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Microcredit Debate: An Anti-Poverty Tool or Trap

By Jubair Hasan;  Journalist of The Financial Express

Microcredit may not be a sustainable optionto eradicate poverty but it takes funding source to the doorsteps of theunderprivileged groups.

Let's start the debate with some shockingstatistics that would probably give us a kind of picture through which we canjudge whether microcredit, which is commonly called money for poor, has anyimpact on poverty alleviation front.

Globally over 3.0 billion people live inpoverty. That means almost half of the world's population earn less than US$2.50 (nearly ¥ 17) a day while daily earning of around 1.3 billion is bellowUS$ 1.25 (around ¥ 9.0) and trapped in the class of extreme poor. Not only that805 million people worldwide lack enough food to eat and 22,000 children die inevery 24 hours due to the poverty. That's why poverty becomes a common butmajor socioeconomic menace to every country whether it is poor, developing anddeveloped.

It is globally acknowledged that the worldcannot get rid of the curse of vicious circle of poverty because it failed toensure access to finance to all sections of the society even in the 21stcentury when the globe witness high technological advancement, innovation andindustrial upgradation.

So, undoubtedly, microcredit is one of themost finest financial inclusions in the 20th century because of its role inextending financial services to the poor and other disadvantaged groups not coveredby traditional financial services. Excepting creation of self-employment forthe unemployed, especially among rural women, microfinance helps the ruralpopulation in various other ways that are emerging over time.

But debate countries to grow worldwidewhether such special financing mechanism truly benefit the poor. Critics argueany successes may be temporary because microfinance programs require trainingand entrepreneurship skills, which many poor populations lack. In addition,some fear that beneficiaries may be charged high interest rates or becomedependent on MFIs (Micro Finance Institutions), borrowing more than they canpay back and becoming further trapped in poverty.

Microcredit is a mechanism of providingsmall amount of loans to the people who typically lack collateral. The historyof microfinancing can be traced back as long to the middle of the 1800s whenthe American theorist Lysander Spooner was writing over the benefits from smallcredits to entrepreneurs and farmers as a way getting the people out ofpoverty.

But it is the Bangladeshi economist Dr.Muhammad Yunus who really felt the pain of the poor seeing that how theyremained trapped in poverty due to lack of financial assistants despite havingentrepreneurship skill while he was a professor of economics at ChittagongUniversity in 1976. Then, the Nobel laureate social entrepreneur developed theconcept of microfinance and applied it at Zobra village close to the universityin a small scale. Following a successful trial, he formed the pioneeringmicro-finance institution (MFI) Grameen Bank and institutionalised the process.Since then, he never look back. 

 Inspired by the success of The Grameen Bank,the model of micro-lending has grown at an exponential rate not only inBangladesh and elsewhere; today, over 160 million people, mostly women, aredirect beneficiaries of the special lending. It, at the same time, resolves themarket failure of formal financial institutions by reaching out to the poor,women, and other disadvantaged groups of society who were not covered by thecommercial banks. By easing liquidity constraints, microfinance helps togenerate employment, income, and assets, as well as improve children’sschooling.

Over the last 25 years, Bangladeshwitnessed phenomenal rise in numbers of both micro-lenders and micro-lending institutions with a reported nearly  34 million borrowers in the country 160million population while total volume of loan crossed $7.5 billion. As ofAugust 09, 2017, a total of 866 MFIs are officially registered with MicrocreditRegulatory Authority (MRA), which was established in 2006, having network ofnearly 19000 branches, compared to only few in the early 90s. But the figuredoesn't represent actual scenario because thousands of unregisteredinstitutions are operating in the country in a small scale. Most scary part isthat a good number of the social entrepreneurs lack enough knowledge andentrepreneurship skill to contribute meeting its prime target of povertyalleviation. It seems that they just come to the area only for business afterbeing allured by the high rate of interest. They even do not think aboutcapability of the possible borrowers to pay back; they just want to keep theirinvestment rolling as fast as they can because of the higher interest. Theregulatory authority, MRA, has scrapped license of over 100 MFIs over the yearson violation of its rules. However, top ten MFIs accounted for over 80 per centshare of micro-lending market.

Contribution of Microfinance to GDP

Bangladesh makes remarkable progress inmany socioeconomic indicators over the last two decades in the areas ofliteracy, women empowerment, poverty alleviation, mother mortality, childmortality, economic growth and so on. For example, once Bangladesh was globallyknown as a poor nation or a nation of natural calamities like flood, cycloneand river erosion. Now, the small country in the Bay of Bengal is being treatedas the resilient one while some call it economic wonder. On poverty alleviationcontext, Bangladesh managed to cut down 31.8 percent poverty rate to 24.8percent in 2015 from 56.6 percent recorded in 1991 while extreme povertyslashed down to 6.5 percent in 2015 from 41 percent in twenty five years ago.In fact, in that area the country lagged behind India, Pakistan, Bhutan and someother counties in the region. And it is firmly believed that microcredit is oneof the key factors behind the significant achievement. Many studies have beendone over the years to find out such leap.

'Beyond Ending Poverty' is one of thefinest publications done by the World Bank that analysed dynamics ofmicrocredit in Bangladesh. The book said around 55 percent of the ruralhouseholds have taken microfinance at some stage in their lives. With such hugeexpansion, microfinance is likely to have direct and indirect impacts on themacro economy. The study shows that the contribution of microfinance to GDP inBangladesh in 2012 is between 8.9 percent and 11.9 percent depending on theassumption regarding the functioning of the labour market. Further, the contributionof rural microfinance to rural GDP in Bangladesh in 2012 is between 12.6percent and 16.6 percent. However, the estimates are likely to have downwardbiases due to several reasons like non-consideration of underemployment and thelabour market adjustments which compensate some of the negative effects ofwithdrawal of MFI-capital and the likely lower share of the rural GDP due toexclusion of high urban incomes in household surveys.

Does Microcredit payoff for povertyreduction

It's a highly debatable issue. Somescholars say it does; some rejects while few takes balance stance saying thatit could give some sorts of relief to the micro-lenders but it is not asustainable option to eradicate poverty that involves many demands which cannotbe met through the tiny finance.

“No. Microcredit alone cannot help reducepoverty, certainly not on a sustainable basis,” Chairman of PKSF (Palli KarmaSahayak Foundation) Qazi Kholiquzzaman Ahmad said. PKSF is a government-fundedorganisation in Bangladesh that provides loans and microcredit services to itspartner organisations.

He said poverty has many aspects likeincome, education, health services, housing condition, access to drinkingwater, access to electricity, access to skill training, and access toemployment.

The economist said human capabilitydevelopment through education, skill training, and health services,particularly among the people at large, remains a major challenge. Anothermajor challenge is the impact of natural disasters which are increasing interms of both frequency and devastation in the wake of intensifying globalclimate change.

“To address these challenges, we'reimplementing ENRICH (Enhancing Resources and Increasing Capacities of the PoorHouseholds Towards Elimination of their Poverty) and it takes into accountmultiple dimensions of poverty, including a wide range of economic, social, andenvironmental indicators; and addresses them in an integrated fashion,” hesaid.

 

Key Challenges

Since the advent of microfinance, thepremise of its improving access by the poor to financial services forconsumption smoothing has never been a subject of controversy. What has beencontroversial is whether microfinance can alleviate poverty, in part, becauseof the high interest rates charged by microfinance institutions (MFIs), whichoffer borrowers little scope for accumulating assets. Controversy also aboundsover the methods and alternative statistical assumptions used to measurebenefits. That the poor lack an effective and affordable alternative financingmechanism to support income and employment generation does not necessarily meanthat microfinance is a panacea—it involves the entrepreneurial skills of borrowers, which many ofthe poor may lack. It is little wonder that studies evaluating the benefits ofmicrofinance have produced conflicting results. Some studies have foundsubstantial positive effects, while others have found none or even negativeones. The major challenges the micro-lending system face are given bellow:

High interest rate: In 2011, Bangladesh’sMicrocredit Regulatory Authority (MRA) capped the interest rate that MFIs cancharge as high as 27 percent. Though MFI interest rates are lower than thosecharged by informal moneylenders, they still have room to reduce rates furtherwhile realizing sufficient returns. But many poor households find themselves indifficulties to borrow at this rate. The rate should be down further because itis a special financing tool designed for poor who lacks enough resources. So,lowering this cap on MFI interest rates will increase the number of poorhouseholds who are able to take advantage of the benefits of microfinanceprograms.

Let's talk about China where MFIs arestruggling to sell their lending service because the higher rate of interestmade a strong bite on their competitiveness with the traditional financialsource like banks.

 Talking about the issue, Professor Wen Tiejunof Renmin University of China, said lower-income groups here in China canborrow loan from public commercial banks at less than 10 percent interest fromevery corner of the country. “Then why they (poor) will go to the MFIs who arecharging interest between 18 to 20 percent,” he said.

 Overlapping of loans: With rising competitionamong the MFIs in a market with limited diversification of product design andmarketing, continued borrowing by poor households could create the conditionsfor market saturation, resulting in village diseconomies. In addition,microfinance growth could create microdebt dependencies, whereby participantswith the possibility of borrowing from multiple sources could becomeoverindebted or trapped in poverty.

Shimul Asaduzzaman, who runs a small-scaledMFI at Tangail district that is located 70 kilometers away from Bangladeshi capital,said loan overlapping is one the key factors that really hurts the sector.

“I know several borrowers of my institutionwho took loan from various MFIs. Even few of them took loans from five MFIs torun their business. So, it's very difficult for the lenders to repay the fund,”he said.

He went on; “The problem is we don't haveany common system of keeping the record of all borrowers so that the MFIs canscreen lending status of any lender before approval,” he said.

It is also observed that many MFIs do notpay serious attention to the issue because there is a market trend of keepingthe fund rolling as fast as possible to cover more people and gain moreinterest.

 'Credit Bureau' could be an effective tool toprevent overlapping. With an introduction of such system, it is possible toestablish an unified information system which would create a screening effectthat improves risk assessment of loan applicants. This would raise portfolioquality, which in turn would reduce rates of arrears.

   Itis a good sign that MRA has been trying to introduce a credit bureau in themicrofinance sector in Bangladesh because it would enable to manage credithistories of microfinance borrowers effectively through the distributed “NationalIdentity Cards.”

It should be noted, however, that creatinga credit bureau is not sufficient to prevent overlapping in Bangladesh.Collecting individual level information does not provide enough information toMFIs in terms of borrower’s household level money transactions. In Bangladesh,multiple family members in the same household (such as a borrower’s husband anddaughters) often borrow from other MFIs. The collection of individual-levelinformation, then, may miss the more critical information regarding the entirehousehold. This example indicates another challenge which a credit bureau wouldface. It is difficult for formal institutions like credit bureaus to managecredit information in the informal sector because they do not record informaltransactions between people.

Not enough education:The prime objective ofmicrofinance is to improve the lifestyle of poor by converting them intoentrepreneur through proper motivation, training and continuous monitoring.Only few large MFIs try to maintain the basics but majority did not pay anyheed to these issues. In fact, some of them are too unprofessional,they evenlack entrepreneurship skill; they just come to the sector only to gaininterest. Many studies touched the matter but no visible result. Many lendersusually take fund from such MFIs on ground of investing in income-generatingsector but the real picture is they investment in non-productive sector due tolack of proper guidance. If any lender invests on productive sector thatdoesn't mean that he/she will be able to get handsome return. For example,someone invest on poultry firm. He needs supports from many sides like balancedpoultry feed, how to maintain proper temperature for the poultry birds insidethe firm, regular veterinary supports and best marketing skills to get fairreturn. It is the responsibility of the MFIs to ensure availability of suchservices in time but many MFIs do not meet these requirements. So, there is noalternative of proper education on microcredit for both lending institutionsand borrowers.

Conclusion

Today, microcredit is an intellectuallydeflated balloon. Years after the concept was introduced to poor communitiesall over the world, the data is mixed at best on whether it actually worked.Many of the people in Bangladesh, where the concept originated in themid-1970s, still face extreme poverty. The death knell might have been theIndian state of Andhra Pradesh, where a booming microfinance market turned tocrisis in 2011 as borrowers began to stop paying off their loans in protest againsthigh interest rates.

But that doesn't mean microcredit is deador even discredited. The problem is that microcredit was saddled withunreasonably high expectations and we lost a sense of its more modestpotential. Credit and investment alone do not drive economic growth in the longrun – these are just tools in a broader development toolbox. Any economistwould agree that the true driver of growth is innovation, which is difficult tocapture simply through financial means.

Microcredit may not be a sustainable optionto eradicate poverty but it takes funding source to the doorsteps of theunderprivileged groups. It should be treated as a first major step towardspoverty alleviation. It's something that will give the poor a kind of strengthto stand up and other services from the government side will fuel up theirenergy to run over the line of poverty. These largely depends on howefficiently and quickly the MFIs overcome the challenges.