How did microfinance start? What were the solutions before it was invented?
Muhammad Yunus, a Bangladeshi economist, founder of the Graamen Bank, and Nobel Peace recipient in 2006, pioneered the concept of microfinance in the 1970s. But microfinance is, in fact, an ancient practice used during the age of Babylonians.
In the beginning: Rotating savings and credit association (ROSCA)
In India, microcredit appeared 3,000 years ago. It took three main forms: Traditional private lenders, merchants’ guild and rotating savings and credit association (ROSCA).
ROSCA consists of a group of people building a savings and lending cycle. Members meet regularly and every one of them contributes equally to a fund financing the revolving loan of which each member benefits during the cycle, each one in turn. This system was created centuries ago in different parts of the world. It’s called “tontine" in Africa, "andas" in Mexico, "pasanaku" in Bolivia, "arisan" in Indonesia, "cheetu" in Sri Lanka, ''esusu'' in Nigeria... This form of savings is still in use today.
In the XIXth Century: Micro loans and collective savings to face crisis
In Ireland, after the great famines of the XVIIth and XVIIIth centuries, national thinker Jonathan Swift advocated the microloan, which allowed breaking the poverty cycle. He set up the Irish Loan Funds that supported up to 20% of Irish families every year.
In Germany in 1848, Mayor Friedrich Raiffeisen was trying to bypass private lenders. He realized that savings cooperatives were more effective than charity to allow poor people to get out of their dependency on private lenders. He created the first Credit Union, with in the end reached 2 million farmers. The idea was taken up in Europe and North America, followed by Indonesia and Latin America.
In the 1970s: The Rebirth of Microfinance
Experimental programs are launched in Bangladesh and Brazil, where social micro loans are granted to groups of women investing in micro businesses.
Microcredit was given a boost thanks to Professor Muhammad Yunus. After studying the ineffective and unproductive economic model of poor craftswomen, he decided to create an institution to help these women: the Grameen Bank. The first modern microfinance bank was born.
Professor Yunus completely upended traditional bank prejudices by proving that the poor were very reliable at repaying their loans.
Towards the XXIth Century
At the end of the 1990s, the success of microcredit allowed for the development of microfinance, which includes a range of financial services intended for poor people: Credit, savings, insurance, and support.
There is a growing securitization of microfinance, which must be supervised and regulated so that microfinance remains a social tool for the development of poor populations.
Microfinance: halfway between humanitarian aid and banking?
Microfinance is one of the few development tools created in a developing country for developing countries. It was developed in collaboration with humanitarian action and thought of as a complementary component.
Indeed, most MFIs were initially development NGOs that diversified their activities and decided bit-by-bit to concentrate on microcredit activities. Besides, self-managed cooperatives or unions began to grant microcredits too, also offering savings options to meet the needs of their members. The microfinance sector gradually developed eventually attracting the interest of banks which entered the sector by adapting their products to the context and scale of microfinance.
Growing regulation of the sector, proof of its professionalization?
For the last few years, there has been an increase in the number of regulations in the microfinance sector. They have been implemented by governments willing to organize microfinance activities in their respective countries, including microfinance programs in their own public development policies and protective measure for their citizens.
The interference of the State and of the regulatory authorities is necessary and advisable in microfinance. By regulating the activity, they offer political stability indispensable to the development of the sector. This change is proof of the growing interest in microfinance, commensurate with its success, and contributes to its professionalization.
However, it is important to let the private sector, of which experience and professionalism are well known, take care of the microfinance programs. The direct interference of governments in the operational field may be unfortunate and counterproductive. For instance, some governments impose an interest-rate limit. However well-meant, this often results in being an obstacle for MFIs, which have to charge high interest rates to balance their accounts. Other governments impose the same regulations as the ones created for commercial banks on all MFIs willing to collect savings.
If the regulations are established after the microfinance sector is already well-developed in the country, its effects will be to limit any abuses while encouraging the activities of regulated MFIs.
On the contrary, strong regulations imposed in the initial stage of development of the microfinance sector in the country will result in limiting innovation and preventing the sector (usually MFIs and NGOs in this context) to take root with the most destitute populations.
Is financialization making microfinance more effective ?
A debate in microfinance opposes two visions :
For some, the best way to grant microcredits to a larger number of people is through achieving financial stability quickly in order to encourage activities and have a sustainable envirnoment for the long term. This vision gives priority to access to microcredit and to the continuation of its activities.
For others, the priority is not only the lending aspect to beneficiaries, but also the technical support and training programs if necessary. On the basis of this vision, MFIs need more time to reach financial balance and are more dependent on subsidies.
To summarize, the second group has its focus on the social mission of microfinance programs while the first will direct its attention to find financings allowing it to increase its loan portfolio.
With investment funds entering microfinance sector, MFIs’ growing financing needs are met, but investors, looking for a return on investment, naturally tend to invest in largen and more stable MFIs rather than in small and medium MFIs that are expanding their operations. Or, more rarely, they will finance small MFIs but impose a more restrictive work model, at the expense of their initial social mission.
This is the reason why Babyloan prefers to conclude partnership with smaller and medium-sized MFIs, allowing them to carry out their growth plans and financing operations without sacrificing social mission or core values.
General public: a new player in microfinance?
There are many players in microfinance : Beneficiaries, MFIs, governments and regulatory authorities, but also backers. Nowadays, a MFI is on average financed 75% locally, by loans from local banks or credit unions, with the remaining 25% from private investment funds or international backers (development agencies and other multilateral foundations). These sources of financing are expensive for MFIs (reaching an average 10% per year), reducing their ability to allocating additonal funds towards training programs or support to beneficiaries.
Given the situation, the general public certainly has a role to play. Indeed, by granting social (interest-free) loans through Internet platforms such as Babyloan, or through community funds such as Babyfund, the general public allows MFIs to have access to financial resources that are more affordable than market rates. With this philanthropic financing, MFIs can increase support to beneficiaries, achieve economic balance more quickly and reduce their interest rates.