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News tagged as "over-indebtedness"
October 17, 2013

What microfinance? Or how to make microfinance work for the poor

Tags: microfinance, over-indebtedness, self-financed communities | by Laia Oto Llorens & Miquel de Paladella, founders of 1x1Microcredit
Microcredit and microfinance progressed unchallenged until 2010, with virtually no criticism or questioning. It looked like the new panacea for development: access to credit would permanently generate opportunities for the poor to escape poverty. The crisis in India that led millions of poor families to dramatic levels of over-indebtedness generated a credibility gap that helped us understand which practices and services are really helpful for poor communities, and which ones have negative impacts. We have finally learnt that microfinance can be counterproductive, irrespective of our good intentions; and we have also learnt that microfinance can be a powerful tool to increase the resilience of vulnerable communities.

Some microfinance institutions have caused high levels of indebtedness among poor communities due to their aggressive attitude to place capital. In Europe, where financial education is somehow higher than in many other countries, many people have fallen into the trap of over-indebtedness. It is then easy to imagine what has happened in countries with a lower educational level. The lesson learnt is that microfinance cannot be directed by the supply, it should not be driven by the interests of investors to place capital and generate financial return, but it should respond to the demand from the clients. The benefits of microfinance may get diluted by the negative effects of over-indebtedness when microfinance is driven by the offer.

The other major criticism to microfinance focuses on interest rates. This is a complex problem. In populated countries, the costs of microfinance services and therefore the interest rates tend to be lower than in countries where the population is scattered. Domestic inflation also complicates the equation. The major challenge of microfinance is in fact the transaction costs. The costs of managing thousands of small loans to people who are in rural areas, geographically disperse, is much larger than when managing a few large credits to a few clients or companies in the same location. Making microfinance services sustainable and scalable requires a full coverage of all its costs.

One of the most powerful and proven solutions that minimize the adverse effects of credit (they never go away) are self-financed communities, the Bankomunales, or similar systems. The idea is simple: credit is important, but savings are even more critical. Indeed, the poor are able to save money. The proof is that there are more than 250,000 savings groups worldwide. These are groups of 20-30 people who manage their money independently: they put their savings together, and respond to the demands of small loans of its members, and they charge a small interest rate. It is an effective, efficient and affordable way of promoting savings, and providing access to credit for small cash flow problems. In these self-funded communities there is often excessive supply of credit, management costs are very low, and interest rates are set at the discretion of its members. Finally, the profits generated by loans and their interests are shared among all members, which makes the interest rates relatively unimportant.

1x1Microcredit ´s obsession since its foundation has been to increase the resilience of the most vulnerable populations, and helping them escape poverty through useful proven microfinance mechanisms. We saw that the benefits of accessing credit depended on the poor communities’ ability to generate savings and investment schemes that would eliminate the negative effects, reduce transaction costs and increase opportunities. Therefore, we have focused on promoting self-funded communities and offer credit only to those engaged in this type of savings groups.

Self-funded communities however fail to finance investment projects of over 1,000€ or 2,000€. This is where 1x1microcredit gets activated. When members of self-funded communities require larger credits for their projects, 1x1Microcredit provides them access to credit through our partner organizations. They also offer microcredit together with financial education and training, as in the case of Fundación Paraguaya -offering quality training, accompanied by a microcredit- or Diyite, advising women entrepreneurs in their income-generating initiatives.

This is how we expect to make microfinance a powerful tool to support the development of many poor families.

 

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Initiative financed by: Initiative financed by AECID
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