Although the importance of microfinance in the process of poverty eradication is realized, it faces multiple problems. This is because offering credit to the poor is a complicated process and the sector is still in its experimental stage.
We’ve divided all problems into two sets; challenges faced by MFIs (this article) and challenges faced by micro entrepreneurs (another article).
Microfinance Challenge 1: Perceived High Risk of Micro Entrepreneurship and Small Businesses
Micro entrepreneurs usually have no collateral to offer to microfinance providers against loans, they usually lack an alternate source of income, and have little, if any, formal education or training in the area of their business. As a result, commercial banks attribute a high credit risk to micro entrepreneurs and steer clear of this sector.
Microfinance institutes (MFIs) are compelled to compensate for this risk by charging interest rates on loans (read 10 determinants of interest rates in microfinance).
Fortunately, the challenge can be resolved through the idea of group lending (social collateral against loans) which ensures good repayment rates.
Microfinance Challenge 2: High Costs Involved in Small Transactions/Microlending
The small size of micro enterprises increases the transaction cost for MFIs because they cannot process loans in bulk (unless good management information systems are in place). This denies MFIs the benefit of economies of scale, hence, they are forced to cover their costs through high interest rates on loans (read 4 ways to control high interest rates).
According to a study conducted by Asian Development Bank, microfinance providers in the Asia-Pacific region charge interest rates on micro-sized loans ranging from 30 to 70% a year, which is much higher than rates offered by commercial banks (Fernando, 2006). However, there are instances where the interest rates charged were too low for the MFIs’ sustainability.
There is, however, a possible solutions to this problem – by improving the technology model used by microfinance institutes, their operational costs can be significantly lowered and efficiencies may be gained during automated loan processing.
Microfinance Challenge 3: Lack of Debt and Equity Funds for MFIs to Pass on to the Poor
Capital availability for microfinance is hardly a problem owing to the rapid growth in the microfinance sector, which has been fueled by attention from the media and development agencies. Even though there are plenty of financing options available for MFIs, there is an emerging shortage of money because of the current financial crisis across the globe. Another reason for this shortfall is the lack of awareness of funding sources by MFI managers.
Microfinance Challenge 4: Difficulty in Measuring the Social Performance of MFIs
Microfinance is delivering the economic returns its proponents promised, but there are only a handful of tools available that measure the social return of loan programs for the poor. To add to the problem, the tools use proxies to estimate the amount of poverty and social change surrounding micro entrepreneurs. This makes the gathering of funds a challenge because donors may quiestion the actual impact made my microfinance.
Wow, this article is great. Keep it buddy.
Surely, I will be linking to this one soon.
Thanks, Florentino. That’s very encouraging
This article excellent .Is it possible to get the challenges face by microfinance sector as a result of global financial crisis?
Thanks for your kind words. Since the microfinance sector’s integration with the mainstream financial economy is limited, the impact of the downturn has been cushioned. However, MFIs are not completely insulated:
– borrowers in certain economies (Pakistan and Kenya) face problems when repaying loans because of high levels of inflation and low demand for their products,
– there is less availability of foreign funds, and that too at low costs, as investors become wary,
– it will take longer for the social and financial impact of microfinance to materialize, and
– as economic opportunities dwindle, more people are turning to microfinance for solutions.
Read more about the various problems and solutions by clicking on those links, and see a relevant interview here.
P.S. You will have to see around 5 minutes of the video/interview before the question is asked.
I apologize for the late response (your comment was accidentally eaten up by the spam guard)
I wonder if there are any models of microfinance which integrate mentorship. Probably the reason this hasn’t been tried is that it would be hard to scale. (perhaps 1 person for 100 entrepreneurs). I’m curious if that model vs. the loan officer focused model would work better?
I think the group model if developed can help #6 and #7.
Definitely! Although Prof. Yunus claims the poor do not need training to survive (Banker to the Poor), I think exceptions occur. Market trends change ever so quickly at times, and when there is an over-supply of certain products/services, the poor need to develop viable business plans that ensure sufficient productivity so the loans and interest payments can be honored. In this regard, I think a mentorship program may work, but there are plenty of issues that will need to be ironed out in that too, as we discussed on your blog some time ago.
Thanks for the comment!