PROs and CONs of Microfinance: An Overview

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Microfinance > Best Practices > PROs and CONs of Microfinance: An Overview

PROs and CONs of Microfinance: An Overview
Elwin Poortman, Analyst, Netherlands, Premium Member
Microcredit has been seen as the magic bullet that can help the poor to escape poverty, however in recent years the flaws of microcredit schemes have become more clear and have shown that not everything about lending to poor is beneficial. The authors of Poor Economics elaborated on these pros & cons, and the major ones are explained below.

Benefits of Microfinance:
  1. Opportunity to invest and gain access to markets & industries that were inaccessible before, due to a financial threshold.
  2. Empowerment, especially for females, since they are less financially and therefore socially dependent.
  3. Microfinance often takes place in groups so that each individual is responsible for the entire group’s investing behavior, which is called joint liability. This increases social capital such as sharing knowhow, partnerships and trust building.
  4. Changing financial markets: The moneylenders that were accessible prior to the rise of Microfinance, were known to have outrageous high interest rates. In order to stay competitive, they are forced to lower their rates.
Limitations of Microfinance for the Borrower:
  1. Lacking extensive knowhow on investing and how to conduct a proper profit & risk analysis.
  2. Spending money on commodities such as food & health care may appear attractive since it can improve the well-being of the borrower in the short term, nevertheless the direct financial returns of these commodities are limited.
  3. The short timespan of the loan limits investment opportunities. The timespan causes that investing in long term opportunities, such as education, is not possible.
  4. Similar strategies due to limited investment opportunities. This causes that most micro lenders invest in the same type of investment, for example fertilizer, land, or seeds, these therefore often increase in price, making the investment less profitable.
  5. Possibility of an insurmountable deficit that will form a great burden financially but also socially due to the joint liability structure. For example, in India this lead to bankrupt people committing suicide on a large scale.
Limitations of Microfinance for the Lender:
  1. In case of bankruptcy, there is no collateral that could reimburse the deficit.
  2. Profitability is marginal which pressurizes the opportunity to provide services such as assistance, monitoring, and consulting, and therefore risk increases.
  3. The short term benefits of a loan are more attractive than the long term liability that comes along with it, this may trigger too many people to get a loan, which can have serious consequences.
⇒ What advantages or limitations of microfinancing did I miss?

Source: Banerjee & Duflo (2011). Poor Economics: A Radical Rethinking of the Way to Fight Global Poverty. New York: Public Affairs.

Another Disadvantage of Microfinance
Karl West, Accountant, United States, Member
Hello Elwin, I would submit that innovation cannot occur with microcredit.
While innovation itself is truly powerful in pulling people out of poverty or the condition of being poor relative to the rest of their society.
However innovation does take time and can probably not be played out on a micro scale to determine the viability of a new vision.
That's why in my opinion Microfinance might help out many families in small ways, but the overall macro impact might not even register socio-economically in a region.

Good Support is Needed for Microfinance
jorge anibal hoyos hoyos, Manager, Colombia, Member
Good results depend upon the good advise and monitoring accompanying the investor in marshaling the resources from the bankers helping them out. Without this opportunity it is impossible to decimate poverty. Without the confidence from the bankers and the control when applying the money on doable projects it avails to nothing. It has been shown that poor people duly supported are the best payers.

Support of a Regional Development Scheme
Niko, Consultant, Slovenia, Member
@Karl West: Micro credit does not aim to start innovation. It helps to develop small business opportunities based on existing skills and products.
I have been involved in the analysis of a small microcredit grant scheme. Few hundred small business got some "fresh push" out of it. And one innovation that turned to success for the team. But there were other factors involved (business incubator, technology center…).
IMHO microcredit is one of the ingredients in the regional development. It aims at helping people who want to work to start their business or to take the next step.

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