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5.8 microcredit in low middle income contexts
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5.8 microcredit in low middle income contexts



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  • 1. Microcredit Claudio Di Benedetto Project Engineer of EWB-MI PhD Students at DIG 01/04/2014
  • 2. History of Microcredit Programs: • Saving and Credit Group • Formal Saving and Credit Institutions (poor) • Model Adaptation to rural context (Rural Support Program) • Modern Microcredit (Muhammad Yunus) Period 1700s 1800s 1900s 1970s
  • 3. Microfinance Definition A small financial loan made to poverty-stricken individuals seeking to start their own business Microcredit, or microfinance, is banking the un- bankables, bringing credit, savings and other essential financial services within the reach of millions of people who are too poor to be served by regular banks
  • 4. Microfinance  Micro-credit  Micro-saving  Micro Insurance  Remittance Management
  • 5. Microfinance Outreach
  • 6. Regions Outreach
  • 7. Grameen Bank
  • 8. Microcredit and Poverty Cycle
  • 9. Microcredit Target
  • 10. (Micro)credit Market (Information Asymmetry theory) Borrower has more or better information than lender In developed countries use of material collaterals (guarantees on loans) Microcredit is a “contract mode” that reduces Adverse Selection and Moral Hazard based on Social Collaterals
  • 11. Economics of Microcredit Microcredit officers by using Innovative Lending (Group) Methodologies are able to distiguish Low Risk Debtors vs High Risk Debtors (Adverse Selection) and Provide the right incentives for the action (Moral Hazard)
  • 12. Mechanisms to reduce Information Asymmetry  Group lending (joint liability)  Threat of non-renewal  Rotating access to credit  Weekly repayment  Forced savings  Meeting participation  Village meeting  Women borrowers  Dynamic incentives Adverse Selection Moral Hazard Moral Hazard Self-signaling Self-signaling Self-signaling Social Pressure Adverse Selection Moral Hazard
  • 13. The lending methodology adopted in every specific context from Bangladesh to South America blends some of the previous mechanisms, but the way in which do that depends on local context, and so does not exist a best lending methodology in absolute, especially if is not well linked to the specific social, cultural, economic and legal environment of the place in which operates. Best Lending Methodology
  • 14.  Individual lending: is the oldest form of micro-lending – generally approximates traditional commercial bank lending. Modify bank methods to meet the needs of low income borrowers.  Latin American Solidarity Groups: consist of four to seven members. Groups self-select members and guarantee each other’s loans (joint liability). Initially, most of the clients were female.  The Grameen Bank: lending programs form small, five-member self-selected solidarity groups that are then incorporated into village “centers”. Clients are women, members assume responsibility and manage themselves, making decisions. Conventional Microcredit Models
  • 15. Village banking: community managed loan fund methodology, 30 to 50 members, mostly women. By this methodology village bank will be independent financially and in the administration and management. Approach successful in reaching the rural poor (income-generating activities).  Credit unions: rely totally on the savings and fees paid by their members. They are financially independent from their creation. Community-based often consist of 30 to 100 members. CUs set their own terms and conditions for loans. Conventional Microcredit Models
  • 16. Loans Type Enterprise Loan are for establishing a new business or expanding an existing one with the aim of enabling the borrower to secure a sustainable livelihood Liberation Loans are for repayment of loans taken from money lenders on exorbitant high interest rates The Education Loan caters to the needs of the poor who are unable to finance their own or their dependent’s education The Health Loan is for those who are unable to support the costs for necessary health care
  • 17. Loans Type The Emergency Loan is intended to diffuse the impacts of major contingencies or crisis situations that undermine the sustainability of the livelihoods of the poor The Housing Loan is for necessary renovation of houses including construction of rooms, roofs and walls The Marriage Loan is to facilitate the marriages of daughters The Silver Loan to support the expansion of existing businesses
  • 18. Sustainability vs Povery Alleviation Interest Rate = Cost of Funds + Loan loss expense + Transaction cost Average MF rate 20% - 37% Money Lenders 200% Transaction cost: (application, evaluation, loan process, disbursing, monitoring and repayment)
  • 19. The Case of Pakistan
  • 20. Riba Despite some discussion among scholars, Riba refers to all forms of interest (Khan 2008). Prohibition of speculation Any form of business activity where monetary gains are derived from mere chance, speculation and conjecture are prohibited Prohibited Activity Activities which are prohibited under the Shari'a (casinos, breweries, etc). Sharing business risk: Funder are not considered creditors but rather investors. Uncertainty is forbidden In commercial transactions must not be any uncertainty about the key terms of the contract. Islamic (Micro)finance Principles
  • 21. Murabaha An asset-based sale transaction used to finance goods. Involves the resale of a commodity, after adding a specific profit margin (mark-up). Mudaraba Financing agreement whereby an investor entrusts capital to an agent for a project. This agreement is akin to the Western style limited partnership. Musharaka Is an equity participation in a business venture. Profits are shared in pre-agreed ratios but losses are borne in proportion to equity participation. Ijarah Is a leasing contract typically used for financing equipment and asset. Qard hasan Borrower should only repay the principal (interest– free), weak or needy sections of society. Islamic (Micro)finance Models
  • 22. Social Innovative Business Model Akhuwat Social Vision: interest-free loans to economically poor (Qard Hasan) Innovative Lending Methodology: Family Loans Sustainability: Transforming Borrowers into Donors Very Open Expansion strategy High Operational Efficiency, Service Quality and Transparency Islamic model (do not limit access due to religious norms)
  • 23. (Individual Lending Methodology)  Family loan is the most common type of loan that Akhuwat offers to its clients for setting up or expanding a business.  Family members have to support the business idea  Loans are co-signed by male and female head of the family  Income from the business is jointly shared by the whole family  Mechanism used: Membership fee, Guarantors, Insurance, Evaluation business idea, family support, public disbursement and repayment, of religious place, interest free loans  responsibility Family Loans
  • 24. Group lending vs Individual Lending • Rural Poor • Strong social ties • Minimize Cost • Empowerment • Urban Context • No strong social ties (Group Leader Role) • Higher Cost • Less Inefficiencies (Timing- Innovative PRJ.- No sharing PRJ. - Higher Amounts)
  • 25. Criticisms  Alleviation of Poverty vs Profit Maximization  Microcredit has driven poor households into a debt- trap  Microcredit has not had a positive impact on gender relationships  Interest rates are too high  The ‘privatizing of welfare’ Strong link to the local context – Integrated Approach