See discussions, stats, and author profiles for this publication at: [Link]

net/publication/352732590

Micro-finance and Rural Development: Exploring concepts, methods, and

impacts

Preprint · June 2021

DOI: 10.13140/RG.2.2.34949.27369

CITATIONS READS

0 1,701

1 author:

Jigme Singye
University of Canberra
15 PUBLICATIONS 0 CITATIONS

SEE PROFILE

All content following this page was uploaded by Jigme Singye on 25 June 2021.

The user has requested enhancement of the downloaded file.

 Micro-finance and Rural Development: Exploring concepts, methods, and
impacts

Part I: Defining Micro-finance and understanding it implications on rural lives

Over the course, the term ‘microcredit’ has shifted to ‘microfinance’ mainly to anticipate the
broader aspect of financial ecosystem to serve the need of the poor through various financial
services (Ledgerwood, Earne, & Nelson, 2013) such as microcredit loans, savings, and
insurance (Newman, Schwarz, & Ahstrom, 2017). The transformation and commercialization
of the microfinance concept has now integrated as a formal financial sector (Ledgerwood &
White, 2006). According to Obaidullah (2008) microfinance is an appropriate stratagem to
alleviate poverty. Nwankwo, et al. (2013) stated that microfinance is drawing greater attention
as a solution to the “… crippling effects of the conventional banks interest on the poor …”
Ledgerwood & White (2006) supported that the microfinance approach is the ideal method to
accomplish the mobilization required to greatly expand exposure to financial resources for
millions of low-income households worldwide.

Recently, there has been increase in the demand of MFIs services in Nepal as the migrant
workers return from other countries due to COVID 19 pandemic (Sinha & Dhakal, 2020). In
2005, the Nigerian government introduced the microfinance scheme to reduce poverty and had
a positive impact on income, employment, and household wellbeing (Awojobi, 2014).
Similarly, the micro-enterprise lending has played a pivotal role in household reconstruction
process in Bosnia and Herzegovina in 1996-2002 (Matul & Tsilikounas, 2004). Further, it is
also evident that the microfinance institutions (MFIs) prioritize women as a key partner in
lending approaches to narrow the gender gap in resources productivity and effectively draw on
the intended objective (Mukamana, Sengendo & Okiria, 2016). According to Khan and Noreen
(2011), as most of the women are not financially functional and disadvantaged members of
society, MFIs aims to empower women to improve infant and child survival, increases child
schooling, etc. Nonetheless, in certain context like Muslim societies as it is complex and
sensitive to work with women, MFIs programs focuses on “family empowerment’ rather than
“women empowerment”. The MFIs are also observed to have tailored the needs of
entrepreneurs, however, characterized by “… small, usually short-term loans; streamlined,
simplified borrower and investment appraisal; quick disbursement of repeat loans after timely
repayment; and convenient location and timing of services” (Obaidullah, 2008, pp. 6-7).
Moreover, economically active disabled people in Uganda are found availing MFIs services
(Beisland & Mersland, 2012).

However, the prevailing disagreement on the influence of microfinance on rural lives, for
instance in Nigerian society has prompted the need for suitable methodologies that would
differentiate the individual effects from a dynamic network of casual and mediating factors
(Nwankwo, Olukotu, & Abah, 2013). According to Hulme (1997), a mixed/pluralist
approaches usage of impact assessment methods such as sample surveys, rapid appraisal,
participation observation, case studies, participation learning and action is critical.

References
Awojobi, O. N. (2014). Microfinance as a strategy for poverty reduction in Nigeria: Empirical
investigation. International journal of current research, 6(9), 8944-8951.
Beisland, L. A., & Mersland, R. (2012). The use of microfinance services among economically
active disabled people: Evidence from Uganda. Journal of International
Development, 24, 69-83.
Hulme, D. (1997). Impact assessment methodologies for microfinance: A review. AIMS,
USAID.
Khan, R. E. A., & Noreen, S. (2012). Microfinance and women empowerment: A case study
of District Bahawalpur (Pakistan). African Journal of Business Management, 6(12),
4514-4521.
Ledgerwood, J., Earne, J., & Nelson, C. (Eds.). (2013). The new microfinance handbook: A
financial market system perspective. The World Bank.
Ledgerwood, J., & White, V. (2006). Transforming microfinance institutions: providing full
financial services to the poor. The World Bank.
Mukamana, L., Sengendo, M., & Okiria, E. (2016). Promoting gender equality in access to
microcredit through flexible lending approaches of female targeting MFIs: Evidence
from Duterimbere MFI of Rwanda. International Journal of Business and Economic
Development (IJBED), 4(3).
Matul, M., & Tsilikounas, C. (2004). Role of microfinance in the household reconstruction
process in Bosnia and Herzegovina. Journal of International Development, 16(3),
429-466.
Newman, A., Schwarz, S., & Ahlstrom, D. (2017). Microfinance and entrepreneurship: An
introduction. International Small Business Journal, 35(7), 787-792.
Nwankwo, O., Olukotu, G. A., & Abah, E. (2013). Impact of microfinance on rural
transformation in Nigeria. International Journal of Business and Management, 8(19),
99.
Obaidullah, M. (2008). Introduction to Islamic microfinance. International Institute of Islamic
Business and Finance, IBF Net (P) Limited.
Sinha, S., & Dhakal, N. H. (2020). A COVID perspective on Nepal microfinance: Advisory
note on the liquidity of MFIs in Nepal. Journal of International Development. M-
CRIL Advisory Note-Covid-19 Nepal 2020, 1-7

Part II: Types of Micro-finance

Sinha (2005, p.1717) stated that there are wide range of informal financial markets in every
economy offering varies financial services. He mentioned that in India, finance companies and
chit fund provide credit and saving facilities while the local (private) money lenders and
pawnbrokers provide access to credits. These services are observed to have varying terms and
conditions, such as;

a. One-time repayment
b. Interest rate depends on amount and urgency (for instance, smaller the amount and
greater the urgency, higher is the interest rate)
c. Compounded interest for late repayment

Interestingly, it was also noted that even friends and relatives plays a vital role as a source for
informal micro-credits, but these borrowings usually come without interest. Khavul (2010,
p.61) stated that the existence of traditional financial institutions is risky and expensive for the
poor. According to Dev (2006, p.4310) presence of such institutions has impacted the financial
inclusion within many poor families, for instance, in India, around 49 percent of farmer
borrowers were indebted in 2003.

Therefore, the provision of collateral free micro-credits by the formal financial institutions
(microfinance institutions) has indeed overruled the dominant of informal lending
arrangements (traditional money lenders). According to Ghosh (2013, p.1209), almost 75
percent microfinance borrowers are based in Asia in the year 2010 – India accounts 32 million
and 22 million in Bangladesh. However, there are evidence where the structural adjustment
policies implemented in developing countries have reduced the social sector spending creating
high unemployment, lack of social safety nets, and affecting the impoverished families
especially women (Kellett, 2011, p.260). It is evident that the microfinance programs in
Bangladesh introduced in 2003 were successful in reaching out the poor but was not able to
reach the very poor and vulnerable (Senanayake & Premaratbe, 2006, pp.150-151). It was
learned that the financial systems approach (banking model for poverty alleviation)
propounded by Yunus focused more on financial self-sufficiency, professional staff and cost
efficiency for clients (Kellett, 2011, p.261).

Thus, for the better outreach, promotion plan and sustainability of micro-credit, it is crucial to
address any approach from both supply and demand sides (Dev, 2003, p.4311). In another
word, it is crucial for financial institutions to look both as business opportunities as well as a
social responsibility to have financial inclusion. Senanayake & Premaratbe (2006, pp.157)
discusses that the development of sustainable microfinance services and reach out to the
poorest people across country, it will depend on the role played by government as ‘laissez-
faire, interventionist and moderate interventionist’ in recognizing and developing different
policies and programs. For an instance, Sinha (2005, p.1719) observed that in India, the
coverage of microfinance institutions for social development programs has been relatively
limited and not systematically integrated with the microfinance programs. Moreover, it is found
vital for banks to even provided advisory services to improve the productivity of small and
marginal farmers besides undertaking just the credits (Dev, 2006).

References

Dev, S. M. (2006). Financial inclusion: Issues and challenges. Economic and Political Weekly,
4310-4313.
Ghosh, J. (2013). Microfinance and the challenge of financial inclusion for
development. Cambridge Journal of Economics, 37(6), 1203-1219.
Kellett, N. C. (2013). Microfinance and economic inequality in the Peruvian
highlands. Ethnology: An International Journal of Cultural and Social
Anthropology, 50(3), 259-279.
Khavul, S. (2010). Microfinance: creating opportunities for the poor. Academy of Management
Perspectives, 24(3), 58-72.
Sinha, F. (2005). Access use and contribution of microfinance in India: Findings from a
national study. Economic and Political weekly, 1714-1719.
Senanayake, S. M. P., & Premaratne, S. P. (2006). Micro-finance for accelerated
development. Savings and Development, 143-168.

Part III: Benefits of Micro-finance

Microfinance institutions provides provision for financial services to those who have been
neglected by the mainstreaming banking industries due to poverty, lack of education and living
in remote location (Parikh, 2006). The MFIs primarily focuses on those households with low
income and microenterprises who are excluded from traditional banking (Obaidullah, 2008;
Lensink, Mersland, Vu & Zamore, 2018, p.2386). Several literatures reveal that women are
prioritized by MFIs as a key collaborator in lending strategies to narrow the gender gap
(Mukamana, Sengendo & Okiria, 2016), for instance, almost 90 percent of clients in
Bangladesh were women in 2011 (Chowdhury & Chowdhury, 2011, p.86). Moreover, in
Uganda, economically active disabled people were also found using MFIs services (Beisland
& Mersland, 2012).

According to Littlefield, Morduch, and Hashemi (2003), MFIs provide range of financial
services including loans, savings, insurance, transfer payments and micro-pensions. Such
provision of financial services has helped poor not just to invest in business ventures but also
in health, education, and livelihood. Further, it is also observed that providing just microcredit
do not adequately solve the poverty crisis, rather poor and underprivileged borrowers get
benefited from a combined service – financial (e.g., credit) and nonfinancial services (e.g.
business trainings) (Lensink et al., 2018, p.2387). In Peruvian village banking program, MFIs
focused on the human capital development within the female microentrepreneurs to improve
the livelihood (Karlan & Valdivia, 2011).

Besides providing social benefits in the form of financial services to those left behind, MFIs
also seeks to attain sustainability either with a win-win solution or at least being at the break-
even point (Lensink et al., 2018, p.2386). It is evident that a well-managed microfinance
institution can provide financial services sustainably – without a donor agency – through
developing resilience and self-propelling growth making huge impact on the lives of the
vulnerable, including the extremely vulnerable (Littlefield, Morduch, & Hashemi, 2003).
Going by literatures, most of the MFIs have different outreach programs, lending
methodologies, philosophy and sustainability goals. Parikh (2006) stated that;

i. Grameen Bank emphasizes on taking banking services to the people rather making
clients coming to banks. Millions of clients were grouped in blocks (villages) and
assigned loan officer whose responsibility is to go to those villages every day
documenting clients, processing applications, conducting meetings, collecting
repayments, disbursing loans, and resolving disputes.

ii. While in India, several MFIs supported by central government collaborates with
regional rural banks for financial service deliveries. Nonetheless, one of the MFIs
in Uttar Pradesh, the CASHPOR operates in a mixed mode of Grameen Bank and
rest of the MFIs in India.

Further, according to Copestake (2003), for the financial assessment and monitoring, the
‘double bottom line’ – where “direct impact (physical, social, economic, political, cultural,
psychological) and wider impact (family members, employees, business associates,
competitors, neighbors)” – approaches are viable for both commercial and catalyzing the social
development.

References
Beisland, L. A., & Mersland, R. (2012). The use of microfinance services among economically
active disabled people: Evidence from Uganda. Journal of International
Development, 24, 69-83.
Chowdhury, S. S., & Chowdhury, S. A. (2011). Microfinance and women empowerment: A
panel data analysis using evidence from rural Bangladesh. International Journal of
Economics and Finance, 3(5), 86-96.
Copestake, J. (2003). Simple standards or burgeoning benchmarks? Institutionalising social
performance monitoring, assessment, and auditing of microfinance. IDS
Bulletin, 34(4), 54-65.
Karlan, D., & Valdivia, M. (2011). Teaching entrepreneurship: Impact of business training on
microfinance clients and institutions. Review of Economics and Statistics, 93(2), 510-
527.
Lensink, R., et al. (2018). Do microfinance institutions benefit from integrating financial and
nonfinancial services? Applied Economics, 50(21), 2386-2401.
Littlefield, E., Morduch, J., & Hashemi, S. (2003). Is microfinance an effective strategy to
reach the millennium development goals? Focus Note, 24 (2003), 1-11.
Mukamana, L., Sengendo, M., & Okiria, E. (2016). Promoting gender equality in access to
microcredit through flexible lending approaches of female targeting MFIs: Evidence
from Duterimbere MFI of Rwanda. International Journal of Business and Economic
Development (IJBED), 4(3).
Obaidullah, M. (2008). Introduction to Islamic microfinance. International Institute of Islamic
Business and Finance, IBF Net (P) Limited.
Parikh, T. S. (2006, May). Rural microfinance service delivery: Gaps, inefficiencies, and
emerging solutions. In 2006 International Conference on Information and
Communication Technologies and Development, pp. 223-232.

Part IV: Micro-finance Donor Agencies and Risk Management

According to Hardy, Holden and Prokopenko (2003), MFIs are now numerous in several
countries and represent a substantial number of customers in general, control a considerable
loan portfolio and hold a significant portion of the financial assets of poorer citizens. The
provision of financial services such as saving and credit to those poor households – who do not
have access to formal financial institutions – through the microfinance institutions has gained
significant attention from scholars, government, and donor agencies as a key strategy for
poverty alleviation (McGuire & Conroy, 2000).

Studies have indicated that the potential synergy between all relevant agencies have been found
benefiting the economy. With the increasingly closer linkages between commercial banks,
donor agencies and MFIs, the prospects for enhancing financial deepening have improved in
several countries. Hardy, Holden and Prokopenko (2003) stated that donor agencies – local,
bilateral, and multilateral government, and domestic as well as foreign NGOs – provides
subsidy to MFIs in various forms such as initial capital injection – loan at preferential terms,
operational subsidies in cash or kind, the provision of training for MFIs staffs, and technical
assistance – improving legal and institutional framework. Ledgerwood (2000, p.16) further
supplemented those donors provide MFIs with, “grants for institutional capacity building,
grants to cover operating shortfalls, grants for loan capital/equity, concessional loans to fund
on-lending, lines of credit, guarantees for commercial funds and technical assistance”.

However, these provisions of services from donor agencies prevails as a liability to most MFIs
which directs MFIs to focus on the risk-taking activities that need to be managed and regulated.
Greuning, Gallardo and Randhawa (1999) illustrated that the primary source of funding for
MFIs – “contributed equity capital, donor funds, concessional and commercial borrowings,
members savings, wholesale deposits from institutional investors and retail savings and sight
deposits from public” – features the structure of liabilities. Further, as rural poor people live in
risker environments who lack assets collateral, formal wage job, and limited credit history, the
process of lending loans to them becomes a very risky and costly procedures for MFIs in terms
of default repayment. In addition, embezzlement, misuse of information and damage to
institutions through irresponsible acts of employees are found as subtle risk for MFIs
(Kwagara, 2006). Kwagara categorizes all associated MFIs risks as: market, foreign exchange,
interest rate, liquidity, derivative transactions, credit, transfer, country, operation, and event
risks.

Ibtissem and Bouri (2013, p.10) thus acknowledged that MFIs must achieve self-sustainability
by covering all its costs and making profits on the services they offer. Therefore, the successful
and effective credit risk appraisal and evaluation such as credit risk management process
determines the continuity and success of MFIs. The credit risk management process includes,
credit control policy, the six C’s risk credit risk assessment and evaluation, credit appraisal
criteria, peer lending and structured disbursement, character assessment and graduated loan
system, and review of past studies – familiarizing lending methodologies of other successful
MFIs (Kwagara, 2006; Hudon, 2007; Ghosh & Van Tassel, 2008). Moreover, Ibtissem and
Bouri (2013, pp.12-17) stated that incentive mechanism of group lending, dynamic incentives,
collateral substitutes, regular repayment schedule, and provision of nonfinancial services are
crucial for credit risk management in MFIs.

References
Greuning, V. H., Gallardo, J., & Randhawa, B. (1999). A framework for regulating
microfinance institutions. The World Bank.
Ghosh, S., & Van Tassel, E. (2008). A model of mission drift in microfinance
institutions. Department of Economics, Florida Atlantic University, December.
Hardy, D., Holden, P., & Prokopenko, V. (2003). Microfinance institutions and public
policy. Policy Reform, 6(3), 147-158.
Hudon, M. (2007). Use of donor funds in the financing of MFIs. Brussel: Université Libre de
Bruxelles, Solvay Business School, Centre Emile Bernheim.
Kwagara, M. P. (2006). An Assessment of credit risk management techniques adopted by
micro-Finance institutions in Kenya (Doctoral dissertation, University of Nairobi.).
Ibtissem, B., & Bouri, A. (2013). Credit risk management in microfinance: The conceptual
framework. ACRN Journal of Finance and Risk Perspectives, 2(1), 9-24.
Ledgerwood, J. (2000). Microfinance handbook: An institutional and financial perspective.
The World Bank.
McGuire, P. B., & Conroy, J. D. (2000). The microfinance phenomenon. Asia Pacific
Review, 7(1), 90-108.
Tulchin, D. (2004). Positioning microfinance institutions for the capital markets. Social
Enterprise Associates. Working Paper No. 5.

Part V: Grameen Bank and other Best Practices of Micro-finance

The provision of financial services to the rural population has always been a challenge for MFIs
owing to the inherent difficulties associated with the rural clients, often characterized by low
population density, isolated markets, seasonality, and highly covariant risk, such as widespread
regional crop failures and fluctuations in commodity prices (Yaron, 2004, p.2). These
circumstances result in loan delinquency and loan default. The loan delinquency is defined as
late repayment that leads to the loan default as there are negligible chances of loan recovery
(Addae-Korankye, 2014, p.37). The rising loan delinquencies poses serious risks to MFIs as it
affects the sustainability – profitability – and general performance (Idama, Asongo & Nyor,
2014, p.111). Thus, it is critical to explore some of the best practices adopted by MFIs to reduce
default loan rate. Ab Rahman, Hassan, & Said (2015, p.474) stated that the best practice of
microfinance is a proven mechanism to provide measurable productivity and to help them
speed up their progress towards improving performance and direct them through traps that
could otherwise delay or even stop their initiatives.

A case study of BRI-Unit Desa (BUD) in Indonesia illustrates a success story for delinquency
management. Yaron (2004, pp.10-11) stated that, “BUD introduced profound changes in
policies, in targeting clientele, in modes of operation, and in the lending and saving instruments
used - measures aimed at achieving self-sustainability” in 1984. Under this paradigm shift in
the structural change, BUD focused on; (i) borrower eligibility requirements, (ii) mandatory
savings, (iii) collateral requirements, (iv) loan maturity and repayment terms, (v) maximum
and minimum loan sizes, and (vi) lending interest rates. Since then, BUD achieved a
remarkable profit, recovering its full costs yielding assets return of 6% in 1986 which increased
to 7.3% in 2002. Further, CETZAM – the MFI in Zambia founded in 1995 based its lending
principle on the enforcement of joint-liability mechanism (Dixon, Ritchie & Siwale, 2007, p.8).
This mechanism mandates a client to be a member of joint-liability group, and loan officer to
assess client’s eligibility, visit businesses, train clients on bookkeeping for ten weeks before
loan disbursement. With this lending mechanism, CETZAM recorded 98% of repayment rates,
negligible percentage of Portfolio at Risk (PAR) and Portfolio in Arrears and expanded its
clients outreach to 50,000 with 25 more branches in 2000.

Similarly, Grameen Bank (GB) established in 1974 in Bangladesh pioneered the success stories
of MFIs in the world. GB integrated its credit delivery system into small solidarity group of
five. Rahman and Nie (2011, pp.212-213) stated that GB developed relatively low-cost
delivery mechanism to meet clients’ needs and generate resources. In their report, GB
assimilated; (i) group lending mechanism, (ii) accountability, (iii) hearing women’s voices, (iv)
targeting ultra-poor, (v) trustworthiness, (vi) women’s contribution, (vii) screening ‘bad’
clients, (viii) collateral free, (ix) peer group monitoring repayment, (x) diversity of products,
(xi) administrative effectiveness, (xii) collaboration with government, and (xiii)
decentralization. Moreover, GB’s clients own 95% of its share while government own only
5%. Besides, GB mandated a force saving of 4 cent per week which accrues 8.5% of interest
(Schreiner, 2003, p.9). It is also worth to note that from accrued 8.5% interest, 5% is credited
to group fund which also earns 8.5% interest. In addition, GB primarily sought to lend to rural
women. As of November 2019, GB had 9.60 million members out of which 97% were women
and recorded 93% (81,678 villages) of coverage with 2,568 branches (Grameen Bank, 2019).
According to GB Annual Report 2018 reflected a credit disbursement of USD 2.96 billion in
2018 indicating growth rate of 5.16%. GB’s success has won several awards including novel
price in 2006.

References
Addae-Korankye, A. (2014). Causes and control of loan default/delinquency in microfinance
institutions in Ghana. American International Journal of Contemporary
Research, 4(12), 36-45.
Ab Rahman, N. A., Hassan, S., & Said, J. (2015). Promoting sustainability of microfinance via
innovation risks, best practices, and management accounting practices. Procedia
Economics and Finance, 31, 470-484.
Dixon, R., Ritchie, J., & Siwale, J. (2007). Managing loan ‘delinquency’and microfinance:
Lessons from Zambia. In Accounting Forum (Vol. 31, No. 1, pp. 47-71).
Grameen Bank. (December 2019). Introduction. Retrieved from:
[Link]
 Grameen Bank. (2018). Annual Report. Retrieved from: [Link]
content/uploads/bsk-pdf-manager/gb_annual_report_2018.pdf
Idama, A., Asongo, A. I., & Nyor, N. (2014). Credit risk portfolio management in microfinance
banks: Conceptual and practical insights. Universal Journal of Applied Science, 2(6),
111-119.
Rahman, R., & Nie, Q. (2011). The synthesis of grameen bank microfinance approaches in
bangladesh. International Journal of Economics and Finance, 3(6), 207-218.
Schreiner, M. (2003). A cost‐effectiveness analysis of the Grameen Bank of
Bangladesh. Development Policy Review, 21(3), 357-382.
Yaron, J. (2004). Rural Microfinance: The Challenge and Best Practices. Best Practise, 2.

View publication stats