a poor person can improve his productivity and break the poverty cycle, but he is unable to afford education because of his poverty. Similarly, overcoming poor health and malnutrition are other methods, but which are again unaffordable by the poor. Information and communication technologies are yet another means to increase awareness and improve business processes to help break out of the poverty cycle, but these are not affordable by all. The key word here is affordable. Economics has evolved over the ages such that almost all services are now tradable through money; affordability means having access to capital to be able to buy these services. Which of these services should be categorized as tradable or as being a fundamental right of people, is a debatable issue. The proponents of microfinance are of the opinion that irrespective of what governments of different countries consider as fundamental rights or not, since today's economy is capital driven, the answer to poverty eradication has to lie in having access to capital.

Microfinance refers to exactly this: Providing financial services for the poor, including savings, credit, insurance, and other financial instruments that mobilize capital and make it easier for the poor to afford other basic services.

Microfinance started as an experiment in the 1970s, and there are now innumerable stories of how it has helped the poor. In fact, it has been termed as the most important phenomenon since capitalism! The unique feature of microfinance as opposed to most other methods for poverty eradication, is that it is financially sustainable. This means that it can be scaled many times over to reach out to the 3 billion people of the world who constitute what is called the bottom of the pyramid. And if these success stories are not just spotty and anecdotal, then microfinance can actually help these 3 billion people break the cycle of poverty.

A talk by Vinod Khosla brings out the essence of microfinance very well: Microfinance: Enabling the Power of Ideas and Entrepreneurial Energy for the Other Half

Cons

Microcredit is the most debated component of microfinance. A very comprehensive article by Thomas Dichter (author of Despite Good Intentions: Why Development Assistance to the Third World has Failed) talks about this in detail: Hype and Hope: The Worrisome State of the Microcredit Movement. To summarize, microcredit is typically cited as fueling the entrepreneurial energies of the poor: Access to credit without any collateral helps the people start their own microenterprises, or scale their existing businesses, thus increasing the returns to a business activity. This article claims that most often microcredit is not used for entrepreneurial activities, but to just smoothen out economic ups and downs in a poor family. Even if it is used for businesses, the success stories are mainly of those people who were entrepreneurial from the start and were already running some business or another. In other cases, the developmental impact it produces is questionable and it can even be counter-productive sometimes.

The question is that even if it is assumed that microcredit builds confidence and helps the poor overcome times of crisis, is it anything more than a channel to distribute aid to the poor? Because if it just a distribution channel, then as the hype builds up and more governments get into microcredit, there will hardly be any difference of this approach from the traditional top-down aid distribution process that has come under heavy criticism because of corruption. Of course, this is an extreme viewpoint and must be taken with a grain of salt, considering that it is coming from Dichter who wrote about why development assistance has failed so far! But the points still remain valid. For example, if microcredit helps only those poor people who are already entrepreneurs, then it is better to give them larger loans and simulatenously develop laws and institutions so that other poor people can somehow be brought into the loop. If most other people use microcredit to overcome times of crisis, then processes for savings or insurance should instead be put into place. This will lead to a more efficient utilization of resources and capital.

Our goal

Scientifically analyze the processes of microfinance and apply our understanding to help MFIs increase their impact in reducing poverty and improving efficiencies.

Literature survey

Components of microfinance

• Savings
• Credit
• Insurance
• Others

Microfinance institutions

• How do MFIs get funding
• Activities they undertake
• Customer profiles

Initiation of microenterprises

• Methods for SHG formation, entrepreneur selection
• Extent of training that is provided
• How are interest rates determined

Types of microenterprises

• Cost requirements
• Success rates
• Common reasons for failure, contextual factors
• Borrower profile: educational qualifications, income levels, size of household, etc
• Interest rates

Impact assessment

• How is the performance of an MFI graded over time
• How is the performance of a microenterprise graded over time
• New mechanisms for fine grained tracking, different mechanisms for different microenterprises

Reading list

Please add your name whenever you've read a paper, and write a sentence or two about it over here if you don't want to reference it in the text above.

• V. Khosla, "Microfinance: Enabling the Power of Ideas and Entrepreneurial Energy for the Other Half", [1], 2004.

• T. Dichter, "Hype and Hope: The Worrisome State of the Microcredit Movement," [2], 2006.

(Adi)

• EDA Rural Systems, "Selh Help Groups in India: A Study of the Lights and Shades," [3], 2006.

• G. Hirsch, J. Rosengard, G. Stuart, D. Johnston, "Symbanc: A Simulator for Microfinance Institutions," [4], Finance for the Poor, Dec 2005.

Meeting time

Mon: 11:00 - 5:00

Tue: 11:00 - 5:00

Wed: 2:00 - 4:30

Thu: 11:00 - 5:00

Fri: 1:30 - 2:30