Academic journal article The Journal of Social, Political, and Economic Studies

Microfinance: Recent Experience, Future Possibilities

Academic journal article The Journal of Social, Political, and Economic Studies

Microfinance: Recent Experience, Future Possibilities

Article excerpt

Microfinance: Recent Experience, Future Possibilities Tyson Rallens S. M. Ghazanfar University of Idaho The Economics of Microfinance Beatriz Armendariz de Aghion and Jonathan Morduch MIT Press, Cambridge, MA; 2005

In the 1970s, an innovative approach to fighting poverty in the developing world was initiated in Bangladesh. Since then this technique has gained wide popularity around the world. This novel approach is generically called "microfinance," and it has been widely discussed by practitioners and by members of the academic community. In 2005, two scholars attempted to synthesize the considerable literature that has evolved on the subject in The Economics of Microfinance. Not only were these scholars trained economists, but they also had considerable experience in working with microfinance institutions in Third-World countries. They defined microfinance as "a collection of banking practices built around providing small loans (typically without much collateral) and accepting tiny savings deposits" (Aghion-Morduch, 1).

Microfinance was pioneered by a Bangladeshi economist, Muhammed Yunus, who began the practice in a village called Jorba by making small loans from his personal resources. Later, a Bangladesh bank helped him expand his efforts to neighboring villages, and Yunus' brainchild has become the Grameen Bank of Bangladesh, one of the largest microfinance institutions in the world. After presenting the highlights of the Aghion-Morduch book we proceed to discuss the need for microcredit and the reasons why conventional banks are not inclined to lend to the poor. Section three then focuses on innovative lending strategies that have made microcredit viable. Then, the potential for extending other financial services, such as savings and insurance, to the poor is discussed, along with a brief explanation of the need for increased participation of women. The presence of subsidies in microfinance and attempts to measure the cost-effectiveness of these subsidies are covered in section five. The paper concludes with some remarks as to problems, not insurmountable, encountered in the conduct of microfinance practices.

I. The Need for Microcredit

Microcredit is the lending side of microfinance. It embodies giving small loans to extremely poor people, usually without collateral. Microfinance institutions have stepped in to provide these loans because traditional banks usually are unwilling to serve the market of the poor. One of the arguments made by poverty activists, however, is that lending to the poor can be profitable for both the borrower and the lender. Those who have very small amounts of capital (the poor) will likely have much higher returns for a marginal unit of capital than a wealthy individual or business that has already realized the high initial returns and is now functioning in the diminishing-returns range of the production function. Thus, microfinance institutions exist partly to take advantage of this opportunity for high-yield investments on the part of entrepreneurs with limited resources. Further, these institutions also have a social mission. Their goals usually include improving levels of living for the poor and helping the poor overcome poverty traps and repressive socio-economic conditions.

The poor do have a need for credit. This credit can be used, among other things, to smooth consumption when income is highly seasonal, due to agricultural cycles, for instance. Credit may also be needed for major expenses such as medical treatment or education of children. Poor villagers usually have access to local moneylenders; but money-lenders often charge usurious-even exploitative-rates. Moneylenders may charge high rates either because they are virtual monopolists, or they may simply be charging risk premiums derived from fear of high default rates. In either case, microcredit institutions can improve the situation by harnessing efficiency and a larger resource base than the local moneylenders have access to. …

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