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The macro impact of microfinance

Publication Date: 03 May 2018 - By Market Mogul By Market Mogul
Actionable
Differentiated

Environmental, Social & Governance Macro Multi Asset MENA Asia ex-China China Financial Services

We live in a time plagued by inequality, in developing and developed countries alike, and segments of society are weighed down by the burden of poverty. This seemingly never-ending problem is rooted in discrimination. Countries still host deeply ingrained forms of societal inequality, ranging from social and institutional sexism to hierarchical social structures such as the caste system in Southern Asia.

Furthermore, simple financial myopia is one of the biggest obstacles faced by those in poverty. This makes it extremely difficult for those in unfortunate circumstances to succeed in the business world. Even though global inequality seems to be falling, there is still a need for a solution. Microfinance has been around for a while, but now is the best time to adopt it.

Microfinance and its Flaws

Pioneered by Muhammad Yunus in 1976, microfinance involves issuing credit and offering financial services to low-income households, small-medium enterprises (SMEs) and unbanked sectors. These services have become increasingly popular with annual growth rates of 20%-30% since 2008Three billion people in the world do not have access to formal financial services delivering savings, loans, insurance, and remittances while 5 million of them have the potential to create income-generating businesses with small loans. Microfinance aims to solve this issue, allowing microenterprises and households to utilise microcredit loans to lift themselves out of poverty despite inadequate local access to these opportunities.

However, in practical matters, microfinance is met with several challenges. One of the key downfalls of microfinance is trust, and this is a problem for both lender and borrower. Customers may not be fully aware of the intentions and credibility of microfinance institutions (MFIs), and MFIs themselves have to follow the Know Your Customer (KYC) protocols. The former is gradually diminishing given the sheer growth of MFI activity. However, the latter is still causing prevalent security issues.

In order to provide microcredit and other services, adequate identification documents have to be provided by customers who are usually in circumstances in which they cannot do so. Secondly, transactions costs and interest rates are inherently high due to the ratio of such small amounts of loans to fixed costs per loan. Lastly, reach is an inevitable barrier preventing microfinance from reaching its potential. The majority of societies in need of microcredit are in rural areas and lack the connectivity to communicate with MFIs, leaving 2/3 of unbanked populations unreached.

Today’s Technology for Tomorrow’s Microfinance

Technological breakthroughs are paving the way for microfinance to fulfil its potential. Developments in wireless communication, internet access and price segmentation for mobile devices has improved drastically. Internet usage has increased over 250% in Asia from 2009-2017 and over 450% in Africa. When integrated with internet banking, microfinance becomes a powerful tool to be used by those in need regardless of geographic access.

FINCA, one of the leading MFIs has made sure their services are available over the internet, allowing 43% of Tanzanian customers to make secure online transactions. Several MFIs are also introducing agent banking systems to reach remote areas, effectively creating mini branches of MFIs through local shops and merchants.

As for interest rates and transaction costs, fintech has allowed interest rates which used to average at 37% and go up to 70% to drop down significantly.

MFIs such as Zidisha and Kiva have made use of technology and machine learning algorithms to replace physical offices with electronic databases, using algorithms offered by SiftScience to detect and filter fraud and others to calculate risk, this eliminates overhead costs given that every transaction is made virtually.

Lastly, issue of security can be effectively combated through blockchain technology. The slow and inefficient KYC process can be accelerated given the decentralised and transparent nature of blockchain which would encourage trust between customers and eliminate the need for intermediaries – further reducing interest rates. The ability to connect borrowers with lenders in a secure manner allows a rethink of microfinance. Blockchain would benefit the microfinancial landscape by speeding up transactions, allowing for increased identity security and reduced corruption.

Next Steps

Microfinance has been effective when properly utilised. Marginalized and underprivileged parts of society have the potential to use microcredit to build self-sustaining businesses. The challenges of scope, security and cost can be solved through technological advancements. Internet access and ownership of mobile devices are growing exponentially, allowing microfinance to extend its reach to more and more people.

Pioneers in the industry are adopting machine learning and AI software to eliminate the need for physical offices, increase security and facilitate transactions. The integration of blockchain technology into MFI activity shows potential to eliminate most, if not all, the issues microfinance faces.

While there is hope for progress, there is still a long way to go. As they say, time heals all wounds, as technology is integrated with the simple idea and ideals of microfinance, layers of complexity are added even if they bring potential benefits. It will take time for blockchain to mature and be adopted by governments and MFIs alike. One thing is for sure; microfinance can only go up from here.

This post first appeared on The Market Mogul.

 

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London, United Kingdom

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