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Economics of Microloans:

Interest rates: Microloans tend to have high interest rates, although not nearly as high as those currently paid by a large number of people in developing countries to local moneylenders. There are three costs that must be covered by MFIs; the first is the cost of the money it lends, this is primarily the cost of what the money could otherwise be doing, it tends to be interest payments on the money to encourage investment. The second cost is the cost of loans that default. The percent of loans that default historically is built into the interest rate of everyone's loans. Finally, there is the cost of running the MFI, the transaction costs that do not scale with the size of the loan. These are the costs that typically keep larger banks from becoming involved in microfinance. Unfortunately, this is also responsible for the high interest rates of these loans. Profitability: It is very possible for microfinance to be profitable, although those serving the very poor tend to be less profitable than those serving the less poor. Still, in November 2001, the MicroBanking Bulletin included data from 62 self-suffiecient MFIs with an average return on assets of 5.5%, with even some that serve the very poor returning over 4%. It is possible for them to not be profitable in some situations, but smart investments with even the very poor can be quite profitable.

Effects of Microfinance:

Studies have found that microfinance has a number of beneficial effects on the public in general and women specifically. General Effects:

• Microfinance helps the very poor meet basic needs and protect against risks.
• Microfinance helps low-income households improve household economic welfare and enterprise stability or growth.
• The magnitude of positive impacts from microfinance is directly related to the length of time in the program.
• Microfinance can smooth consumption levels and significantly reduce the need to sell assets to meet basic needs. Allows for coping with expenses resulting from death, illness, or loss of assets.
• Credit allows the poor access to more economic opportunities by allowing for the planning and expanding of business activities. Many studies have shown that those in microcredit programs tend to become more wealthy than those without, and they sometimes even move out of poverty.
• Microfinance allows poor households to move from thinking about every day survival to planning for the future, allowing them to invest in their children's educations and to invest earnings into better nutrition and living conditions, as well as health care.
• Studies have shown that those with access to microfinance programs were able to improve their individual and household well being much more than those who did not have access to those financial services.
  • In Bangladesh, Bangladesh Rural Advancement Comittee (BRAC) clients increased their household expenditures by 28% and assets by 112%. The incomes of Grameen members were 43% higher than the incomes of those villagers not in the program.
  • In El Salvador, the weekly income of FINCA clients increased by an average of 145%.
  • In India, half of the villagers participating in the SHARE program graduated out of poverty.
  • In Ghana, 80% of Freedom from Hunger had secondary income sources, compared to 50% for non-clients
  • In Lombok, Indonesia, the average income of Bank Yakyat Indonesia (BRI) borrowers increased by 11% and 90% of households graduated out of poverty.
  • In Vietnam, Save the Children clients reduced food deficits from three months to one month.
• Microfinance typically targets poor women to help empower them, promoting gender-equit and in proving household well-being
• Many studies have shown how making women responsible for loans, savings, accounts, and insurance coverage programs improves the status of women in the family and the community, causing them to become more confident and assertive. They have also seen increases in mobility and the ability to negotiate publicly. Women are more likely to own assets, including land and housing, and play a stronger role in decision making.
• Microfinance programs have some influence in lowering rates of violence against women.

Criticisms

For all of these benefits, there are limits to microfinance and there are some definite times when it is not an appropriate method for trying to reduce levels of poverty. When conditions are such that there are severe challenges to repayment, burdening the poor with loans to repay may actually make problems worse. In these situations, grants, infrastructure improvements, or education and training programs may be more appropriate. Examples of these conditions are with populations that are highly nomadic or have high rates of debilitating disease. Also, a dependence on barter as opposed to cash and the presence of hyperinflation or absence of law and order may all make microfinance less attractive of a solution to poverty. Below are some alternatives to microfinance explored in depth:

• Grants: These can be used to overcome some of the barriers to microcredit by allowing the very poor to be put in a place where they can take on the extra risk of a loan.
• Investments in Infrastructure: Investing in roads, communications, and education create jobs directly and also allow for the production of centers of production that may help cultivate small businesses that can take advantage of microcredit.
• Employment Programs: Food-for-work and public works projects that help prepare the poor for self-employment.
• Non-Financial Services: Literary classes, community development, market-based business development services, etc. that will help aspiring small business owners succeed. These programs and microfinance systems sometimes go hand in hand.
• Legal and Institutional Reforms: Creates incentives for microfinance by making regulations more favorable to microfinance lenders and clients. Examples of these reforms include removing caps on interest rates, loosening regulations governing non-mortgage collateral, strengthening the judicial system, and reducing the cost and time of property and asset registration as well as microenterprise registration.

There is also the criticism of microcredit that while it may help individuals graduate out of poverty, it does not necessarily help improve the economic conditions of very poor countries on the whole. The reason for this is that while microloans may allow entrepreneurs to begin businesses without fear of disastrous economic conditions breaking them, it is for this reason that loans tend to not be used for expanding capital or hiring more employees as would ideally occur. Instead, the money is often used for tiding a borrower over in times of crisis or funding a child's education. The benefits listed above all help the individual, not necessarily the economy on the whole, and we must remember that the economies may not work in exactly the same way Western ones do because they are still being established. Most of the small businesses funded by microloans have only one employee, the owner, but funding that generates jobs are the best way to grow economies, which is why the US Federal Reserve lowers interest rates to try to expand the economy, to make taking out loans to hire more people a more favorable business practice. In the US, only 14% of people are entrepreneurs, whereas in Peru, for example, almost 40% are, simply because they don't have other options, and microfinance does not particularly change this situation. Developing countries really need more small-to-medium-sized businesses, rather than microbusnesses, the sort of businesses that general 60% of all jobs in Western economies. These are the companies that currently fall through the cracks, the \"missing middle\" it has been called, those too small for traditional financing sources, but too large for microfinance. There is also the problem of a lack of investors willing to buy ownership stakes in companies of this size. Investors with ownership stakes are a much better source of income than loans for growing businesses. Among other criticisms are the fairness of the high interest rates charged by borrowers. A report by MicroBanking Bulletin in 2006 found the average yield cited by 704 microfinance institutions was 22.3% annually, but this is lower than the rates charged to clients, because those also include local inflation and bad debt expenses. To help face this criticism, Muhammad Yunus has proposed that microfinance institutions that charge over 15% above their long-term operating costs should face penalties. There is also the criticism that microlenders do not do enough to make sure the poor have decent working conditions, especially when the borrowers sell products through an organization controlled by the microfinance institution.

A New Direction:

An important distinction that is being made recently is the difference between saving up and saving down. Saving up is the accumulation of wealth or valuable materials that can be used to produce a valuable final product or service, such as building a new home, financing a child's schooling, etc. Saving down is borrowing money to finance large costs such as buying land, food, or business equipment. The point is being made by some is that microloans only address half of this equation, and that broader microfinance institutions must be created to address both ends of this equation, allowing them to save and accumulate assets. Grameen Bank and two other large microfinance institutions in Bangladesh found that for every $1 they lent to clients to finance microbusinesses, about $2.50 came from other sources, mostly clients' savings. Recent studies have found, however, that informal methods of savings are very unsafe. For example, a study by Write and Mutesaria in Uganda found that those who saved in the informal sector lost around one quarter of the money put in. Microfinance is moving away from focussing only on lending and helping the poor save as well, there is a movement away from microcredit and towards a financial systems approach. There are four different categories of microfinance providers that must all be engaged in any attempt to develop a system-wide approach for microfinance.

• Informal Financial Service Providers: Examples of these include moneylenders, pawnbrokers, savings collectors, money-guards, ROSCAs, ASCAs, and input supply shops. These tend to offer very flexible, convenient, and fast services, but are also very costly and are at times viewed as predatory. The financial product choices are often limited and very short-term.
• Member-Owned Organizations: These include self-help groups, credit unions, and organizations such as CVECAs. These are also typically small and local, allowing them to be flexible and convenient. They have low costs of operation because they are operated by the poor. The providers tend to have little financial skill, however, and they may fail if the economy turns or their operations become too complex. They can become easily compromised if they are not effectively regulated and supervised with one or two influential leaders taking advantage of the group.
• NGOs: As of the end of 2005, there were 3,133 microcredit NGOs lending to about 113 million clients. These institutions have managed to make lending to the poor a profitable enterprise.
• Formal Financial Institutions: These include commercial banks, state banks, agricultural development banks, savings banks, rural banks, and non-bank financial institutions. These institutions are regulated and supervised, offer a wider range of financial services, and control a branch that network that can extend across the country and internationally. They tend to not adopt social missions, however, and so often do not deliver services to the poor due to higher operational costs.

Each of these four types of institutions need to be integrated to solve the microfinance problem. For example, efforts are being made to connect self-help groups to commercial banks to network member-owned organizations to create a scale large enough for commercial banks. There are also efforts to help commercial banks be more profitable at lower scales by integrating mobile banking and e-payment technologies into their branch networks.