By: Bikal Dhungel
This article is not about rich countries. This can be generalised
for poor countries but I deal with the situation of Nepal.
Nepal has no problem with liquidity. Financial Institutions have
money but only the problem is, they dont want to lend. Why they dont
want to lend is because the large portion of borrowers lack
collateral. Without collateral, it is hard to get any fund from
financial institution. However, every economist or development expert
knows that, availability and access to financial sector is crucial
for economic growth. Without an opportunity to borrow, the poor will
never come out of poverty trap. As they cannot get fund from
traditional banks, they turn to landlords or other unconventional way
of borrowing mostly with very high interest rates. Countries have
recognised this problem and step in to lend the poor either directly
or through the schemes like Micro-credit, which was first introduced
by Bangladeshi Economist and Nobel Peace Prize winner Mohammad Yunus.
Access to finance and credit is vital for poverty reduction. The
poor need liquidity to come out of poverty trap. This might be for
investment in businesses, education, health or buy other goods. In
the present situation, they borrow from friends or neighbours or
other family members. Poor also go to moneylenders who charge very
high interest, sometimes as much as 100%. The interest rate in
traditional banks would be much lower. But still, they dont lend to
the poor. Reason for this, as above mentioned, the poor dont have
collateral. Also if the banks would lend them, normally poor borrow a
very tiny amount leaving the banks with less profit. The
transaction cost is higher hence lending is not lucrative. Also in
the case of default, banks do not want to run after the poor as it is
time and money consuming and the gains from this are tiny.
In poor countries where the banking culture is not well
established and where only selective businesses and political elites
have access to finance, the problem of adverse selection remains
high, which means, the ability of banks to select good borrowers from
bad ones. So, in such an environment, moneylending by the local
moneylenders gain popularity. In a typical village for example, the
moneylenders also live in that particular area. So, they have local
knowledge, meaning that they watch the borrower in regular basis.
Chances of misuse is lower and the loan repayment can be transferred
to generations. This is an advantage for the lenders but if the
borrowers cant read and right, this can cause a serious problem.
There are many inter-generational poverty trap based on such
lendings. The grandfather had borrowed some money sometime and to pay
that back, his son or even grandson should work for free at the
lenders fields and the credit never finishes. This is why the program
of Microfinance gained popularity. Micro finance charge little bit
more interest rate than traditional banking, sometimes even lower
rates are applied but they are not 100% and never passes over to the
borrowers children or grand children. The default rate in
microfinance is lower than traditional banking.
What is especial about it is that, this is basically a group
lending. There are few people in a group and to borrow money, they
need an ok by other group members. The members monitor the borrower
closely because if she fails, their credit rating will be bad, giving
incentive to spend the money intelligently. Microcredit has over 97%
women, may be because women are careful money managers. And
frequently there are group meetings where they discuss about the
current situation, business possibilities, how the current business
is running, etc. This scheme was extremely successful in terms of
lending. In 1997, there were about 8 million users worldwide, in
2010, it grew to 140 million. There was a huge savings available in
south asia wide and the scheme was expanded into other financial
services as well. In 2009, there were almost 600,000 micro finance
institutions in Nepal and the number was growing. To shorten it,
Microfinance indeed changed the lives of millions which traditional
banking sector couldnt. Still, the long term impact of it is still to
be seen.
However, Microfinance is not without controversies. There were
rumors that institutions use Mafia methods to recover loans, using
brutal methods like physical harm. Others point that many
microfinance institutions are profitable so why do they still charge
high interest rates. But interest rates differ in different places.
Then there is an issue of long term impact to economic growth. Some
people use it for investment but some for consumption. Those who use
it for consumption, are likely to be trapped in debt, so how to deal
with these issue is a matter of discussion. But there are still some
evidence that microfinance was able to reduce some poverty. Yet, the
great change is still to be seen.
The aim of this article was to show that, as large portion of the
population is poor in Nepal, they are using Microfinance scheme
because it is more suitable for them. Even though the importance of
big banks will remain, their share in lending is decreasing day by
day. However, if they fail to come up with creative finance packages,
they might be out of business because what we see as successful
models of cooperative banks in Europe had a similar origin like
Microfinance. The most successful story of saving associations are in
Germany. The German Sparkassen is quasi state institutions who are
autonomous in some degree but operate under an umbrella of national
board. They are called the lending institutions to the middle class.
They basically support local businesses and even the profit are
retained and can be used for social purposes. They are non-profit
institutions but not fully. It has proved to be a successful model.
During the financial crisis of 2007/2008, the Sparkassen were able to
maintain their liquidity and they survived the crisis without any
problems. However, even in Germany, it doesnt mean that there are no
big banks. There are several big banks but it will not be appropriate
to compare Germany with Nepal. What I mean to say is, where there is
a problem, there will be a solution. Where the traditional way has
failed, innovation prevailed and it will gain importance even further
in the future.
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