Microfinance: An Introduction

"Microfinance", as defined by ADB's Microfinance Development Strategy is the financial service such as deposits, loans, payment services, money transfers, and insurance to poor and low income households and their microenterprises. Studies in Nepal and elsewhere have clearly indicated microfinance as a powerful tool for alleviating poverty. MFIs in Nepal are serving primarily the microentrepreneurs who operate or are starting to operate very small enterprises, termed as microenterprises. 

Microfinance is a kind of a banking service given to low-income or jobless people or organizations who would not have access to other financial services otherwise. It provides financial services to small businesses and entrepreneurs who do not have access to banking or associated services. It also benefits low-income individuals, particularly women who are excluded from economic activities. Because commercial banks offer huge amounts of loans for high-level and income areas with some mortgages, it assists those members of society who do not have access to commercial banks for financial services. Individuals with modest incomes lack the necessary assets to maintain a mortgage and qualify for loans from commercial banks.

Microfinance and Poverty Reduction:

Previous development experiences have demonstrated that reducing poverty is a necessary requirement for the nation's overall growth. Nepal's development process cannot proceed smoothly unless those who are below the poverty line are given the opportunity to participate and become naturally involved in the decision-making process on all matters pertaining to themselves by raising their per capita income and giving them opportunities to generate income. The purchasing power of a person determines what they can afford to consume in terms of products and services, including necessities like food, clothes, housing, health care, and education. Additionally, these are the requirements for the development of the nation's infrastructure, which includes roads, buildings, irrigation systems, and power.

One effective way to identify the poor and disadvantaged populations is through microfinance, which offers income, employment, and opportunities for capacity building to the impoverished, disabled, Dalits, marginalized groups, and destitute, including women. Microfinance also helps these individuals achieve socio economic empowerment through the support of social mobilization. In Nepal, poverty is primarily associated with rural areas. We must be conscious that additional progress towards reducing poverty cannot be done without carefully examining the fundamental traits of the person, the group of individuals, and/or the household level. Nepal has been developing for more than 50 years. 

Microfinance institutions (MFIs) have been actively operating in the country, providing financial services to the unbanked and underprivileged population. Microfinance provides following benefits and complements the poverty reduction goal in the following ways: 

Financial Inclusion: Nepal has a large portion of its population residing in rural areas where traditional banking services may not be readily available. Microfinance has been instrumental in bringing financial services to these remote areas, promoting financial inclusion and providing access to credit, savings, and insurance.

Empowerment of Women: Microfinance programs in Nepal, like in many other countries, have focused on empowering women. By providing them with financial resources and training, microfinance has enabled women to engage in income-generating activities, fostering economic independence and contributing to gender equality.

Rural Development: Microfinance has supported rural development by facilitating the establishment and growth of small businesses in agriculture, livestock, and other sectors. This has had a positive impact on the income levels of rural households and, consequently, on their overall living standards.

Community Impact: The benefits of microfinance extend beyond individual borrowers to entire communities. As local businesses flourish and incomes rise, communities experience improvements in infrastructure, education, and healthcare, contributing to broader socio-economic development.

NGOs and Microfinance Institutions: Non-governmental organizations (NGOs) and microfinance institutions have played a crucial role in implementing microfinance programs in Nepal. They often work in collaboration with international organizations and government agencies to reach a larger population.

Challenges:

While microfinance has made positive contributions to poverty reduction in Nepal, it also faces various challenges. These challenges can impact the effectiveness and sustainability of microfinance programs in the country. Here are some common challenges associated with microfinance in Nepal:

Geographic Barriers: Nepal's challenging topography, with many remote and inaccessible areas, makes it difficult for microfinance institutions (MFIs) to reach certain communities. The lack of infrastructure in these areas hinders the establishment and maintenance of financial services.

Limited Financial Literacy: Many individuals in Nepal, particularly in rural areas, may have limited financial literacy. This lack of understanding about financial products and services can lead to challenges in managing loans and making informed financial decisions, contributing to over-indebtedness.

High-Interest Rates: Some microfinance institutions in Nepal have faced criticism for charging relatively high-interest rates on loans. While interest rates are often higher in microfinance due to the higher costs associated with serving small-scale clients, excessive rates can lead to over-indebtedness and financial stress for borrowers.

Over-Indebtedness: The rapid growth of microfinance in Nepal has raised concerns about over-indebtedness, where borrowers may take multiple loans from different sources without the ability to repay. This can lead to a debt trap and negatively impact the economic well-being of individuals and households.

Regulatory Challenges: The regulatory environment for microfinance in Nepal is evolving, and there may be challenges in ensuring a balance between promoting financial inclusion and protecting the rights of borrowers. Effective regulation is crucial to prevent exploitation and ensure responsible lending practices.

Capacity Building: Building the capacity of microfinance clients, staff, and local institutions is essential for the long-term success of microfinance programs. This includes providing training in financial management, entrepreneurship, and other relevant skills.

The major hurdle in reaching financial sustainability is attaining operational self-sufficiency. It refers to the extent, to which a MFI covers its expenses such as salaries and other administrative costs, depreciation of fixed assets, interest on borrowings and deposits (i.e., cost of loanable funds), and provisioning for loan loss (i.e., the cost of loan principal lost to default) out of fees and interest income. Operational self-sufficiency requires MFIs to cover all administrative costs and loan losses from operating income. 

The second hurdle in reaching financial sustainability is financial self-sufficiency. It refers to the extent, to which a MFI (i) covers from its fees and interest income expenses such as interest on borrowings at the market rate, and also the inflation in addition to other costs included in assessing operational self- sufficiency; (ii) has its loan repaid, and (iii) makes a profit for expansion and further growth. MFIs that have been involved for more than five years in microfinance services have not yet achieved operational self-sufficiency level. Achieving financial self-sufficiency is still a long way for them. 

Addressing these challenges requires a multi-faceted approach involving collaboration between microfinance institutions, government agencies, non-governmental organizations, and local communities. Continued efforts to improve financial literacy, regulatory frameworks, and the resilience of microfinance programs can contribute to overcoming these challenges and enhancing the positive impact of microfinance in Nepal. 

The best possible solution to these problems can be a mandatory acquisition of MFIs by either commercial or development banks because the objective for which NRB implemented concepts of MFI in Nepal has been irrelevant today. Dispersed types of BFIs aren't healthy for the financial well being of a country like Nepal.

Conclusion:

In a nutshell, microfinance is concerned with providing loans, savings accounts, and other essential financial services to low-income individuals. Working capital loans, consumer credit, savings accounts, pensions, insurance, and money transfer services via the official banking sector are among the financial services that the disadvantaged require. The majority of the financial services that the impoverished use to meet their needs are forms of informal credit, which may be obtained from unofficial commercial and noncommercial money lenders, generally at a very high cost to the borrowers.