BANKS: by Jeffry Babb News Weekly
Microfinance: money for the people that banks ignore
, May 12, 2012
Microfinance is not a new idea. The Franciscan monks founded community-oriented pawnshops in the 15th century. Microfinance is really just a word for providing financial services for poor people who are ignored by established financial institutions. Usually, the poor simply don’t have enough money to make it worthwhile for commercial banks to handle their business.
Efforts to rescue the poor from the clutches of rapacious money-lenders go back centuries, often led and inspired by clergymen. Early credit unions encouraged the poor to pool their limited resources for their mutual benefit.
Canada, for example, has a strong credit union tradition. Microfinance in Francophone Canada was originated by Quebec journalist Alphonse Desjardins (1854-1920). Some 30 years later, Father Moses Coady (1882-1959) introduced credit unions into Nova Scotia, to bolster an area plagued by poverty and out-migration.
In Australia, the state banks and the Commonwealth Bank were established to serve the needs of working people who were ignored by the major commercial banks. These institutions had little incentive to make profits and justified their existence by providing finance at concessional rates for housing. When they stopped doing that and ventured outside their area of competence — as happened in the 1980s with the State Bank of Victoria, especially with it merchant banking arm Tricontinental — they went down the gurgler.
The reason microfinance is important is that it provides a financial lifeline for many poor people who would otherwise remain mired in poverty. The trouble with the conventional banking system is that the relatively small amounts of money that the less well-off deal in are not commercially feasible for conventional banks.
Take, for example, an Indian microfinance lender. If a microfinance institution lends $100 (a typical amount), it will be repaid over 52 weeks, meaning a repayment of about $3 a week. In the unlikely event the borrower has a bank account, it can be debited directly from the account.
The more likely scenario is that an agent will turn up on the borrower’s doorstep and ask for the instalment of the loan that is due that day. That is a very expensive way to collect money. Consequently, interest rates are high to cover those costs, in excess of 20 per cent per annum.
The big selling point for micro-lenders is that they lend mostly to women — commonly, in excess of 90 per cent of borrowers are women. These loans are not made for consumption; they are made with the intention that they will be used to set up a business or generate income in some other way, such as buying livestock.
In India, the borrower might buy a cart to sell fruit; in Bangladesh, she might buy a sewing machine; in the Philippines, she might set up a sari-sari store, which is a small shop selling rice, canned fish and so on. Her husband might get a loan to buy some piglets to raise for sale. The reason lenders prefer women is that they are more reliable in making repayments and they are more likely to use the money for its intended purpose.
This form of finance fits very neatly with the economic principle of subsidiarity, which holds that matters should be handled by the smallest, lowest or least centralised competent authority. As mentioned above, clergymen have played a large part in establishing microfinance as a viable enterprise. Among them are two Polish priests, Piotr Wawrzyniak and Augustine Szamarzewski, who established cooperatives during the 19th century, which became commercially viable and freed the Polish peasant from reliance on money-lenders.
The famous Grameen Bank — which. along with its founder Muhammad Yunus, won the Noble Peace Prize in 2006 — has done wonders in Bangladesh; but its model does not seem to be perfectly transferable. Its funding comes from bonds issued by the government of Bangladesh. The bank, which was founded in 1976, now has some seven million customers, most of whom are women.
Microfinance has now spread to many countries, but each model is different. Microfinance is not charity. Its loans must be repaid. In some areas, people are so poor that a cash economy barely exists and charity may be the only suitable way of raising their income.
Some charities do work in microfinance. Opportunity Australia, for example, provides support for micro-financiers, particularly in India. It works in this way. Opportunity Australia recruits donors who can make a substantial donation immediately. That capital is used to leverage commercial loans for microfinance lenders, in much the same way that a deposit on an investment property can leverage a mortgage.
The commercial loans come from banks, which would not normally lend to micro-financiers but who will lend against the capital “deposit” from Opportunity Australia. That way, donors get maximum “bang for their buck” and administration and marketing costs are minimised.
On the other hand, most charities these days want donors to commit themselves to a regular monthly donation plan, with the money coming straight out of the donor’s bank account. What they don’t tell you is that a donation plan lasts on average for around 18 months, but the payments for the first 12 months go straight to the marketing company that recruited the donor!
Opportunity Australia recruits donors who can make a substantial donation immediately. That minimises marketing costs and appeals to people in business and finance who see the logic of the Opportunity Australia scheme and have the resources to make a substantial one-off donation instead of smaller monthly donations.