Emerging Divergence in Microfinance Industry

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An overview of Microfinance

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<p>Harin GuptaFIN 320 Money &amp; BankingProfessor PakravanAugust 17th, 2014</p> <p>Emerging Divergence in Microfinance Industry</p> <p>The underlying purpose of a business is to make profit for it shareholders and to create positive externalities for all the stakeholders. The profit making aspect of a business is what at the core differentiates itself from the Not for Profit world. Microfinance phenomenon that was spearheaded by Dr. Mohammed Yunus through Grameen Bank in Bangladesh was created on the fringes of for-profit and non-profit world. The non-profits and international aid organizations focused on rallying aid to poorer sections of the world in form of goods and services, donated or subsidized by national governments and wealthier sections of the society. In the world of microfinance the poorer sections of the society are extended credit to create a means of living rather than rely on aid and subsidies enough to just continue their existence. But the way credit functions is by extending liquidity and ability to consume today to the those who are creditworthy and have something to secure their debt with. Traditionally, lending to poorer sections of the society is perceived to be risky and underserved. Whereas in the case of developing world where much of the poverty is abject; institutional lending did not exist until the advent of Microfinance. What distinguishes microfinance lending from traditional lending is that the sums lent are smaller, women borrowers are the almost exclusively preferred, and no collateral is required to secure the debt. The non-profit side of lending provides complimentary services like financial literacy and small business incubation for entrepreneurs, etc. The transformational idea of microfinance is based on recognizing that the working poor can act in an entrepreneurial manner and are, in principle, creditworthy. For these micro-borrowers, microcredit is often the only alternative to paying excessive interest rates charged by unofficial moneylenders or pawnshops in developing countries (Dieckmann 3). The transformational aspect of reflects the not-for-profit characteristic of microfinance. But as we learn in financial economics that there is no free meal and risk requires return. The risk of unsecured and unconventional nature of microfinance lending raises issues of asymmetric information, adverse selection and moral hazard. The risk-return trades off of the way microfinance institutions finance their activities and deal with issues of asymmetric information and moral hazard is creating a divergence in the nature of microfinance industry. There are over 10,000 MFIs operating around the world with divergent models suitable to the markets they operate in. Global Microfinance industry has reached a volume of $25 billions, with a funding gap of $250 billion. The aim for the industry is to serve 40% of the worlds population that lives on less than one dollar a day. The average size of a microfinance loan ranges from $149 in Asia to $1597 in Eastern Europe and Central Asia.1 Most of the micro financing activity is based in developing country of South-East Asia and Latin America. Bangladeshi MFIs like BRAC (Bangladesh Rural Advancement Committee) and Grameen bank pioneered micro lending showcase high penetration rate in their home countries. India due to its sheer market size showcases the highest volume of micro lending and promising future growth. SKS Finance, Spandana, Bandhan, and BASIX are major players in the Indian market2. Accion and Banco Compartamos are major players in the Latin American market. There are several microlending institutions in the developed countries but they differ in the size of loans they make, services offered, and business model. Overall, the market for micro lending is growing both in developing and developed world, and so is the appetite for investors to provide funds to MFIs due to the high rates of returns associated with MFIs and engagement in socially responsible investments. Investing MFIs offer (Micro-Finance Institutions) can be classified and understood based on the model presented below: 1</p> <p>1. Dieckmann, Raimar. "Microfinance: An Emerging Investment Opportunity."Microfinance: An Emerging Investment Opportunity(n.d.): n. pag. 19 Dec. 2007. Web. 17 Aug. 2014.</p> <p>2. "Ranked Nonprofits: International Microfinance 2012."International Microfinance 2012 Top Nonprofit Ranking. N.p., n.d. Web. 18 Aug. 2014.</p>

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