Term Paper on "Microfinance as it Relates to Economic Inequality"

Term Paper 10 pages (3040 words) Sources: 10 Style: MLA

[EXCERPT] . . . .

Microfinance - as it Relates to Economic Inequality

Microfinance

Microfinance is generically understood as the offering of financial services, products and support for the poorer population -- including both individuals as well as entrepreneurs -- in order to present them with opportunities that would otherwise be inaccessible to them. Historically, microfinance would target women and its aim was that of supporting social development. In recent years nevertheless, it has become a noteworthy investment, able to generate profit and to as such attract investors.

"While the Grameen Bank promises to alleviate poverty and empower women through a non-profit model of financial services, new models of microfinance institute strict norms of financial sustainability and emphasize profits rather than human development. This […] is the microfinance revolution. It bears a new promise: that the bottom billion -- the world's poorest -- will serve as a frontier market, opening up new horizons of capital accumulation. Microfinance is no longer the sole domain of non-profit organizations such as the Grameen Bank, it is the domain equally of commercial banks, investment vehicles and money makers" (Roy, 2010).

2. Founders of microfinance

Microfinance has traditionally emerged through donations and sponsorships, but it gradually moved up a new level, in which institutions were formed and specialized in the field of financial aid to the poor. Emphasis was traditionally placed on domestic operations and lending, with less focus on international operations and resources. The chart below reveals the general scenery of microfinance institutions:

IFIs stands for international financial institutions

Source: Helms, 2006

"The landscape of funding options in microfinance is highly dynamic and complicated. Existing funders range from those with primarily a social mission to alleviate poverty (international donor agencies and foundations) to those with more commercial motivations (commercial investors and domestic capital markets) and many options in between" (Helms, 2006).

One notable founder within the microfinance community is represented by Grameen Bank in Bangladesh, which commenced to lend to the poor without requiring collateral, and which gradually inspired other players in the region to support the access of the poor to borrowed financial resources. The table below reveals the list of international financial institutions and private funds investing in microfinance:

Source: Helms, 2006.

3. Microfinance and poverty reduction

The scope of microfinance operations is that of reducing poverty and also decreasing the income gap between the rich and the poor. The underlying principle is represented by the need of the poor to gain more access to funds, as well as by the realization of the diverse needs of the poor. The major advantage microfinance reveals over other types of borrowing is symbolized by the flexibility involved, such as the lack of a need for collateral or the personalization of the loan and its conditions based on the particularities of each solicitant (Johnson and Rogaly, 1997).

4. Global approach

At a global level, microfinance is generically based on the centralization of funds to support the access to loans of the poor population. Generally, emphasis is placed on domestic sources of loans, but international microfinance institutions are also gaining momentum. An interesting note has to be made in the fact that the microfinance solutions differ from one region to the other, and one criterion which generates the differences is represented by the level of economic development.

Marguerite S. Robinson (2002): "My impression is that microfinance in former centrally planned economies is somewhat different from microfinance in most developing economies."

5. The United States

The United States possess one of the most developed credit markets, which strives to serve the needs of as many U.S. citizens as possible. In this context then, a question is being posed as to why should microfinance intervene in credit markets. The question is offered by the continued failures of the current system in attending to the needs of the poor. And the efforts have also included the support of the government, and in spite of this support, failure was still encountered and it as such reveals the need to intervene within the credit markets. Beatriz Armendariz de Aghion, Beatriz Armendariz and Jonathan Morduch (2007) explain:

"Good intentions often went awry as state owned-development banks mismanaged resources and interest rate restrictions prevented banks from operating viably in poor areas. Against this background, microfinance emerged as an especially promising way to rethink banking for the poor."

6. The Conservative perspective

Similar to any other economic concept, the field of microfinance is subjected to the influences of the four perspectives of political economy. The diagram below places these perspectives at the intersections of four different values: individualism, community, equality and hierarchy.

Source: Clark, 1998

At the level of the conservative perspective, it is attested that the central role for the development of the economy is represented by hierarchy and community. Community harmony is as such essential for development, but progress is sustained through a hierarchy which promotes those individuals with leading skills and abilities (Clark, 1998).

7. The Classical liberal perspective

The liberal dogma is focused on the individual, and the classical liberal perspective centers on both individualism as well as hierarchy. At its incipient stages, the economists militated for equality of the individuals, but they concluded that inequalities and hierarchies were necessary in order to stimulate economic growth and development (Clark, 1998).

8. The Modern Liberal perspective

The modern liberal perspective centers on the equivalent importance of both equality as well as individualism. The economists militating for this perspective are firm believers in the fact that equality and liberty protect human dignity and economic prosperity. The supporters of this belief recognize the existence of potential conflicts between the two values of equality and individualism, but argue that the disputes can be settled in a constructive manner and insist that this combination of principles is essential for economic development (Clark, 1998).

9. The Radical perspective

Finally, the radical perspective combines the commitments to the community and the equality of the individuals within the community. The underlying idea of this political view is that economic wealth and prosperity is to be attained at the level of the community, and only when the members of the community become united to support this development (Clark, 1998).

10. Microinsurance

As the field of microfinance developed, incremental emphasis came to be placed on microinsurances. These are generically understood as "insurance products that offer coverage to low-income households. A microinsurance plan provides protection to individuals who have little savings and is tailored specifically for lower valued assets and compensation for illness, injury or death" (Investopedia, 2011).

11. The role of gender

Microfinance institutions were traditionally opened to serve women. While they do not exclude men, an estimated 80 per cent of the customers of the microfinance institutions are female. The Grameen Bank for instance commenced by serving mostly men, but nowadays, as the social and cultural barriers have been weakened, 95 per cent of the bank's customers are women. De Aghion, Armendariz and Morduch (2007) argue that this situation has been created as a result of changing roles of women within the impoverished communities. Modern women are less prone to give birth to as many children and they focus more on education and profession. This makes them turn to financial aid from the microfinance institutions. Also, from a financial standpoint, the focus on women was due to technical information, such as higher repayment rates among the women and an improved household status when women are lent in the detriment of men -- the borrowings of which do not seem to impact the household living standards (de Aghion, Armendariz and Morduch, 2007).

12. Empirical evidence of effectiveness

At the level of actual empirical evidence to confirm the effectiveness of microfinance, it has to be noted that the number of studies detailing the topic is rather restricted. Additionally, most research projects focus exclusively on one country at the time. In a context in which the variables of the problem vary in each situation, the results of the individual studies are not relevant to confirm or infirm the theory according to which microfinance reduces the income gap.

Hisako Kai (2009) however has developed one of the most comprehensive approaches of the problem. The university professor has collected evidence from 61 countries and has found that, with few exceptions, the microfinance operations do indeed support the reduction of the income inequality.

"This paper provides a cross-country empirical study of 61 developing countries, concerning the impact of microfinance on inequality. We show that microfinance plays an important role in creating a financial system endowed with the equalizing effect. Until now, only a few single-country analyses of the impact of microfinance on inequality have been performed; a cross-country analysis has not been conducted thus far. To the best of our knowledge, our study is the first one to indicate the universality of the equalizing effect of microfinance by applying the cross-country methodology. Moreover, we contribute to the research accumulation of the impact assessment of microfinance at the macro level, which has seldom been analyzed" (Kai, 2009).

13. Management of MFIs… READ MORE

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