Advantages and Disadvantages of Microfinance

Microfinance presents many opportunities to the non-profit sector, but also comes with some qualities that make it a unique
Form of philanthropy. Although the idea of microfinance seems to be a simple way of helping those in need, the actual paying
Back of a loan and qualifications for a borrower make it a difficult to assess whether all markets are suited for microfinance. In
the case of S2S, we will be communicating with established microfinance agencies to determine which groups are the prime
Candidates to be borrowers.
The following is an excerpt about the pros and cons of microcredit:
"In the last two decades, substantial progress has been made in developing techniques to deliver financial services to the
poor on a sustainable basis. Most donor interventions have concentrated on one of these services, microcredit. For
microcredit to be appropriate however, the clients must have the capacity to repay the loan under the terms by which it is
provided. Otherwise, clients may not be able to benefit from credit and risk being pushed into debt problems. This sounds
obvious, but microcredit is viewed by some as "one size fits all." Instead, microcredit should be carefully evaluated against
the alternatives when choosing the most appropriate intervention tool for a specific situation.
"Microcredit may be inappropriate where conditions pose severe challenges to standard microcredit methodologies.
Populations that are geographically dispersed or nomadic may not be suitable microfinance candidates. Microfinance
may not be appropriate for populations with a high incidence of debilitating illnesses (e.g., HIV/AIDS). Dependence on a
single economic activity or single agricultural crop, or reliance on barter rather than cash transactions may pose problems.
The presence of hyperinflation, or absence of law and order may stress the ability of microfinance to operate. Microcredit
is also much more difficult when laws and regulations create significant barriers to the sustainability of microfinance providers
(for example, by mandating interest-rate caps). (http://cgap.org)
I completely agree with this assessment of the advantages and restrictions of microfinance. Although it is a promising way
to help global education and poverty, there are certain aspects to microfinance that make it unrealistic for some groups that
are in need of help. Similarly, one aspect that was not brought up is the necessity for people who are easily accessible by a
team that is on the ground in the area being helped. If a certain country has restrictions on who can enter and do what, it
may be difficult for our team to help the people there.


While microfinance can not reach all economic segments of society, it has been shown to reach segments previously un-serviced by other financial markets.
- "Evidence of Microfinance's Contribution to Achieving the Millennium Development Goals", http://freedomfromhunger.org


Assessing the advantages and disadvantages of linking with
M-PESA
This note analyzes the advantages and disadvantages to both customer and financial institutions of
linking with M-PESA. It concludes by describing consequences of the difficulties that financial institutions
face with M-PESA.
MicroSaves recent research with fourteen financial institutions in Kenya revealed perceived opinions
about advantages and disadvantages of linking with M-PESA. Findings indicated that:
Banks, MFIs and Deposit Taking Microfinance Programs look for cost reduction, increased staff
efficiency and customer convenience, which may lead to more transactions;
M-PESA helps customers to cut costs, increase convenience and reduce risk of carrying cash by
allowing them to transact their accounts from the nearest M-PESA agent, instead of travelling to a
bank branch,;
Financial institutions are facing difficulties in reconciling deposits initiated by M-PESA users to
customers accounts;
Banks are delaying informing customers that money has been credited to their account;
Customers are also finding it difficult to make withdrawals from a bank account using the M-PESA
channel.
Institutions that have agreements with M-PESA are not heavily promoting the opportunity, despite
potential benefits, as a result of these difficulties. Financial institutions are looking for alternative
arrangements to mitigate the challenges of linking with M-PESA.


The Limitations of Microfinance
If you pay any attention to economic development in the third world, you have heard about
microfinance. Its the hottest thing going. Development organizations announce their
involvement in microfinance with a kind of sacred hum. People are appropriately fascinated by
the rise of Kiva.org, a website that enables you to engage in microcredit from the comfort of
your computer chair.
Microfinance organizations offer financial services to people too poor to attract the services of
traditional banks. They offer small loansmicrocreditand may also offer savings accounts,
insurance, and fund transfer services. For example, I wrote a forthcoming article for Christianity
Today Magazine about a wonderful Filipino group called CCT. The article features a woman
named Cindy Caro who first borrowed $85, which she put into a processed meat business, selling
hotdogs, sweetened beef and pork, ham and spiced beef door to door. Now she operates a small
store.
Some microcredit organizations place borrowers in small groups that meet together and
guarantee each other, so that nobody can get a second loan until everybody in the group has
repaid their first loan. Peer pressure and peer encouragement help borrowers stay on task. They
are less isolated and less prone to discouragement.
Ive been amazed how many organizations have taken up microfinance. They all offer stories of
families transformed by small businesses made possible through small loansusually less than
$100, at least to begin. Women buy supplies or equipment with these loans and (typically) make
and sell food, leather goods, or clothing. Their profits enable them to send children to school,
provide food for the family, improve their homes, and build an expanding business.
Without question, microfinance is a wonderful development. Still, its quick rise to prominence,
and its adoption by practically every last development agency, says a lot about how tough
development is. They must not have had very effective tools, if they are all so eager to adopt
this new one.
Microfinance promises to be something differentan approach that really does transform lives
and communities. Heres a short list of the benefits of microfinance:
Taking out loans, buying insurance, and saving money all teach people how to be future oriented.
Instead of living day to day, they have to think about their lives into the future, plan for the future,
make sacrifices in anticipation of a better future, and work toward improved lives. This is the
essence of capitalism. It is worth noting that development agencies that have historically had mixed
feelings about capitalism are devoted to teaching small-scale capitalism through microfinance.
Microfinance helps women. Almost all micro-borrowers are women, who develop home businesses.
Women are generally more responsible than men, as any development worker will tell you. They use
their profits to feed and educate their children, instead of blowing it on booze and gambling. In
many patriarchal societies men control all the resources, and waste them. Microfinance gives women
some power over their own lives, which they often use for the benefit of their families.
Because many microfinance programs rely on peer pressure and peer support, they promote
community building and mutual accountability. A culture of responsibility and encouragement can be
built up.
Microfinance programs can be self-funding. Some microfinance organizations even operate
successfully as for-profit banks. For charities, theres the prospect of investing once and moving on,
rather than continually pouring resources into a bottomless pit.
However, microfinance has its limitations. This you wont probably learn from the websites of
development organizations.
Microfinance helps women. Thats good, but not good enough to transform communities.
Communities are formed of equal parts of men and women, who have a strong affinity for forming
bonds with each other. Development that helps women but doesnt involve men has a natural self-
limitation. You cant have transformational community development without transforming
men and women. (For more on this, see my article Where are the
Men?http://www.christianitytoday.com/ct/2005/august/23.41.html)
Microfinance is small scale. True, small businesses become large businesses sometimes. But more
often they dont. A family may be greatly helped by the extra income from selling sandals at the
market. Creating something larger, something that fully supports the family and creates jobs, is
rare. (This is probably one reason men dont participate. They are attracted to larger enterprises
outside the home.)
Microcredit loans are expensive. Interest rates charged by microfinance programs are often over
20%. They have to be, because overhead is high for administering tiny loans. That means its hard
for borrowers to make enough profit to really get ahead, after they pay loan costs. My friend
Wachira counsels poor people to start with what resources they have or can borrow interest-free
from family members.
Certainly all microfinance organizations tell amazing stories of family transformationand
sometimes even of community transformation. When you hear those stories, though, keep in
mind what I call developmental cherry picking.
In every community, whether rich or poor, there are a few people who are naturally curious,
adventurous, and adaptive. Their lives may be indistinguishable from their neighbors because
there have been so few opportunities in their community. But as soon as some outside force
comes into the neighborhood, they see opportunities and take them.
If you read missionary stories from earlier times you will often learn of such people. When
missionaries came into their community the early adopters sent their children to the missionary
school, they tried missionary medicine instead of traditional remedies (sometimes violating their
own communitys strongly-held customs), and they adopted European agricultural methods. In
these missionary stories a common plot development has to do with the difficulty of getting the
rest of the community to stop persecuting these early adopters, but to follow their example.
Similarly, when microfinance programs go into an Indian slum, they will unfailingly find people
who seem to be waiting for just such help. They not only take loans, they build businesses. Their
transformed lives make great stories, and since they appear just like other slum dwellers, it
seems as though microfinance will transform other lives too, as it spreads.
Its not necessarily so. Others will take loans, which will help them augment their incomes, but
microcredit wont necessarily change their lives. As I understand it, research studies have yet to
demonstrate the power of microfinance to alleviate poverty. Theres a big difference between
transforming early adopters and transforming everybody else.
Which brings me back to an earlier point: development is tough. Where it happens on a large
scalein China, Taiwan, Korea, and Vietnam in recent decades, in Europe and America many
generations agoit is not brought about by agencies. There is some combination of opportunity
(usually brought about by a decent government) and a widespread cultural mindset and mood.
We dont know how to develop those. Microfinance helps teach future thinking and planning, and
that may contribute to a large-scale cultural shift. But nowhere is it written that alleviating
poverty on a small scale naturally leads to community transformation.
Our job is to help people in need. Microfinance is a good way to do it. But dont think its the final
solution. Were still looking for that.







A main disadvantage to micro-finance is that the deal is too small for the lender to devote ample time and
money to doing proper due diligence. As a result, default rates by borrowers are often rather high
(witness Prosper.com). Borrowers seldom if ever give lenders the full story on their situation and with a
small amount at risk, it does not make sense for lenders to spend a lot of money to check out the story.
When lenders get burned, they decide to stop microlending and the next round of microlending must be
done by greenhorns who have no idea what they are getting into. In other words, to some extent
microlending depends on an ever-increasing number of lenders in order to be successful.

As for alternatives, there probably aren't many. Microlending is a promising area and I am hopeful that
sites like Prosper and Zopa can use their size to reduce the due diligence costs to a point where
microlending can be profitable.
Source:
These are my opinions as a (former) lender on Prosper.com.


Disadvantages of microfinance? For whom? For the clients, it is probably the high interest rate, although
the financial margin of small business in their risky environment are usually high and allow to afford the
20-40% annual effective interest rate. I do not see other downsides, apart that in competitive markets (e.g
Peru and Bolivia), microfinance can introduce over indebtedness where it was not present before - to low
income population.

Alternative to microfinance? That's a weird question as microfinance is a broad definition of the
development finance filling the gap uncovered by mainstream financial service providers (banks,
insurance companies). For me, we need it as long as formal finance players have not completely stepped
in these more informal market.

Hope this answer will help you

Benefits and Limitations
The benefits of microfinance are that it helps to manage the assets of the poor and generates
income. Through microfinance institutions such as credit unions, financial non-governmental
organizations and even commercial banks poor people can obtain small loans and safeguard their
savings. The limitations of microfinance are that through this savings plan participants are losing
money by having to pay a fee. The user can also pay back their loans whenever they chose
therefore encouraging a borrower to have various outstanding loans. The lender is also vulnerable in
that there is no guarantee of the loan being repaid in the given arranged timeframe, and the
consequences to defaulting are not defined.
When looking at a micro-finance initiative, there are three main benefits and limitations for the
model. These are based on a basic micro-finance initiative though they can be applied to many
variations. When looking at the three benefits and limitations, they revolve around three key ideas,
poverty, mistrust, and promoting change.
A micro-finance initiative wishes to address these issues in a positive way. For example, micro-
finance can be an alternative program to address poverty reduction where the tools needed to raise
an individual or a family out of poverty are given to them directly. In a micro-finance project these
tools include money primarily, and may also be accompanied with a savings program, and financial
help. Along with poverty reduction, a micro-finance initiative can aim to avoid a general sense of
mistrust between the citizens and their national banks. The money in this case, is not coming from a
bank, but rather within the community which allows those participating to foster social capital and
community cohesion. Lastly, a microfinance initiative can promote larger poverty reduction
movements by increasing the financial knowledge of the average citizen.
However, these initiatives are not without limitations. These limitations focus on the same issues as
stated before, but the negative consequences that may occur. For example, while there may be
mistrust in the national banking system, there can be microfinance initiatives where the outside
creator takes advantage of those participating. The money may not end up in the right places,
resulting in distrust to all who have interest in monetary programs, and could potentially ruin the
chance of any further microfinance projects becoming successful. Secondly, when creating a
microfinance project, time may be an issue. What happens when the program is finished and the
people who were participating are still in poverty? In this case, it may be more beneficial for there to
be an on-going program. To see what would be an appropriate choice in regards of time, the
community must be assessed before the project is put in place. Lastly, in regards to limitations,
someone is always going to be left out. Not everyone can be a part of the program, and therefore
one must decide who is going to participate. Often, for a community development project to be
sustainable, all must be affected positively.
There are two ways in which the needs of the poor are not being met by micro finance. Firstly, the
poor need to store savings for the long run; such as for their retirement, widowhood or their heirs but
the examples such as saving up, down and through do not directly meet these needs. Secondly, the
poors ability to save fluctuates with time and so they may not be able to save the fixed rate of
saving. These two shortcomings are difficult for the poor and they often get excluded or exclude
themselves (Rutherford, 2009). Poor people have to take a risk to turn their savings in to large lump
sum of money because there is no perfect system that would protect their deposits. For example,
there is a lack of trust among the members and the organizer; most community micro finance
projects only include family and close friends and do not reach beyond that. Also, there is no or very
little growth in the amount of money that they save if saving up but if saving down, there is an
interest rate that the members have to pay.
Also, there are complications associated with implementing micro-finance projects in Canada. For an
example, inflation rates make it difficult to analyze interest rates across countries, so ASCAs in high
inflation would have to charge more interest on their loans which may result in their funds to decline
in value themselves (Rutherford, 2009). In many countries, ASCAs have become permanent
institutions referred to as Credit Unions, Savings and Credit Co-operatives. Rutherford argues that
credit unions are not owned by the poor because they require specialized skills and higher educated
personals to regulate the operation of these institutions themselves (Rutherford, 2009). Although
these institutions aim to benefit the poor, they are very different from neighborhood ASCAs and
issues arise when they purse collateral or securities for loans given. Similarly, there are language
barriers between formal federal banks and credit unions that causes complications (McMillian,2010).
The major benefit of microfinance projects is that it allows low income families to save their money;
most of the poor live day to day with the little money that they earn and cannot afford to save. Poor
people need such alternatives in order to turn their savings in to large lump sums or receive large
sums and pay monthly with low interest rates. Banks and other money lending institutions have high
interest rates and simply wont extend loans to poor people with little or no assets or employment.
Microfinance helps the poor people get access or save funds over a period of time with low interest
rates. Also, the poor could solve their own issues by working together as a community and this
creates trust and social capital in their communities. It also leads to stability and growth in their
households, as well as their communities.


Microfinance involves extending small loans, savings and other basic financial services to people that dont currently
have access to capital. Its a key strategy in helping people living in poverty to become financially independent, which
helps them become more resilient and better able to provide for their families in times of economic difficulty.
Considering nearly half the world survives on less than $2 a day, microfinance is a vital solution. Here are six benefits
of microfinance:
1. Access Banks simply wont extend loans to those with little or no assets, and generally dont engage in the small
size of loans typically associated with microfinancing. Microfinancing is based on the philosophy that even small
amounts of credit can help end the cycle of poverty.
2. Better loan repayment rates Microfinance tends to target women borrowers, who are statistically less likely
to default on their loans than men. So these loans help empower women, and they are often safer investments for
those loaning the funds.
3. Extending education Families receiving microfinancing are less likely to pull their children out of school for
economic reasons.

Assa serves tea in her grocery and snack shop in Nepal. Assa received skills training and a business loan from Plan.
4. Improved health and welfare Microfinancing can lead to improved access to clean water and better
sanitation while also providing better access to health care.
5. Sustainability Even a small working capital loan of $100 can be enough to launch a small business in a
developing country that could help the benefactor pull themselves and their family out of poverty. Watch Salamatus
story of starting a rice-selling business in Sierra Leone.
6. Job creation Microfinancing can help create new employment opportunities, which has a beneficial impact on
the local economy.

Criticisms
Making microcredit facilities available to the poorest members of society has attracted strong
support from neoliberals (because of its emphasis on individual responsibility) and those on
the left of the political spectrum (because of its potential to empower women).
The basic idea sounds so simple and easy that a toddler could think of it. Why are people poor?
Because they have no money. So let us give them money then they will not be poor any
more.(Indian economist Jayati Ghosh)
Although it would appear to be self-evident that providing finance for the poorest in society to
invest in the means to increase productivity is a good thing for development, there is a problem
when it comes to providing evidence of the benefits of microfinance programmes. There are
very few evidence-based studies and those that have taken place only offer partial support.
The first randomized studies of microcredit appeared in 2009. MIT economists found that in the
slums of the megalopolis of Hyderabad, India, small loans caused more families to start micro-
businesses such as sewing saris. Existing businesses saw higher profits. But over the 12 to 18
months the researchers tracked, the data revealed no change in bottom-line indicators of poverty,
such as household spending and whether children were attending school. (David Roodman,
Microcredit doesnt end poverty, despite all the hype, Washington Post, 8 March 2012)
Microcredit has not had a positive impact on gender relationships
A study in Bangladesh (2008) found that, although the majority of loans were made to women,
they were often acting as collecting agents for their husbands. Women had to accept
responsibility for repaying the loans that men had spent. This is particularly true for larger
loans - women have 100% control over loans that are smaller than 1000 Taka but only 46% of
control if the loan is bigger than 4,000 Taka. (Source: Lamia Karim, Demystifying Microcredit:
The Grameen Bank, NGOs, and Neoliberalism in Bangladesh, a 2008 study of micro-lending)
Interest rates are too high
The cost of servicing loans is higher than for commercial banks because administration charges
for small amounts are proportionately higher than for larger amounts of money. Institutions
have to charge an interest rate that will cover those costs and continue to lend to future
borrowers. The result is that the worlds poorest people pay the worlds highest cost for their
loans. Grameen Bank interest rates are typically 20% but in other countries and institutions
they can be much higher. The global average interest rate is estimated at 37%, with rates
reaching as high as 70% in some markets.
High interest rates are a major criticism and the high demand for the services of microcredit
institutions is one of the major causes. The rapidly expanding demand for micro-lending
encouraged institutions to look for capital from foreign commercial private equity providers.
The non-profit models of the micro-lending institutions were in conflict with the private equity
providers. As a result, many of them changed their status to for-profit in 2005, converting their
philanthropic nonprofit assets into private for-profit assets.
One such micro-finance program was Compartamos in Mexico, which in 2007 launched an initial
public stock offering. According to a New York Times article, it charged its borrowers an annual
interest rate of near 90 percent, producing a return on equity of more than 40 percent, nearly
three times the 15 percent average for Mexican commercial banks. This made Compartamos
highly attractive to private equity investors. The public offering brought in $458 million, of which
private Mexican investors, including the banks top executives, pocketed $150 million. (David
Korten, Microcredit: The Good, the Bad, and the Ugly, Yes Magazine, 9 January 2011)
For some people it is this neoliberal intrusion into micro-lending that has subverted a
philanthropic ideal and caused many of the problems identified by critics. Others think that this
notion is too simplistic and fails to take account of other basic problems.
Microcredit has driven poor households into a debt trap
One of the impacts of high interest rates has been to force poor households into a debt trap.
Households borrowing money have to earn more than the interest accumulating on the loan or
face increasing debt. The previously mentioned 2008 study in Bangladesh found that some
families were using a microcredit loan from one organization to meet interest obligations from
another. Officials working for the microcredit institutions often had their own wages based on
repayment rates paid by lenders and sometimes used coercion to collect repayments on loans.
In some situations, instead of gaining release from the poverty cycle, families were driven
deeper into debt.
Microcredit does not alleviate poverty or improve health and education.
Claims by some supporters of microcredit about the contribution that microcredit can make to
alleviating poverty are deemed to be unrealistic by many. One estimate by a researcher in
Bangladesh suggested that 5% of the loans given by Grameen Bank resulted in the loanee
escaping poverty a worthwhile contribution to development but not the panacea that some
people hoped it would be.