How do you explain microfinance

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The microfinance crisis

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Wolff, Peter
The Current Column (2010)

Bonn: German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) (The current column of March 15, 2010)

Bonn, March 15, 2010. Microfinance has become a popular instrument for fighting poverty in recent years. Ever since Muhammad Yunus and the Grameen Bank were awarded the Nobel Peace Prize in 2006, the general public has known that small loans can give even the poorest a chance to free themselves from absolute poverty.

The image of microfinance, which is often somewhat socially romantic, has recently become cracked. What happened?

Initially, in some countries there were problems with the enormous growth of microfinance institutions (MFIs). Often these are non-governmental institutions that have sprung up like mushrooms in some countries since the 1990s. These institutions, which are sometimes not very professionally run, have often grown too quickly. Financing from outside, through state and private donors and mostly not on the basis of mobilizing local savings, has often created incentives for expansion with which human resources could not keep pace. In Morocco and Bosnia-Herzegovina, for example, this led to difficulties in a number of MFIs, which have now been countered with closings, mergers and increased state regulation.

There are also problems in South Asia, the region with the most prevalence of microcredit. Microcredit is now so prevalent in some regions of India, Bangladesh and Pakistan that MFIs tend to compete to lower lending standards, thereby deteriorating the quality of their loan portfolios. It has become increasingly common for borrowers to repay a microloan by taking out a loan from another MFI or from a moneylender. This also explains the high repayment rates of the MFIs of over 95%, which, however, are beginning to decline in South Asia.

In order to counter the problem of multiple borrowing from several MFIs and the associated over-indebtedness of many borrowers, the establishment of credit information points to which all loans, including microcredit must be reported, is being considered.

Finally, the impact of microfinance on poverty has also been the subject of controversy recently. A large number of studies and evaluations have yielded positive results. They show that borrowers' incomes have increased and the educational and health standards of families who have received microloans have improved. However, it can only be proven in rare cases that this can be attributed to the microcredit. More recent, methodologically rigorous studies do not provide a clear picture. No convincing positive effects on poverty reduction can be demonstrated. Why is that?

More often than assumed, microloans are not used for small business investments, but for a variety of purposes that arise almost daily and always surprising in the unpredictable life of a poor household with no regular income: illnesses, crop failures, sudden price increases, etc. The fact that microloans help stabilize household incomes is, however, to be viewed positively. This may make it possible for the children to go to school regularly. However, this is not yet associated with a permanent increase in income, let alone an economic transformation towards a higher level of productivity as the basis for income increases. As a rule, the sewing machine financed with a microcredit does not become a clothing company; the pig in the backyard does not become a competitive farm. Nevertheless, the effects of poverty are alleviated and the opportunities for a self-determined life, especially for women, are often improved. This is a valuable contribution to the fight against poverty, but it is not the breakout out of poverty for millions, let alone the basis of an economic transformation such as that which took place in East Asia - without microcredits.

There are critics of microfinance, such as the Korean Ha-Joon Chang, who teaches at Cambridge, who see microfinance as an incorrect economic use of capital, which should not be invested in unproductive micro-companies but rather in dynamic medium-sized and large companies, as just mentioned in the successful model of Korea. In fact, it's not about an either / or. It is true, however, that the “transformative” effect of microfinance is largely overestimated. A strategy for combating poverty must complement microfinance and include the financing of larger, competitive companies and infrastructure. Otherwise poverty reduction will remain very modest.

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