The relationship between microfinance and economic development in developing nations

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This article aims at examining the Relationship between Microfinance and Economic Development in Developing Nations

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International Journal of Management (IJM) Volume 9, Issue 4, July–August 2018, pp. 1–9, Article ID: IJM_09_04_001 Available online at http://www.iaeme.com/ijm/issues.asp?JType=IJM&VType=9&IType=4 Journal Impact Factor (2016): 8.1920 (Calculated by GISI) www.jifactor.com ISSN Print: 0976-6502 and ISSN Online: 0976-6510 © IAEME Publication THE RELATIONSHIP BETWEEN MICROFINANCE AND ECONOMIC DEVELOPMENT IN DEVELOPING NATIONS Apurva Kumar, Piyush Seth and Harsh Sethi BBA Student-Jain University-Center for Management Studies, Bangalore, India Prof Abhishek Venkteshwar Assistant Professor -Jain University-Center for Management Studies, Bangalore, India ABSTRACT Purpose Research in the field of Economy of developing nations have become a dynamic study area over the past few decades and is likely to become even more so as the importance of economic development is rapidly gaining momentum. Therefore understanding the economy of developing nations will be viewed as increasingly important. Microcredit is a great way of providing financial aid to the people who do not have any means to take loans from a traditional bank, and that may have a positive impact on the economic growth. However on the other hand it is just a medium to exploit the poor by charging high interest rates and costs for providing various other services, thus making them poorer. This article aims at examining the Relationship between Microfinance and Economic Development in Developing Nations Key words: Microfinance, microcredit, financial, bank, loan, economic. developing nations. Cite this Article: Apurva Kumar, Piyush Seth, Harsh Sethi and Prof Abhishek Venkteshwar, The Relationship between Microfinance and Economic Development in Developing Nations. International Journal of Management, 9 (4), 2018, pp. 1–9. http://www.iaeme.com/IJM/issues.asp?JType=IJM&VType=9&IType=4 1. INTRODUCTION Microfinance is a type of banking service that gives micro loans, savings and insurance to unemployed or low-income individuals or groups who otherwise have no access to the common banks or investors. Traditional banks do not give loans to the poor people because they are not sufficed enough to even give a collateral to the bank for the money they want. These are the people who seek for micro financing services in order to fund their idea and grow out of poverty. Microfinance aims to provide micro loans to poor people to work things out and invest in their businesses and ideas. In short it gives them an opportunity to grow. As http://www.iaeme.com/IJM/index.asp 1 editor@iaeme.com
Apurva Kumar, Piyush Seth, Harsh Sethi and Prof Abhishek Venkteshwar the Nobel Laureate, Mohammad Yunus says, “It is not that they are not talented, it is just a sheer lack of opportunity”. According to Diana Nicholson, Microfinance is a form of financial services that lends money to extremely low-income individuals, who typical do not have access to typical bank lending options. The loan (microloan / microcredit) is generally used to start or expand a small business. The recipients microloans are often fairly new entrepeneurs that have a 1-3 person business. Typically microfinance loans are $100 or less. This dollar amount varies by the geographic location of the recipient and the investment project. I have seen loans that range up to $1,000 or $2,000. This can be for two reasons. The investment is for a more established business This is a pooled investment with more than 1 loan recipient. Often, microfinance projects will focus on a specific type of investor. For example one project could be investing in small farmers in a specific region. Therefore each individual farmer would receive a small loan, but the project would aim to help many farmers. Figure 1 Source:Diana Nicholson (2010) http://www.iaeme.com/IJM/index.asp 2 editor@iaeme.com
The Relationship between Microfinance and Economic Development in Developing Nations Table 1 Change in microfinance indicators across the regions from 2002 to 2013 Source: Yousuf Sultan and Mansur Masih(2016) 2. ECONOMIC DEVELOPMENT According to Aaron Hill, economic development is usually the focus of federal, state, and local governments to improve our standard of living through the creation of jobs, the support of innovation and new ideas, the creation of higher wealth, and the creation of an overall better quality of life. Economic development is often defined by others based on what it is trying to accomplish. Many times these objectives include building or improving infrastructure such as roads, bridges, etc.; improving our education system through new schools; enhancing our public safety through fire and police service; or incentivizing new businesses to open a location in a community. Economic development often is categorized into the following three major areas: Governments working on big economic objectives such as creating jobs or growing an economy. These initiatives can be accomplished through written laws, industries' regulations, and tax incentives or collections. Programs that provide infrastructure and services such as bigger highways, community parks, new school programs and facilities, public libraries or swimming pools, new hospitals, and crime prevention initiatives. Job creation and business retention through workforce development programs to help people get the needed skills and education they need. This also includes small business development programs that are geared to help entrepreneurs get financing or network with other small businesses. 3. DEVELOPING NATIONS According to WTO Developing countries comprise a majority of the WTO membership. They are grouped as “developing countries” and “least developed countries There are no WTO definitions of “developed” and “developing” countries. Members announce for themselves whether they are “developed” or “developing” countries. However, other members can http://www.iaeme.com/IJM/index.asp 3 editor@iaeme.com
Apurva Kumar, Piyush Seth, Harsh Sethi and Prof Abhishek Venkteshwar challenge the decision of a member to make use of provisions available to developing countries. Figure 2 World map showing advanced, transitioning, less and least developed countries. The CIA gives the following definitions: Advanced Economies: A term used by the International Monetary Fund (IMF) for the top group in its hierarchy. Similar to the term "Developed countries" but adds Hong Kong, South Korea, Singapore and Taiwan, but drops Malta, Mexico, South Africa, and Turkey. In transition: A term used by the International Monetary Fund (IMF) for the middle group in its hierarchy. This group is identical to the group traditionally referred to as the "former USSR/Eastern Europe". The group includes the countries which are close to reaching "advanced economy" status, such as Moldova, Albania, Montenegro, FYR Macedonia, Serbia, Bosnia and Herzegovina, Armenia, Georgia, Azerbaijan, Turkmenistan, Uzbekistan, Kazakhstan, Kyrgyzstan, Tajikistan, Belarus, Ukraine, and China Less developed: The bottom group in the hierarchy. Mainly countries and dependent areas with low levels of output, living standards, and technology; per capita GDPs are generally below $5,000 and often less than $1,500; however, the group also includes a number of countries with high per capita incomes, areas of advanced technology, and rapid rates of growth; includes the advanced developing countries, developing countries, low-income countries, middle-income countries, newly industrialized economies (NIEs), the South, Third World, and underdeveloped countries. Includes OECD and G-20 Industrial Nations members like Brazil, Mexico and Turkey, because the Russian editor who prepared this map misinterpreted the definition made by the IMF. Least developed: Subgroup of the less developed countries (LDCs) initially identified by the UN General Assembly in 1971 as having no significant economic growth, per capita GDPs normally less than $1,000, and low literacy rates; also known as the undeveloped countries.(CIA World fact book 2008) http://www.iaeme.com/IJM/index.asp 4 editor@iaeme.com
The Relationship between Microfinance and Economic Development in Developing Nations 4. LITERATURE REVIEW Kapilananda Mondal (2014): the founder & CEO VSSU, in his article „Community Development through Innovative Microfinance‟ published in Microfinance Barometer 2014: he has pointed out that the microfinance sector in India has recently witnessed the catastrophic impact of excessive focus on numerical achievements. Development does not follow any scientific formulae of progress; it needs to be client focused, process-oriented, and have a holistic approach with sustainable impact as its goal. Jayati Ghosh (2013) : is a Delhi based Feminist Economist & an observer of Microfinance, listed the review of the recent literature on microfinance in developing countries and a critical assessment of its effectiveness in her article “Microfinance and the challenge of financial inclusion for development”. In the article, the author examines the experience of India, which has one of the largest microfinance sectors in the world, and particularly the unfolding of the microfinance crisis in Andhra Pradesh. It concludes that microfinance cannot be seen as a silver bullet for development and that profit-oriented microfinance institutions are problematic. To satisfy even some of its progressive goals, it must be regulated and subsidised, and other strategies forviable financial inclusion of the poor and of small producers must be more actively pursued. NABARD (2013) : it has initiated new microfinance delivery model i.e., SBLP which become popular in the whole world . Microfinance in India, as elsewhere, originally began as part of a developmental and poverty-reduction project, led by NGOs who thought this would be an effective way of allowing the poor to lift themselves out of poverty by their own efforts. Many NGOs began the process of group lending based on self-help groups (SHGs) and the linkage with commercial banks (whereby banks were allowed to lend to groups with a proven track record of repayment) further enlarged its scope. SHGs and their federations became the intermediaries between individual clients (who were mostly women) and the commercial banking system through the SHG–Bank Linkage Programme (SBLP).National Bank for Agriculture and Rural Development estimates that currently around 97 million households have access to regular savings through 7.46 million linked to different banks. About 4.78 million SHGs also have access to direct 16 credit facilities from banks; around 82% of these are women-only SHGs. The focus on women borrowers has been a major feature of microcredit provision in India as in Bangladesh and is frequently cited as one of the ongoing public strategies for women‟s economic empowerment Microfinance Summit Campaign Report (2012) : the report provides information about the out reach of microfinance world wide. It states that out of 3,652 microfinance institutions, 1009 are found in operation in Sub-Saharan Africa, 1746 in Asia and the Pacific, and 647 in Latin America and the Caribbean. Microfinance as a financial intervention is popular in developing countries of the world. In those continents Asia and the Pacific, have majority of client outreach of some 82 Arunachalam (2011) : has pointed out a number of causes for the Andhra Pradesh crisis, which are closely related to the very functioning of the sector in both for-profit and not-for- profit variants. In particular, the explosion of multiple lending and borrowing was a prime cause, and this was positively encouraged by MFI lenders. Poor households took on multiple loans from different sources, often only for the purpose of repaying one of the lenders, and this was fed by the combination of aggressive expansion in the number of clients and strict enforcement of payments. Further, despite the claims about personal involvement and group solidarity being the basis of the lending process, Arunachalam notes the widespread use of agents. There are two main types of microfinance agents: local grassroots politicians, who use the loans to add to their political clout; and the heads of federations of borrower groups (or SHGs), who make an additional profit by controlling or appropriating the flow of loans. http://www.iaeme.com/IJM/index.asp 5 editor@iaeme.com
Apurva Kumar, Piyush Seth, Harsh Sethi and Prof Abhishek Venkteshwar Sriram (2011) : A constant observer of the activities of Microfinance Institutions in India, in his article “Micro Finance Industry inIndia: More Thoughts” finds that, Micro finance institutions need not be treated as holy cows. Shows there need not be any soft regulations on MFI‟s. MFI should be treated on par with NonBanking companies. Soft corner on MFI‟s will certainly allow them to deviate from their specified objectives of serving the poor. Also provides an insight into behavioural problems prevailing in MFI‟s. Sriram (2010) : In his article he pointed out that unlike Grameen Bank and similar institutions around the world that are funded primarily by deposits raised from their own borrowers and non-members, Indian MFIs are prohibited by law from collecting deposits. So Indian MFIs did not have a legal framework that would allow them to „involve the community in the ownership structure of an MFI‟ has also pointed to another aspect of this transformation that has more in common with the various other methods of the „get rich quick‟ capitalism of the past decade in India. In a study that examines in detail the „transformation‟ of four prominent MFIs in India (SKS Microfinance Ltd, Share Microfin Ltd, Asmitha and Spandana), he noted that in some cases this was also associated with the private enrichment of the promoters through various means. These included inflated salaries and stock options provided to the top management, who were usually the promoters. A more interesting legal innovation was the use of mutual benefit trusts (MBTs) that aggregated the member- 18 borrowers of SHGs as members. The grant money received for the purposes of „developmental‟ microcredit could then be placed in the MBT, which would in turn contribute to the newly created for-profit MFI. In the case of two of these companies (Share Microfin and Asmitha) the matter was compounded by cross-holding, since the promoters of the two companies were the same family. Sriram (2010): In his article titled “Microfinance: a Fairy tale turns into a nightmare” mentioned that it was inevitable that the commercial model of microfinance in India, with its minimalist and standardised model of lending, would grow into a bubble and run into trouble. Many microfinance commercial organisations have entered the market in search of profits and are competing to lend to the poor. In the process, they have put the “understanding” of the needs of the poor aside and have started chasing targets and numbers. For these institutions, the poor are not seen as human beings having individual identities and needs. Instead, they are seen as data points that add up in their profit statements. The anxiety for growth is dictated by the fact that the investors in the market-based models are impatient and look for high returns – and then exit. Adonsou & Sylwester (2015) investigated the macroeconomic effects of microfinance using a sample of 71 developing countries over the 7 period 2002-2011. They found that the growth of microfinance loans has a positive and significant effect on economic growth and total factor productivity. As far as investment and education are concerned, they did not find strong evidence of positive effects from microfinance loans. Their results suggest that microfinance leads to development in developing countries. However, given the small economic impact of microfinance, the development process will not be swift. Raihan et al. (2015) studied that the contribution of microfinance to GDP in Bangladesh and found that in 2012 the impact was between 8.9 percent and 11.9 percent depending on the assumption of the labor market. Furthermore, the contribution of rural microfinance to rural GDP in Bangladesh in 2012 was between 12.6 percent and 16.6 percent depending on the assumption of the labor market. However, such estimation is subject to underestimation due to two major reasons: (i) the model didn‟t consider underemployment, and the labor market adjustments compensate some of the negative effects generating from withdrawing of MFI capital; and (ii) the share of the rural GDP might be lower than 60 percent as very high urban http://www.iaeme.com/IJM/index.asp 6 editor@iaeme.com
The Relationship between Microfinance and Economic Development in Developing Nations income are not usually captured by household survey; and this would imply that the contribution of rural microfinance to rural GDP in Bangladesh would be even higher. Maksudova (2010) found that there is evidence of microfinance to Granger-cause economic growth and it is positive only in less developed countries through lagged values where formal financial intermediation is immature, leaving significant space for alternative means such as microfinance. However, with further economic development this contribution has risk to be negative as middle income countries already face it through current values. Sharma & Puri (2013) studied the inter relationship between GDP and Micro loans to Self Help Groups (SHG). They found a very high level of correlation, i.e. 0.96, between the variables and a significant impact of Microloans on GDP Ahlin & Maio (2011) concludes that MFIs are more likely to cover costs when growth is stronger; and MFIs in financially deeper economies have lower default and operating costs, and charge lower interest rates. There is 9 also evidence suggestive of substitutability or rivalry. For example, more manufacturing and higher workforce participation are associated with slower growth in MFI outreach. Overall, the country context appears to be an important determinant of MFI performance; MFI performance should be handicapped for the environment in which it was achieved. Alimukhamedova (2013) mentions that strong financial development facilitates poverty reduction, therefore roles played by microfinance and mainstream finance in tackling poverty should be regarded as complementary and overlapping rather than as competing alternatives. A World Bank research indicates that a high level of financial development is a powerful tool to reduce poverty. This implies that as financial sector deepens it also increases its reach, providing financial services directly to the poor. However, financial development does not touch poor people directly; it nevertheless promotes aggregate economic growth, thus benefiting the poorest in a disproportionately better way This research clearly proved that Microfinance significantly impacts the economy of developing nations. 5. OBSERVATION On completing an extensive secondary research and literature review, the following conclusions can be made.  Microfinance has a direct impact on the economy of developing nations.  Microfinance has a positive impact on the economy of developing nations This clearly indicates that Microfinance has a direct impact on the economy of developing nations. 6. RESEARCH GAP Research has been conducted extensively on Microfinance and economic development. However; little research has been conducted on the extent of the impact of micro finance on the economy of developing nations. This research aims at filling this gap by understanding how microfinance has a direct impact on the economy of developing nations. http://www.iaeme.com/IJM/index.asp 7 editor@iaeme.com
Apurva Kumar, Piyush Seth, Harsh Sethi and Prof Abhishek Venkteshwar 7. CONCEPTUAL MODEL • Economic development. • No collateral • Inflation and • Acclerated deflations Interest rates POSTIVE • Affects FDI and IMPACT FII • Significant MICRO-FINANCE impact on Start ups. ECONOMY OF DEVELOPING NATIONS The Conceptual Model explains that Micro finance has a direct impact on the economy of developing nations and its affect the following.  Economic development.  Inflation and deflations  Affects FDI and FII  Significant impact on Start ups. 8. CONCLUSIONS On doing an extensive Secondary Research and Literature Review about the impact of microfinance on the economy of developing nations, it has been concluded that microfinance has a positive impact the economy of developing nations. REFERENCES [1] Abdelkader, I. B., & Salem, A. B. (2013). Islamic vs Conventional Microfinance Institutions: Performance analysis in MENA countries. International Journal of Business and Social Research, 3(5), 218-233. [2] Abraham, H., & Balogun, I. O. (2012). Contribution of microfinance to GDP in Nigeria: Is there any. International Journal of Business and Social Science, 3(17), 167-176. [3] Ahlin, C., Lin, J., & Maio, M. (2011). Where does microfinance flourish? Microfinance institution performance in macroeconomic context. Journal of Development Economics, 95(2), 105-120. [4] Ahmad, M. M. (2010). Impact of microfinance of IBBL on the rural poor's livelihood in Bangladesh: an empirical study. International Journal of Islamic and Middle Eastern Finance and Management . [5] Ahmeti, F. (2014). Microfinance as a Tool for Economic Development in Transitional Countries: Experience from Kosovo. European Scientific Journal (ESJ), 10(4). Alimi, R. S. (2015). Financial deepening and economic growth: A System GMM Panel Analysis with application to 7 SSA countries (No. 65789). University Library of Munich, Germany. [6] Alimukhamedova, N. (2013). Contribution of microfinance to economic growth: Transmission channel and the ways to test it. Business and Economic Horizons http://www.iaeme.com/IJM/index.asp 8 editor@iaeme.com
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