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Microfinance: Theory and Practice Beatriz Armendariz Littauer 323 Lecture 1: Overview.

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Presentation on theme: "Microfinance: Theory and Practice Beatriz Armendariz Littauer 323 Lecture 1: Overview."— Presentation transcript:

1 Microfinance: Theory and Practice Beatriz Armendariz Littauer 323 Lecture 1: Overview

2 Microfinance: “formal” financial institutions delivering credit & other financial services to poor individuals without collateral Salient features: Technology credit delivery often attributed to Muhammad Yunus (Peace Nobel Prize 2006) Main idea: group lending under joint responsibility (GLJR)  High repayment rates at “affordable interest rates) Idea has been widely analyzed theoretically: GLJR circumvents: adverse Selection, moral hazard, and enforcement  lower than usurious interest rates

3 GLJR rooted in: ROSCAs Informal credit arrangements among individuals acting both as lenders and borrowers. Defaults averted under the threat of social sanctions 19 th Century Credit Unions Villagers that are linked by a “common bond” and where the threat of stigma or social sanctions prevents individuals from defaulting

4 Main innovations introduced by Yunus in 1977 and parallel efforts in Latin America 1) Foreign savings mobilized a) via donations from charities and multilateral organizations, b) via private entrepreneurs in recent trends pertaining for- profit microfinance institutions, and c) via “social business” or “socially responsible” investments

5 2) Strong biased in favor of women for two reasons: a) Donors’ standpoint: women are the main brokers of health and education; empowerment concerns, and gender equity concerns (in line with the millennium development goals (MDGs). (Pitt and Khandker (1998 JPE article in your syllabus) have helped to reinforce this view: “Consumption increases by 18 taka for every 100 taka lent to women; and only 11 taka for every 100 taka lent to men” b) Microfinance enterprises’ standpoint: women are more conservative in their investment behavior, have no access to other sources of credit, among others…

6 Recent research, however, shows that: GLJR under the threat of social and bank sanctions is not the only way to ensure high repayment rates. In particular: a)Under individual loan contracts, a non-refinancing threat may suffice b)All forms of collateral (precious to the borrowers more than to the lenders) can be equally effective c)Public repayments can be imposed as a way to insure that social sanctions are effective And this has in turn popularized microfinance in sparsely populated areas. Eg., Eastern Europe and Latin America d) Aside for an under-provision of savings and basic insurance, microfinance is not under-serving farmers in most developing countries, not even now (commodity prices crisis)

7 Managerial Issues Microfinance enterprises struggle to meet a dual objective of alleviating poverty on the one hand and attaining self-sustainability on the other Conflicting objectives have often led a number of practitioners to bias their managerial skill – formation in favor of one Managerial skills in microfinance also change across regions: Asia versus Latin America, for example Some researchers and practitioners would argue that microfinance should move away completely from “dual objective”. Some even suggest that the core poor qualify for grants not loans. (PROGRESA/OPORTUNIDADES, for example Over-emphasizing self-sustainability and growth has its dangers, however….

8 Let us now turn to the issue of “subsidies” (next class in greater detail) Ever since microfinance was invented, most NGOs and for-profit institutions have benefited from subsidies because social objectives However, critics would argue that such subsidies are either detrimental or not needed because (among other things): a)Microfinance enterprises can easily attain self – sustainability and make profits a)Competition among microfinance entrepreneurs will prevent for-profit institutions to charge astronomical interest rates A way to tone-down the anti-subsidy critics is the idea of “smart subsidies” Infant industry argument? Skill acquisition? Poverty alleviation?  Next class

9 Other exceedingly important challenges: Based on growth estimates, heavily subsidized microfinance remains at its infancy: 1)Far less than expected households have benefitted from microfinance products 1)Not necessarily the core poor 3) Microsavings and microinsurance still exceedingly small 4)Potential “mismatch” between what microfinance institutions offer and what the potential clients would wish 4) Regulation 5)Interest rates -  Next Class: Armendariz – Morduch (2005) Chapter 1: Rethinking Banking


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