Prof. Dr. H. D. Seibel (2001), one of the persons give clearest frameworks of microfinance has been defined microfinance as follows: ?A sector of formal and non-formal financial institutions providing micro saving, microcredit and micro insurance services to the micro economy, thereby allocating scarce resources to micro investments with the highest rates of return. In a narrow sense, microfinance institutions are small local financial institutions. In a wider sense, they may also comprise national or regional banks with microfinance services for small savers and borrowers.
Thus, Microfinance is the provision of financial services such as credit, savings, cash transfers, and insurance to poor and low-income people. Microfinance became a powerful tool of poverty alleviation. The provision of finan?cial services to the poor helps to increase household income and economic security, build assets and reduce vulnerability, create demand for other goods and services (especially nutrition, education, and health care), and stimulate lo?cal economies. When possibilities for asset management are limited, the role of microfinance in risk management or protective strategies may be as or more im?portant than income generation in preserving a household?s standard of living.
Models of Microfinance ?
The main difference between microfinance and mainstream finance is its alternative approach to collateral that comes from the concept of joint liability. In this concept individuals from the same economic status come together to form small groups and apply for financing. All the members of the group are trained regarding the basic functioning of financing and the requirements they will have to fulfill. The loans are disbursed to individuals within the group after they are approved by other members. Repayment is a shared responsibility of entire group members. That means they share risk. If one defaults the entire group face problem. This is the basic and effective form of credit mechanism practiced by most of the microfinance institutions.
John D. Corney(2003), explains four major models of micro finance institutions. But when we go through the entire institutions working for the promotion of micro finance in the organized and unorganized sector we have found more than ten models in microfinance practice. Some models are not common in international level. Here listed twelve important models of microfinance institutions. Few models are complimentary. NGOs and self help groups are example. Most of the self help groups have a promoter NGO. At the same time many NGOs have direct microfinance chains. And some models are seeing in the informal sector only. Here trying to explain briefly important models of microfinance.
1. Grameen Bank Model ? The model that has popularized and has replicated in many countries in a wide variety of settings is Grameen Bank model. Minimum of 20 countries are officially practicing this model now. This model is targeting poor through comprising mostly women groups. It requires intensive field work and staff motivation for supervising the groups. A group normally consists of five members who guarantee each other?s loans. A different variant of the model exists but the key feature of model is group based and graduated financing that substitutes collateral as a tool to mitigate default and delinquency risk. A bank unit is set up with a Field Manager and a number of bank workers, covering an area of about 15 to 22 villages. The manager and workers start by visiting villages to familiarize themselves with the local milieu in which they will be operating and identify prospective clientele, as well as explain the purpose, functions, and mode of operation of the bank to the local population. Groups of five prospective borrowers are formed; in the first stage, only two of them are eligible for, and receive, a loan. The group is observed for a month to see if the members are conforming to rules of the bank. Only if the first two borrowers repay the principal plus interest over a period of fifty weeks do other members of the group become eligible themselves for a loan. Because of these restrictions, there is substantial group pressure to keep individual records clear. In this sense, collective responsibility of the group serves as collateral on the loan.
Village Bank Model ? Second model is village bank, widely popularized mainly in Latin America and Africa. The model involves an implementing agency that establishes individual village banks with about thirty to fifty members. They provide external capital for onward financing to individual members. Individual loans are repaid at weekly intervals over four months, at which time the village bank returns the principal with interest/profits to the implementing agency. Full repayment is eligible for subsequent loans. Loan sizes also depend on the saving accumulated by the village bank. Peer pressure operates to maintain full repayment, thus assuring further injections of capital. When the village bank accumulates sufficient capital internally, it graduates to become an autonomous and self-sustaining institution. This model has been very successfully implemented in Syria and Afghanistan.
3. Credit Union (CU) ? Third type of microfinance is Credit Union (CU). A credit union is a member-driven unique self-help financial institute. It comprising of members of a specific group like labor unions or a social fraternity who assent to save money and make loans to each other out of that fund at reasonable interest rates. A credit union membership is free to all, and its members have the right to elect the director as well as the committee representatives. CUs mobilize savings, provide loans for productive and other purposes and have memberships which are generally based on some common bond. CUs generally relate to an apex body that promotes primary credit unions and provides training while monitoring their financial performance. This model is popular in Asia notably in Sri Lanka.
4. Co-operative Societies ? A co-operative is an independent association of people who come together voluntarily to meet their mutual economic, social and cultural aspirations and needs through a jointly owned and democratically controlled enterprise. Sometimes the cooperatives also include savings activities and member-financing as well. The loan is got only after the recognition of the director board. Co operative was first registered in India in the first decade of 20th century. To provide loans for agricultural sector and rural development Indonesia and Sudan has been promoting this model.
5. Self Help Groups (SHGs) ? Another important model is originated in India that is Self Help Groups (SHGs). An SHG is formed with about ten to fifteen members who are relatively included in the same category of income. The members of SHG pools together its members savings and uses for lending. It also seeks external funding to supplement internal resources. The rules and regulations of loans differ among SHGs. Most of the SHGs are promoted by an NGO. Some NGOs act as financial intermediaries for SHGs while others act as social intermediaries in between licensed financial institutions or other funding agencies. This model is a good platform for combining microfinance with other developmental activities.
6. Commercial Banks ? Many commercial banks in different countries have microfinance port folio. These institutions specially provide funds for development of microenterprises, social development, self employment projects and agricultural promotion. Most of the banks provide loans directly with receiving physical collateral. This method is not beneficial for the poor people because they have no enough collateral to give the banks. Other models of micro finance institutions mainly depend on social collateral. So some banks are promoting self help groups or NGOs for promoting microfinance.
7. Non Banking financial company (NBFC) ? Non Banking financial company is another model followed in different countries for the implementation of microfinance. This model is comparatively new one in this field. Registering of a financial company under the law prevailed in the country is the first step. The working capital is collected through shares and giving loans to micro entrepreneurs. This model is seeing mainly in India and Pakistan. These types of institutions are providing loans only for productive purposes. National Rural Support Programme (NRSP) is the important company in Pakistan working under the government sector. In India number of companies is working in the finance sector for providing microfinance.
8. Association of Persons ? A simple way for providing micro loans is forming association of persons. This model is manly functioning in the unorganized sector. A target community forges together to form an association through which a variety of microfinance activities are initiated. The associations may comprise of youth, women, or be formed around cultural, religious, or political issues. In some of the countries a legal body can also form an association. These legal associations have certain advantages, like collection of insurance, fees, tax breaks, and provide other protective measures. The association collects saving from its members and then disburse it among them as loans. Mutual help for increasing welfare is the principle behind this. In Kerala number of associations is working successfully. This type of institutions is not needed license or registration in our country.
9. Nidhi s ? Nidhi model of microfinance institutions are also found in different countries. This is a straight forward credit lending model where micro loans are given directly to the borrower. It does not include the formation of groups, or generating peer pressures to ensure repayment. A common fund is forming by collecting savings or through donations and it is utilized to give micro loans to poor and needy. Most of this loans are consumption purpose or for meeting emergencies like hospital expenses. In India this type of institutions are working from 19thcentury. Now in our country thousands of Nidhis are functioning. Some Nidhis are registered under societies act or as charitable trusts. But most of them are unregistered and in unorganized sector. In Iran around 6000 institutions same as Nidhis are working.
MICROFINANCE AND POVERTY ALLEVIATION
Poverty is a socio-economic phenomenon in which a section of the people is unable to meet even their basic necessities of life. In general, those who are unable to fulfill their minimum needs due to lack of income or wealth are considered to be poor. Poverty is the sum total of a multiplicity of factors that include not just income and calorie intake but also access to land and credit, nutrition, health and longevity, literacy and education and safe drinking water, sanitation and other infrastructural facilities.
The discussion on poverty largely revolves around the notion of a poverty line: a critical threshold of income, consumption, or more generally, access to goods and services below which the individuals are declared to be poor (Ray, 2002). To determine poverty line based on nutritional requirements, the minimum physical quantities of cereals, pulses, milk, butter, etc. are determined for a subsistence level and then using price quotations, the physical quantities are converted into monetary terms. Aggregating these monetary terms for various physical quantities of commodities, the poverty line is thereby drawn. People whose income is below poverty line are said to be poor. The most common measure of poverty is the Head-Count ratio, defined as the percentage of population living below the poverty line.
The pioneering work by Prof. Amartya Sen and Prof. Martha Nussbaum (1993) put forward another way of analyzing the poverty. They identified it as a lack of capabilities and freedoms. The conceptual foundations of the Capability Approach can be found in Sen?s critique of traditional welfare economics, which typically conflate well-being with either opulence (income, commodity command) or utility (happiness, desire fulfillment). Sen makes a distinction between commodities, human functioning/capability and utility. He argues that the lack of command over commodities (entitlement) leads to decline in the levels of utility and vice-versa. So according to Dr. Sen financial empowerment of the poor is a must to eradicate poverty. Poverty invariably affects all the indicators of human development index. Thus, we should look at a comprehensive picture inclusive of both income and non-income indicators while analyzing overall poverty scenario.
According to the United Nations (UN), almost one-fifth of the world population (1.3 billion) is living in extreme poverty, earning less than one dollar a day. The World Bank estimates that 456 million Indians (42% of the total Indian population) now live under the global poverty line of $1.25 per day (PPP). (The World Bank 2004). This means that a third of the global poor now reside in India. On the other hand, the planning commission of India uses its own criteria and has estimated that 27.5% of the population was living below the poverty line in 2004?2005, down from 51.3% in 1977?1978, and 36% in 1993-1999. Despite significant economic progress, 1/4 of the nation's population earn less than the government-specified poverty threshold of 12 rupees per day (approximately USD $0.25). A 2007 report by the state-run National Commission for Enterprises in the Unorganized Sector (NCEUS) found that 77% of Indians, or 836 million people, living on less than 20 rupees (approximately USD $0.41) per day with most working in "informal labour sector with no job or social security, living in abject poverty."
Studies on poverty indicate that the reason poor households are unable to participate in the development process is their exclusion from the financial system. Financial inclusion is the ease of access, availability and usage of the formal financial system by all members of the economy. These include not only banking products but also other financial services such as insurance and equity products. It has generally been observed that the poor people don?t have access to bank loans. Private money lenders charge very high interest rates. This makes it difficult for poor people to access funds for starting small income generation activities like sewing, buying buffalo, opening a tea stall or some other small shop. Micro Credit caters the need of people for small loans. Micro finance includes support services along with the loan component.
Raghuram Rajan (2008) observes ?India?s poor, many of who work as agricultural and unskilled/semi-skilled wage laborers, micro-entrepreneurs and low-salaried worker, are largely excluded from the formal financial system. Over 40 per cent of India?s working population earn but have no savings. Even accounting for those with financial savings, too large a proportion of the poor lie outside the formal banking system. For example, only 34.3 per cent of the lowest income quartile has savings, and only 17.7 per cent have a bank account. By contrast, in the highest income quartile, 92.4 percent have savings and 86.0 per cent have bank accounts. Similarly, 29.8 per cent of the lowest income quartile had taken a loan in the last two years, but only 2.9 per cent had loans from banks (about one tenth of all loans), while 16.3 per cent of the highest income quartile had loans and 7.5 per cent had loans from banks (about half of all loans)?.
Traditionally, banks have not provided financial services to clients with little or no cash income. In addition, most poor people have few assets or no assets that can be secured by a bank as collateral(Hernando de Soto, 1989). In the absence of formal financial institutions the poor people regularly depends on local moneylenders, relatives or friends for their credit needs. Raghuram Rajan in his report quotes a data from Indian Institute of Social Science (IISS). The data points out that in the 25% of lowest income population (they are extremely poor) 39.8% of credit needs are fulfilled by moneylenders and 39.8% by relatives and friends. Their only 9.6% of credit needs are met by banks 5% by co op societies. In the next 25% of population (relatively poor) only 20.7% of credit needs are fulfilled by banks. Majority of their credit needs are also fulfilled by moneylenders and relatives/friends, 32.2 and 34.3 respectively. The high dependence on informal sources in turn implies that bulk of the borrowing by the very poor is at very high interest rates. Almost half the loans taken by the lowest income quartile carry annual interest rates above 48.4 per cent. The loans taken by second lowest income quartile carry 39.7%.as interest. Non accessibility of formal financial institutions is the reason behind the high interest rate payment of the poor. (Raghuram Rajan 2008)
Implementation of microfinance is a powerful tool for financial inclusion and poverty alleviation. Raghuram Rajan 2008 ?Microfinance is the fastest growing ?non institutional? channel for financial inclusion in India. A key factor that influenced the success of microfinance was its ability to fill the void left by mainstream banks that found the poor largely uncredit worthy, and were unable (or unwilling) to design products that could meet the needs of this segment in a commercially viable manner. Using group-based lending and local employees, microfinance provides financial services (largely credit) using processes that work, and in close proximity to the client. These qualities facilitated the proliferation of microfinance from a virtually non-existent activity in 1990 to a small, but increasingly important, source of finance for India?s poor?. (Raghuram Rajan 2008). In order to address the issues of financial inclusion, the Government of India constituted a ?Committee on Financial Inclusion? under the Chairmanship of C. Rangarajan. The Committee submitted its final report to Hon'ble Union Finance Minister on 04 January 2008. This report also suggests opening specialized microfinance branches / cells. (Rangarajan 2008)
Building inclusive financial systems therefore is a central goal of policy makers and planners across the globe. Microfinance has proven to be an effective and powerful tool for poverty alleviation. In this context, the United Nations announced that year 2005 as ?The International year of Microcredit?, which paved way to microfinance as global attraction for investment and the private sector began to make more serious interest in the field. The same is reflected in the Millennium Development Goals (MDGs) set by United Nations in the year 2000 and international initiatives that have followed. The MDGs are eight goals to be achieved by 2015 that respond to the world?s main development challenges. The MDGs are drawn from the actions and targets contained in the millennium declaration that was adopted by 189 nations and signed by 147 heads of state governments in September 2000. Eradicate extreme poverty and hunger is the first goal in it (Millennium declaration 2000). Towards achieving the goals the UN General assembly adopted 2005 as the international year of micro credit to ?address constraints that exclude people from full participation in the financial sector?. International conference on financing for development in 2002 explicitly recognized that ?microfinance and credit for micro, small and medium enterprises as well as national saving schemes are important for enhancing the social and economic impact of financial sector?. (Obaidullah and Tariqullah 2008)