Microfinance: A Cure for Poverty

When Muhammad Yunus founded the Grameen Bank in Bangladesh, little did he know that his idea would become so successful that there would be debates as to whether it can significantly reduce poverty from the entire planet?

Microfinance has rapidly risen from its humble beginnings in the remote villages neighbouring Chittagong in Bangladesh. Many financial organizations in the world have backed the idea of microfinance. Organizations like the World Bank are amongst the leading investors as more than $20 billion have been aggregated to replicate Muhammad Yunus’s experiment on a very large scale globally.

In this article, we will discuss the concept of microfinance as well as how it is supposedly assisting in reducing poverty.

The Logic behind Microfinance

Believers of the free market are of the opinion that politicians cannot possibly legislate poverty out of existence. They believe that magical laws and social schemes which promise to eradicate poverty are mere pipe dreams used by politicians for their own sinister purposes. In reality, the only people that can drag the poor out of poverty are the poor themselves. The poor need to be industrious and create micro industries which allow them to fend for themselves and not depend on seasonal employment for their sustenance. Hence, microfinance believes in alleviating people out of the cycle of menial employment in the form of landless labor or labor intensive jobs.

According to this doctrine, the poor do not require welfare handouts and neither do they require trade unions or minimum wage laws. Instead, they need some seed capital, a small loan which they can use to kick start their micro industry. They can then use this seed capital to fend for themselves and end their dependence on exploitative corporations. This premise is the building block of the concept of microfinance.

How Microfinance Works ?

Microfinance is the business of providing these poverty ridden people with these seed loans that will eventually help them come out of poverty. Microfinance institutions typically make unsecured loans to people below poverty lines. A traditional banker would frown at this idea calling it infeasible. People below poverty lines are notorious for not repaying their loans, and they don’t have any assets that can be held as collateral. Hence these loans seem to be heading for disaster the moment they are made.

This is where the microfinance model became innovative. Instead of giving out loans to individuals, the microfinance organization provides loans to groups. If one person in the group defaults, the others are held jointly liable for it. This exerts social pressure on all the individuals in the group. The group, therefore, acts as one cohesive unit and loans tend to get repaid.

Sustainable Business Model: Why for Profit ?

Muhammad Yusuf argued that the business model needs to be “for-profit” for it to be scalable as well as sustainable. Business models which are based on the benevolence of their donors are simply not scalable. Not everybody is benevolent all the time. However, if the model generates its own profit, it is both sustainable as well as scalable. Therefore, microfinance institutions all over the world try to manage their social responsibility with their economic responsibility. If they lean excessively on any one side, the business model may implode.

Also, the business model is based on rising profits as a result of a growing relationship with customers. When Grameen Bank was successful in pulling many of its customers out of poverty, they would sell other financial products like insurance to them. This is where the microfinance organization was able to make substantial profits.

Poverty Reduction

Microfinance allows for the unifications of social as well as economic goals. The beauty of this business model is that eliminating poverty and generating profits cease to be at odds. Instead, both these goals can be simultaneously achieved at the same time. Time and again multiple organizations have proven that this is possible. In countries like India, some microfinance institutions have grown so profitable that they have been able to conduct public issues of their shares and raise millions of dollars from equity markets.

At the same time self-help groups, which are the primary benefactors of microfinance have witnessed a massive increase in self-employment. The number of micro industries and microservice based businesses in rural areas has grown exponentially.

Social Benefits

Microfinance institutions do provide a lot of social benefits. The youth finds itself gainfully employed as a result of microfinance. Their time is spent thinking about a business opportunity which they can utilize to climb out of poverty. As a result of this anti-social activity like crime and addiction have reduced substantially. Fewer people are likely to engage in criminal activity when they have a viable economic alternative.

The idea of microfinance has now become a global phenomenon. There are institutions trying to alleviate poverty by giving out loans in South America, Asia, Africa as well as Eastern Europe! However, many believe that the model is broken and that in due course of time the flaws will become visible to the investing population. In the next article, we will have a look at the disadvantages of the microfinance model.

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