1. Introduction

2. Theory and review of literature

MICROFINANCE:

“When a United Nations “Year of Microfinance” in 2005 was followed in 2006 by the award of the Nobel Peace Prize to the Grameen Bank and its founder, Dr. Muhammed Yunus, the world got to know about the supposedly esoteric business of providing financial services to the poor. Ian Calligan Forbes”

What is Microfinance?

Microfinance is a small scale financial service provision for the poor that can take a form of credit and savings. Savings provide people with opportunity to save excess liquidity to use in the future and obtain return on this investment. Microfinance can help poor people reduce risk, raise productivity, increase incomes and improve the quality of their lives (Robinson, 2001).

Microfinance also provides the so necessary full range of financial services. Such as working capital for their businesses, credit to meet emergencies and everyday needs, a safe place to deposit savings and insurance to reduce vulnerability.

In other words microfinance provides access to credit and capital markets to certain groups of people where this supply is limited. Microfinance is not only about microcredit. There is a host of other services – savings, insurance, remittances – that the poor need and are willing to pay for.

HISTORY of Microfinance :

During the 60s and 70ies…

“Financial services are, of course, not a panacea for poverty alleviation. Other strategies are needed simultaneously, especially for very poor people who need food and employment before they can make use of financial services.”

In 70s and 80s “What resulted was a model for financing the economically active poor through profitable financial institutions.” (Robinson 2001 Microfinance revolution)

“Appropriately designed financial products and services enable many poor people to expand and diversify their economic activities, increase their incomes, and improve their self-confidence. Financial institutions knowledgeable about microfinance can become profitable and self-sustaining while achieving wide client outreach. Governments and donors no longer need to provide ongoing credit subsidies; they also need not cover the losses of state banks providing credit subsidies.”

Microfinance borrower is expected to have a viable business

Microcredit aims to avoid the problem of creating dependency, because it is market-based and is a part of a commercial relationship with the people who receive the money. “A microfinance borrower is expected to have a viable business, even if on a tiny scale.” So far default rates have been very low.

However, “people at the bottom of the pyramid tend to face unfair barriers, whether in trade or in the organization or society, and so it makes sense to direct capital towards them specifically.”

Microfinance helps easing access to capital for the world’s poor. But is it the most effective route to ending poverty?

Where does microfinance funds come from? And investors perspective.

SOURCES -> Self sufficient Microfinance ect.

As microfinance funds are sweeping the world and becoming very popular for investors we want to know what the main source is.

Microfinance funds nowadays come from wide variety of sources:

1. Themselves – self sufficient and profitable MFI

2. NGOs – World development banks, World banks ect

In a form of aid

Private investments

Some of the MFI has become self sufficient and profitable there is still a very large proportion coming from NGO such as World Bank, development banks and in a form of aid.

Importance of being self sufficient

(evidence from local studies papers?), (what it means to be self sufficient and profitable?)

NGOs – World development banks, World banks ect

Form of aid

Microfinance as investment vehicle with a social side

So why private investments are so important in tackling poverty? “Private investment was a key driver of economic growth in poor countries” (Sullivan N.P “You can hear me now”)

Private investments, entrepreneurship and microfinance go hand in hand in developing countries fighting poverty and making environment for sustainable growth.

However, in the recent times microfinance has been also approached as a type of an investment with social side of it … meaning that there is a double return for an investor…. Therefore many private individuals may support this sort of thing not as a charity donation but as socially responsible investment. Difference is that charity donation only gives social return, yet micro lending brings return plus … These private investor funds play crucial role in development and widespread of microfinance industry. Thus, there is a need not only to understand the microfinance from the small sample case studies but from a broader macroeconomic perspective, assessing results across the world on a more global scale. If I put myself in the shoes of an investor, I want to see what is microfinance success rate is nowadays. How successful microfinance projects tend to be on a global scale and if we can find a link between accessibility to credit markets and improved welfare for the residents of the developing countries.

Providing this new model, where we have microfinance as additional asset class and where investors lend money for financial and social return. Then we have emerging philanthropists and business people who work with NGOs and try to help with their business knowledge – and then we have development agencies with government funds and vast knowledge and experience in the field. So we have more and more funds flowing (yet requiring return on investment), we have more knowledge and experience flowing, and these people being present also helps in monitoring progress, overseeing projects, thus, helping to fight corruption and this involvement and accountability factor can also be very attractive for investors. For the microfinance to become on a larger scale an investment vehicle, investors and philanthropists are interested in RESULTS< INVOLVEMENT and ACCOUNTABILITY

Acumen Fund – using venture capital techniques to tackle global poverty. Their secret of success is only investing equity and loans in both for profit and non-profit organisations and insisting on accountability for results. This approach creates a partnership rather than top-down relationship. The capital gets invested in long term at below-market rates and complemented with management assistance.

“Billionaires, global leaders and Nobel Prize recipients are hailing these direct loans to uncollateralized would-be entrepreneurs as a way to lift them out of poverty while creating self-sustaining businesses.” from Forbes.

According to Forbes, that promise has had a magnetic effect on private capital sources. Microfinance funding from private investors more than tripled to $2 billion in 2006. The field has attracted sterling banks and fund managers, including Citigroup, blue-chip venture capitalists like Sequoia Capital, tycoons like eBay founder Pierre Omidyar and Oscar-winning screen stars such as Robert Duvall–they’ve all joined the chase for returns in microfinance. Today, there are upward of 12,000 microfinance institutions issuing loans.

The perspective of a private investor and philanthropist or microfinance from the individual investors perspective.

Before deciding on an investment, private individuals may be wondering on the most effective ways to use their own money for worthwhile causes. Nowadays, we are presented with a wide variety of choices when it comes to socially responsible investments and charitable donations. One may choose to what type of Non-governmental organisations (NGOs) or charities she donates money, as to what type of activities they support, their goals, experience and accomplishments. We can even choose on the area of the world, we can choose the time horizons of the assumed impact. However, questions are present – should I donate to disaster relief? Give cash to a fair-trade campaign? Finance poor entrepreneurs? Or perhaps the not-for-profit firms that sell them services? Or shall I buy shares in listed companies that score well on social issues like human rights? Or, should one invest in purely capitalist companies that aim to maximize profit via any legal means in the world’s poorest countries? The range of choices has started to expand rapidly in recent years. Nowadays, investors can choose to invest in financial vehicles that use business methods to tackle poverty, environmental and other key social issues. The areas that have grown rapidly over the last 30 years within the range of socially responsible investments. One of them is microfinance funds that have become significant in the last few years.

Types of responsible investments:

Microfinance fund is ….

But they are growing rapidly. Further types of socially responsible investments now becoming available are “bottom of the pyramid” private equity and investments that allocate part of their income as charitable donations.

AID vs Investments and loans

So what is the difference between the straightforward charity or aid and these so called “investments”. Investment by its very core means ….. (definition). And what is the difference of impact/effect.

Thus, capital that is placed in such assets is not given away, as it happens with outright charity. Instead it is invested with the expectation that it will deliver two types of return: a financial return, and a sense of well-being from the “social return” that accrues to other members of the global community. (Keating)

Fighting poverty… Is aid the solution or the problem?

“There is intense debate about the role of aid in eradicating poverty and the scope for business to make an impact.”

There is an opinion that market can make a difference (Oxfam, papers), but it can’t provide solution for everything. However others (Papers) say that “aid fosters a mindset of dependence that prevents people from helping themselves”

Markets and trade can help in fighting poverty; however there are unfair rules that have to be addressed.

“The power of market is fundamental in getting economic growth to work for poor people. But far too often we see growth happening without the benefits being captured by poor people.” Thus, businesses are important but what is also vital is the environment where those businesses operate and the state institutions that facilitate this environment.

Problems with poverty reduction programmes: ill-defined goals, lack of accountability and indistinct measurement mechanisms.

Problems with aid programmes: “reinforcement of a dependency mindset” Aid might prevent establishment of functioning markets and an environment of prosperity.”

Programmes like UN Millennium Development Goals “are positive”.

One of the biggest challenges and criticisms with aid programmes are that “they can distort the effective functioning of local markets”. However the counterargument for the criticism is that some of these people are living in the “middle of nowhere” and are not a part of functioning markets, thus, they can’t afford to pay for the medicine or bed nets when people are dying and are in need of help immediately.

As investors allocate their money across the spectrum spanning pure charity, socially responsible investments and pure financial investments, they are sending market signals. Different forms of socially responsible investments and charities are generously discussed amongst economists and anthropologists, policy makers and within the private sector. The effects have been assessed, and debate has awakened as to the best way to tackle social and environmental problems. As more money flows into microfinance funds, the more charity trustees question their old models of aid and start to build their own business-oriented strategies to tackle poverty. “So, as more investments finance African telecom networks and transform local economies – enabling fishermen to find out the fair price for their catch, for example – the more contrast can be drawn with costly government aid projects that have far less impact on daily lives.” (Keating, 2008; BBC 2010)

To deeper analyse charity is beyond the scope of this paper.

EFFECTS and IMPACTS of microfinance.

Effects and impacts of microfinance

How do we measure the positive social impacts of microfinance? Do we have clear and universal standards for reporting on social performance?

Papers tend to assess the impact of small case studies

What is the poverty line?

Current Statistics

Why care

Causes of poverty:

There are multiple complex causes; one of them is economic exclusion, with poorer people lacking access to information about fair prices for the goods they produce or being unable to connect to open markets.

POSITIVE EXTERNALITIES

Positive externalities of microfinance. What is a positive externality?

“the total impact of microfinance intervention is being underestimated through conventional impact studies which do not take into account the possible positive externalities on spheres beyond households and the subsequent feedback effect on both participant and non participant households.” (Zohir, Matin 2004) And they suggest that we can assess positive impacts on cultural, economic, social and political levels, “each of which has its counterpart in the narrow micro level (individual, enterprise or household level)

Studies of wider impacts – Rahman and Khandker 1996

“Growth is, above all, the surest way to free a society from poverty” The Growth Report. It has been reported in various models and literature taht growth is very important in poverty reduction, hence, I would like to see and assess how good is the environment for the business:

First of all – what determines a good growth/business environment

Can we see a correlation between better business environments and growth?

What determines market efficiency and assessment of availability of credit markets.

“The pover of market is fundamental in getting economic growth to work for poor people. But far too often we see growth happening without the benefits being captured by poor people.” Thus, businesses are important but what is also vital is the environment where those busniesses operate and the state institutions that facilitate this environment.

Problems with poverty reduction programmes: ill-defined goals, lack of accountability and indistinct measurement mechanisms.

Problems with aid programmes: “reinforcement of a dependency minset” Aid might prevent establishment of functioning markets and an environment of prosperity.”

CREDIT markets and COLLATERAL

“Inequality, capital markets, and development.” – from the development book

“what you have as collateral and the perceived extent to which you value the future relative to the present determine the degree to which you have access to the credit market” (Ray, 200…) “In unequal societies, the poor may lack access to credit markets for precisely the reason that they lack collateral. To the extent that credit is necessary to (a) start a small business, (b) educate oneself or one’s children, (c) buy inputs so that you can rent land and farm it, (d) smooth out consumption expenditures in a fluctuating environment, and a whole host of other things besides, the poor are shut out from a, b, c, d, and everything else that credit can nourish. (..) A missing or imperfect credit market for the poor is a fundamental characteristic of unequal societies. The macroeconomic implications can be quite severe, as the following simple model illustrates (* The discussion that follows draws on ideas in Banerjee and Newman [1993] and Galor and Zeira [1993]) (..) The credit markets might be shut down for individuals who have relatively small amounts of collateral. This is true because these individuals cannot credibly convince their creditors that they will not default on their debt obligations.

Whether the enterpreneur will get a loan depends on:

How much wealth is available for collateral?

How profitable will the business be?

What kind of punishments are available in the event of default?”

So there is a model on page 230 that says “banks or moneylenders will only advance loans to an individual whose initial wealth is “high enough”, If initial walth is lower, you cannot credibly convince the bank that you will repay your loan, The individuals who start out with wealth lower than this critical level are, therefore, unable to be enterpreneurs whether they want to be or not.”

….. because of these reasons – access to credit and credit markets should help in redistributing wealth? Fighting inequality???? P 236-237 development economics

The importance of a credit market??

Can we actually see if the countries where microbanking is available and has developed during the recent years, can we see if something is happening on the wealth distribution side and the

How friendly is the environment in developing countries for an entrepreneurship?

We have index assessing that. On importance of entrepreneurship on development – Ray??? Other papers?

Evidence and importance of well functioning credit markets…

1) Assessment of credit markets

2) Assessment of how friendly is the environment to start a new business there

MICROFINANCE PLUS:

“Patient capital” – capacity building, not just short-term hard currency loans.

“Is this institution driven purely by profit or by some more socially responsible motive of service to the poor? The latter can take many forms, from lending at effectively subsidized rates to what in industry parlance is often referred to as “microfinance plus.” (The “plus” can refer to health and education programs, for example.) But the underlying idea is that finance alone doesn’t create the development effects that truly lift people out of poverty. Needless to say, evaluating such fungible definitions can be difficult. Same article” http://www.forbes.com/2007/12/20/ian-callaghan-microfinance-biz-cz_ic_1220callaghan.html

How to help the very poor still remains the challenge

Nascent Markets. First, since the commercial-oriented investment is going mainly to advanced microfinance institutions and markets, many countries are left behind. Who will build the microfinance field in Sudan? Reaching poorer, more rural clients remains a key challenge. Research shows that microfinance actually tends to reach those at or around the poverty line, rather than those at the very bottom of the pyramid. The aid agencies, with their grant money and willingness to take higher risks for social aims, will be the ones to support early-stage microfinance in these markets.

“The endgame, of course, is for microfinance to principally fund itself–as most retail banks do–through local deposits. Local funding is more stable and carries no foreign-currency risk. Moreover, secure deposit services are highly valued by poor people, some say far more than loans.

New technologies–especially wireless services–promise to dramatically transform microfinance, allowing us to bring services to even the most remote and isolated areas where no branch would be viable. But this will only happen with the cooperation and complementary efforts of public and private players to develop markets and institutions that work for poor people.

http://www.forbes.com/2007/12/20/elizabeth-littlefield-microfinance-biz-cz_el_1220littlefield.html ”

“Any intervention that seeks to meaningfully roll back poverty–whether it is microfinance, education, primary health care, housing or access to basic services such as water and energy–must fulfill four basic conditions.

The first is scale. When there are three billion people surviving on $2 or less a day, reaching a few thousand is like aspirin in the face of a raging cancer. The second is permanence, an assurance that the intervention will be present not only for today’s poor but for their children and their children’s children. In turn, this requires that the intervention outlast the finite lives of its current champions. The third is continuous efficacy, the ability of the intervention to become better and better through time. The fourth is continuous efficiency, the capability of the intervention to become cheaper and cheaper with each passing day.

http://www.forbes.com/2007/12/20/michael-chu-microfinance-biz-cz_mc_1220chu.html ”

Importance of entrepreneurship:

in fact, humanity has found only one way to deliver consistently and simultaneously the four attributes of scale, permanence, efficacy and efficiency, and it is through private enterprise. This is the result not of any single firm–individual enterprises are born, prosper and die–but of the emergence of an entire industry. And industries are born out of the union of two factors: an economic activity and above-average returns.

Like in any other industry, it is high returns that attract competition. And competition is what ensures that the benefits of this growth flow not only to investors but to the ultimate end-user. The lowest interest rates, the widest array of financial products and the best customer service for the poor in Latin America can be found in Bolivia, where the native chola with her 10 skirts and tilted bowler hat has gone from an invisible to a sought-after client of world-class microfinance institutions, all with higher ROAs and ROEs than the average conventional bank. The outstanding returns of Banco Compartamos and the success of its IPO has ensured that this process will soon occur in Mexico.

So if you want to put your money in microfinance just to feel good, by all means direct it to the organization that most pulls your heartstrings. But if your objective is to roll back poverty and change the world, don’t believe those that have been telling you that returns on your investment are the icing on the cake. It is the cake itself.”

Conclusion

Chapter 3

3. Empirical analysis

Data

Model

Chapter 4

4. Conclusion

5. Bibliography

Ray, D. (1998). Development Economics. Princeton University Press.

Robinson, M. S. (2001). The Microfinance Revolution: Sustainable Finance for the Poor. Washington, D.C.: World Bank.