MICROFINANCE AS A FINANCIAL SERVICE

INTRODUCTION 
Microfinance is regarded as an effective tool for poverty reduction.
The World Bank has proposed a set of strategies for attacking poverty: promoting opportunity, facilitating empowerment, and enhancing security. Microfinance provides access to financial services that can help to reduce poverty by both promoting opportunities and facilitating empowerment. In general, formal financial services are not available to poor people because of the high-interest rates, collateral requirements, complicated application procedures, and long admissions processing. The high-interest rates caused by high transaction costs are ascribed to the lack of collateral and the small loan amounts desired. The biggest contribution of microfinance has been showing that lending to the poor is feasible and that keeping good repayment records is achievable when institutions are appropriately designed. One of the successful models of microcredit is Grameen Bank, which provides loans to 7.9 million borrowers, of which 97% are women. The bank's accumulated loans are worth US$8.17 billion and the repayment rate is 98%. Other successful microfinance institutions (MFIs) are Banco Sol in Bolivia, Bank Rakyat Indonesia (BRI) in Indonesia, and ASA and SafeSave in Bangladesh. Various types of MFIs are now operating around the world.
These successful experiences of MFIs have prompted academic studies to identify the mechanisms for solving the problems associated with asymmetric information. Although many studies are being conducted, the practices of microfinance continue to evolve and are rapidly expanding in scope. Reflecting the increased interest, the United Nations set the year 2005 as the “International Year of Microcredit,” and, subsequently, Dr. Muhammad Yunus and Grameen Bank were awarded the Nobel Prize for Peace in 2006. These successive events were the outcome of the good reputation for the performance of microfinance over several decades which led to a new phase in microfinance. Microfinance has attracted the attention of various circles who consider it a good business opportunity. As a result, the microfinance “field” has changed into a microfinance “industry,” and the idyllic era that just celebrated the success of Grameen Bank is now over. In fact, Grameen Bank itself has introduced a new credit scheme, Grameen Bank II, as well as a Grameen Bank mobile phone program and GrameenObopay which makes full use of information technology.
As the industry has grown, the focus of microfinance has shifted from that of a social movement to the integration of microfinance into the formal financial sector. This integration has led some to argue that microfinance and formal financial business are irreconcilable; they condemn the practice of pursuing profit as deviating from the mission of microfinance (regarded as mission drift). For example, in 2007 Banco Compartamos, one of the biggest MFIs in Mexico, held an initial public offering (IPO). Shareholders sold 30% of their existing stock holdings, resulting in a record amount of profit taking. Dr. Yunus criticized Compartamos for being on the moneylender's side and asserted that Compartamos, which charged 100% interest on some loans, was generating profits on the backs of poor people to win investors' money, compromising the movement's idealistic principles.
There are arguments for and against microfinance institution IPOs and profit taking, but what is important is the fact that dynamic changes in microfinance are continuously expanding its scope and transactions with various types of circles. At the same time, this substantial expansion is increasing the possibility of access to financial services for poor and lowincome people. By narrowly defining microfinance, one can limit its prospects in poverty reduction and in seeking out promising microfinance opportunities.
MICROFINANCE AS A FINANCIAL SERVICE 
A.  What Is Microfinance?
What is microfinance? Microfinance offers poor people access to basic financial services, such as loans, savings, money transfer services, and microinsurance.5 Initially, MFIs provided microcredit as their sole financial product. Among the various types of microcredit schemes, which vary according to location and MFI, Grameen Bank is regarded as the prototype of microcredit. Grameen Bank credit is motivated by a social mission: its ultimate goal is overcoming poverty, empowering the poor, especially women, and supporting startup selfemployment businesses. In essence, the schemes involve noncollateralized, jointly liable, groupbased lending with a frequent installment schedule.
Today, group lending is just one element that makes microfinance different from conventional banking. There are several other elements that make microfinance work effectively, including progressive lending, repayment schedules with weekly installments, public repayment, and the targeting of women. As a result, lending that does not involve groups has increased.
In this issue address the impacts, innovative mechanisms, and recent challenges of MFIs through a review of the existing published literature. Specifically, they describe the accumulated empirical evidence on microcredit, the recent theoretical developments on the mechanisms underlying the high repayment rates, and the problems and possible remedies associated with microinsurance operations. The distinction between this article and previous literature surveys, such as, is that the authors focus more on recent topics and draw attention to new theoretical developments in a comprehensive way through the use of simple models.
B.  Microfinance as a Financial Service
In the 1960s and 1970s when microfinance was mainly provided through the public sector, its usefulness was discredited as a result of the low repayment rates due to lax government management. But microfinance schemes have succeeded in broadening financial outreach to the poor and have demonstrated that a high repayment rate is achievable. Furthermore, the pioneering Grameen credit schemes showed that microfinance consists of various elements, including poverty reduction, empowerment of the poor, increasing income, creation of business opportunities, investment, and family risk management. The emphasis of microfinance has been on poverty reduction and empowerment, i.e., the social mission, but in recent years, the focus has shifted from social aspects to financial function. Although the benefits of access to financing are clear, poor people were widely considered “unbankable,” as the small amounts of their loans and deposits are costly and unprofitable products for banks. However, decades of experience in microfinance have revealed that the problems of the high transaction costs associated with information asymmetry can be solved with appropriate institutional designs and improvement of the financial system.
Development practitioners are becoming all the more convinced of the importance of the financial system. Efficient, wellfunctioning financial systems are crucial in channeling funds to productive uses and in allocating risks to those who can best bear them, thus boosting economic growth, improving opportunities and income distribution, and reducing poverty. Therefore, the importance of financial access, which entails not only obtaining credit but also making deposits and money transactions, and obtaining insurance, has become broadly recognized.
In developing countries, especially in rural areas, the credit market is segmented. Information problems in the rural credit market are severer than in urban and conventional markets; hence, it is easy for poor people in rural areas to face financial constraints. One of the important roles of finance is to allocate credit to optimize the intertemporal problems of output and consumption. Without a credit market, people have to cover their consumption and investment using their income in the current period. The income of poor people, however, is too small and unstable to sufficiently cover both consumption and investment. For instance, a sudden decrease in income because of illness of the head of a household means that family members have to find another income source. If this is impossible, they have to reduce their investment and consumption. Because poor people are generally quite vulnerable to unfavorable incidents and unexpected risks, reducing investment in education leaves the next generation poor, and the vicious circle of poverty never ends. Financially constrained people have to prepare for unexpected risks by themselves, meaning that risk management is much more important for poor people. Therefore, risk management, encompassing loans, savings, and insurance, is a crucial role of microfinance.
It has been said that poor people are too poor to save money, and, hence, there is no demand for savings. Theoretically, household members might simply be too impatient to save sufficiently. However, saving is a core principle of risk management for households.
Insurance is an effective measure for coping with risk, which has made microinsurance the focus of an important financial service. Microinsurance is defined as the protection of lowincome people against specific perils in exchange for regular monetary payments (premiums) proportionate to the likelihood and cost of the risk involved. As with all insurance, risk pooling under microinsurance attempts to allow many individuals or groups to pool risks and redistribute the costs of risky events within the pool. The definition of microinsurance does not differ from conventional insurance, except for the target: lowincome people. However, microinsurance is not just a scaleddown version of conventional insurance.
Micro insurance has different marketing channels: small communitybased schemes, MFIs, or partnerships with large and multinational insurance companies that offer microinsurance. As the conventional, marketbased distribution system has not served lowincome people adequately, the establishment of a different distribution channel has been necessary. The features of micro insurance are: group pricing with links to other services, limited period and scope of coverage, limited screening on preexisting conditions, simple and easy to understand policy document, and smaller indemnity.
Although the greatest demand is for health insurance, such insurance is likely to be more difficult to market than life and property insurance because: (1) a third party is necessarily involved (e.g., a healthcare provider); (2) a number of classical insurance problems apply (e.g., those more likely to get sick are more likely to sign up and those who are insured are more careless and overuse health services), which makes insurance costly for all involved; and (3) the only policies that are affordable to poor people are those that are highly restrictive in terms of the kinds of benefits offered.
These difficulties of micro health insurance are examined by in this issue using survey data from India. Microinsurance is at an early stage of development in India, where a uniform product is being offered to poor people. There are, however, problems: low takeup rates, high claim rates, and low renewal rates. The authors endeavor to investigate the causes of these practical but basic problems based on recent insurance literature and behavioral economics literature, along with experimental survey data. Novel and advantageous features of this article are its application of behavioral economics to microfinance and its utilization of experimental survey data to discern household characteristics that affect the purchase of health insurance.
OBJECTIVES AND MISSION OF MICROFINANCE 
A.  Paradigm Shifts
There have been two paradigm shifts in the microfinance field. During the 1960s to 1980s microfinance focused on agricredit or microcredit subsidized by government and/or donors to small farmers; after the 1980s the target shifted to the poor. The first paradigm shift began to emerge in the second half of the 1980s. The new paradigm recognized the problem of high transaction costs and risks because of information asymmetries, and the focus became the building of costefficient MFIs.
The second paradigm shift emerged in the middle of the 2000s. This shift was from microfinance to inclusive finance, from supporting discrete MFIs and initiatives to building inclusive financial sectors. In 2004, the Consultative Group to Assist the Poor (CGAP) endorsed the “key principles of microfinance.” These principles were explained within a framework for an inclusive financial system. The framework recognized that the massive number of excluded people would gain access only if financial services for the poor were integrated into all three levels of the financial system: micro, meso, and macro. Within this framework, poor and lowincome people are the clients at the center of the financial system. The micro level of inclusive financial systems consists of financial service providers that offer services to poor and lowincome clients. The meso level includes the financial system's basic financial infrastructure and its range of services. The macro level consists of an appropriate government legislative and policy framework. Traditional microfinance focused on the micro level of financial providers, but current microfinance focuses on a more comprehensive financial system.
The second paradigm shift can be described as a shift from a productcentered to a clientcentered approach. The productcentered approach is one where microcredit organizations offer a standardized product targeted to the “average client” during “normal times.” By contrast, a clientcentered approach focuses on identifying and meeting the effective demand from both current and future clients.
B.  Ultimate Objectives of Microfinance
Although the perspective of microfinance has widened, essential microfinance objectives remain unchanged. Outreach to the poor is one basic motive, and making a positive impact and maintaining financial sustainability remain important focuses. 
1.    Outreach and mission drift
Although microfinance continues to expand, many poor people still remain mired in poverty. The fact that outreach to the poorest of the poor is not being achieved has provoked criticism that microfinance has drifted from the mission. As the microfinance industry has grown, financial sustainability has been increasingly emphasized. The concern about financial sustainability has led to MFIs commercializing or scalingup, which is suspected of interfering with further outreach and bringing on mission drift. The process of scalingup, mainly by the involvement of large donors, may lead to an increase in the size of loans and the inclination to lend to wealthier people.
2.    Anecdotal episodes and evaluation of impact
There have been a large number of microfinance success stories over the past few decades. Such anecdotal episodes may have encouraged poor people to borrow money, leading to the rapid expansion of microfinance. This expansion has been assessed mostly based on the increase in the number of borrowers and MFIs, the increase in the total amount of loans, and the high repayment rates. Recently, more rigorous efforts to evaluate the impact of microfinance have been conducted in place of only evaluating quantitative expansion. However, accurately assessing the impact of microfinance is not straightforward. To accurately gauge the effect of microcredit, it is necessary to compare a client's situation with a counterfactual situation where microfinance is not provided, which cannot be readily examined.
3.    Financial sustainability and commercialization
The commercialization of MFIs is one solution for financial sustainability. One of the reasons that transformation or commercialization of MFIs is important is the increasing demand for savings. The focus on the importance of savings for poor people is a recent development. In general, a microcredit provider cannot be allowed to accept deposits from the public. Almost all countries require an organization to have a license for collecting savings. To obtain a license, a certain level of management skills and size as a financial intermediary is required, thus the transformation or commercialization of microfinance comes into play.

Nitisha Mandhanya (B.Com.)
Fintech Intern Air




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