The biggest strength of microfinance is bringing financial services to poor people and making it financial sustainable by the economies of scale effect. In India the National Bank for Agriculture and Rural Development (NABARD) finances more than 500 banks that lend funds to self help groups (SHG). SHGs comprise twenty or fewer members, of whom the majority are women from the poorest rural areas in India. Nearly 1.4 million SHGs comprising approximately 20 million women now borrow from banks, which makes the Indian SHG-Bank Linkage model the largest microfinance program in the world. Self help groups are an advantage to driving a country’s development, as it encourages people in group to get to know each other and keep an eye on other’s financial situations. This can cut costs for Micro Finance Institutions as they would not have to spend as many resources on overseeing the progress of people spending their loans. Similar programs are evolving in Africa and Southeast Asia with the assistance of organizations like Opportunity International and Oxfam. Also it helps in the development of an economy by giving people in poverty the chance to establish a sustainable means of income. Eventual increases in disposable income will lead to economic development and growth.
One reason micro finance is not necessarily a stimulus for economic growth is because of the low demand. The intended target market is for people with low income who do not have access to formal financial institutions. There are more than 3 billion people who live in poverty in the world. However (estimate total amount of people that use micro finance). First, the most common reason for not borrowing that is self-reported in surveys is the poor’s desire to “not to be in debt”.. Ironically, most of microloans have extremely high interest rates, often over 20%, which is also a reason 10 to 13% of respondents in several projects decide not to take up micro finance when approached. Preliminary results from an Innovations for Poverty Action project in Mexico show significant and large (larger than 1) elasticities of demand for credit to interest rate. Reasons interest rates are so high include fear from potential borrowers from not being able to pay back loans as their financial status is already unstable in the first place, plus the administration costs on loans are very high.
As worldwide microfinance experience has shown, access to safe and flexible savings services can play a critical role in poor people’s strategies for minimizing risks, mitigating income fluctuations, facing unexpected expenditures and emergencies, and building a small asset base over time. In particular, the very poor living in rural areas, who may lack investment opportunities and safe ways of keeping their savings, greatly value access to safe savings services. Most poor families do save and often in a non-financial form, for example, small gold items or stockpiling goods, because they frequently lack access to good formal savings facilities. In-kind savings are suboptimal options, because they are subject to fluctuations in commodity prices, and destruction by pests, fire and theft. While microfinance institutions offer both good loan services and good voluntary savings services, worldwide experience shows that there is usually more demand for savings than for loans. Better availability of safe savings facilities increases self-financing capacity and thus reduces the need to borrow, with its inherent risks. When a poor household needs a relatively large amount of money for an investment purpose, saving is a less risky way to obtain it than taking on a debt with a fixed repayment obligation. Traditionally, microfinance mobilization of savings has taken place in the form of compulsory savings under group or individual lending methodologies. Often a percentage of the loan amount is required as mandatory savings and is meant to guarantee group loan repayment. Compulsory savings were also seen as a way to instil savings habits in poorer households. Experience has shown, however, that compulsory saving is not conducive to encouraging clients’ saving habits, but rather is considered as one of the requirements for accessing loans. It is the mobilization of voluntary savings, ensuring safety, flexibility and accessibility, which can have the strongest impact on poor people’s lives. With the right products and incentives, microfinance institutions can rapidly mobilize very significant resources. Rural households and their enterprises are likely to have difficult access to microfinance institutions, which tend to avoid areas of sparse population and remote access due to the higher costs involved. Given the importance of seasonality and deferred income for small rural enterprises, savings are very important not only to build an asset capital, but also for smoothing consumption, affording continued access to health and education services, and as an insurance against emergencies.
Another reason micro finance might not be as good as it sounds is because most of the micro loans acquired by people with low income are spent on consumption. Instead of using the loans as investments for their busiensses, poor people use them for daily uses. They do not make any profit, which results in them not being able to pay back loans and become in debt. The S Curve is commonly used to describe how people with low income in developing countries are often affected by the poverty trap. As we can see from the diagram above, there is a steep curve between beng under the poverty line until you can escape poverty. Without aid, it is very likely that most poor people would not be able to get out of poverty. The intention of microfinance is to act as a form of aid. However, in reality it does not always work. If the poor obtains microcredit, the temptation of having short term pleasure might take over. They would realise that the steep part of the S curve means that it would requrie a long time until they can escape poverty. It might be something that won’t happen in the duration of their life. Something that might not happen during the loan might be spent instead on tea and better food etc. As a result because the money borrowed was not spent on their business, there is no return on profit and the poor would struggle to pay back the loans. This would affect them with their overall wealth, which is also likely for them to have less money than they did before obtaining micro loans.
Surprisingly, microfinance focuses on providing services for women, and this might in some way benefit thecommunity. Various arguments that relate to both supply and demand for microcredit can explain the targeting of women by microfinance organisations Firstly, demand for microfinance services is probably higher among women for a number of reasons. In many countries, women are more credit constrained than men. They are more restricted in their access to finance and control over land and capital. As a result they are considered with poorer credit ratings by traditional banks. Lower education levels, as well as limited time and mobility also prevent them from engaging with the complicated procedures usually requested by the formal banking sector to apply for a loan. Social norms are another factor: Discrmination and gender in equality are typical factors that affect women in a developing country. In some countries women do not even have the legal right to open a bank account. Gender aspects of the labour market are a second cause. A growth in the numbers of women in self-employment and entrepreneurial activities explains increased demand for microfinance. With respect to gender equality, microfinance is considered an effective means to promote the empowerment of women. By enabling women to develop or strengthen income generative activities, microfinance is likely to increase their monetary income, their control over their income and their bargaining power. These effects are then expected to lead to various social, psychological and even political effects which are mutually reinforcing: better self-esteem and self-confidence, improvement in status within the family and the community,