Microfinance has been steadily increasing in popularity since Dr. Muhammad Yunus first popularized it with the Grameen Bank in 1976.  With thousands of microfinance organizations around the world, there are now countless variations to Yunus’ lending model.  However, most microfinance organizations are based around one of two platforms: individual lending or group lending.  This article will discuss the pros and cons of group lending, as a variation of this model was used by our partner organization Fundación BanIgualdad.

Group Lending Rationale:

Since microfinance mainly benefits the poor, most of whom do not have any collateral, it is very risky to lend them money.  This lack of collateral, in addition to a severe lack of financial and personal information about each potential client, puts a bank in the impossible situation of guessing who is going to pay them back, and who is going to default or run off with their money.  Banks typically use this level of risk to determine the interest rates for each loan, but with a lack of information this is impossible to do.

Group lending solves both of these problems.  In this model, if one member of the group is unable to pay back their loan, the other members of the group must pay back that person’s share for them. This provides a form of insurance for the bank, as they know they will get paid back, even if one person defaults on their loan or is unable to make a payment. Group lending also addresses a bank’s lack of information by making the members of a community form their own groups.  Since each member of the community has a more in-depth knowledge of whom is likely to repay on time and who is more risky, all of the less risky people will group together leaving all of the risky people together.  This means that the more responsible groups will very rarely have to pay for each other, whereas the more risky groups will have to pay for someone else more often, thus effectively creating a higher interest rate for those riskier people.  The group-lending model is an ingenious way of overcoming some of the challenges that lending to the poor entails.

Below are some of the Pros and Cons of group lending based on our experience working with Fundación BanIgualdad:

Pros:

• Helping financially: By having a group lending model, the group is able to pay for the loan of someone who is undergoing severe financial strains due to illness, unemployment, or numerous other factors.
• Helping their businesses: By meeting with a large group of small business owners each week, there are often instances when one business owner shares some business knowledge or gives a suggestion to another owner about how to improve their businesses.  This is often beneficial for the whole group, as they are able to greatly learn from each other.
• Women’s Empowerment: Many of the business owners receiving loans are women, and therefore it is an opportunity for these women to meet out of the house, and make an income that allows them to not be completely reliant on their husbands. 
• Social affair: It is also a chance for the business owners to chat about life while drinking tea or coffee and eating sweets.

Cons:

• Paying for someone else: While the group lending model is designed so that the group covers the cost of someone that is unable to pay, this often causes tension within the group, even among friends.  When many of the business owners are struggling to make ends meet themselves, the last thing they want to do is have to pay more to cover someone else’s loan.
• Group attrition: While there is no shortage of people wanting to receive a loan, there is a very high attrition rate as people decide they no longer want loans anymore.  This usually stems from an unwillingness to attend weekly meetings, the above-mentioned un-satisfaction with paying for others, etc.
• Differences in abilities and knowledge level: For microfinance organizations that also provide capacity classes to their clients, a big challenge they face is the wide variety of learning abilities, education levels, and levels of motivation.  By allowing groups to be formed based on geographical location or outside of the control of the organization, it is very difficult to effectively help teach each group essential business skills.

Conclusion:

As the microfinance field starts to become under more scrutiny, the different lending models will have to prove themselves as effective, or perish.  The group-lending model is a great foundation for a microfinance organization to use, but it does have significant drawbacks, like anything that involves a large group of people.  The future of microfinance remains to be seen, but the group-lending model will remain to be an effective way of overcoming the challenges of lending to the poor.

What are Chile’s most recent economic development and growth made up of? What has pushed the country to emerging market status? Within the past decade, much credit can be given to Chile’s export-economy.

The pace at which Chile’s export activity has developed and grown epitomizes an emerging market. With $64.28 billion worth of exports achieved in 2011, exports make up one fourth of Chile’s GDP. For a country of only 17 million people, Chile is highly integrated in the world economy with $15 billion of FDI in 2010. Last year, Chile earned two big thumbs up by the OECD and was welcomed as the organization’s first South American member.

China is Chile’s number one export partner, and that is for one primary reason: copper. Apart from Chile’s infamous wine and fruit, the world is after Chile’s copper reserves. Given the fact that Chile boasts the planet’s largest reserves, copper is Chile’s number one export and makes up one third of the Chilean government’s revenue.

Interestingly enough, having this pot of copper alone would not make Chile a rich and prosperous country… at least not in the long run. 

A resource rich country like Chile with its copper is vulnerable to the natural resource curses and Dutch Disease, which occurs when one sector of an economy is made rich by the discovery of a natural resource. This results in a weakening of the rest of the economy due to a shift in resources, an increase in government spending, and the loss of competitiveness due to currency appreciation. Far too often, when a developing country discovers the wealth of a natural resource, government spending increases astronomically on public programs to promote social development among the people: the spending effect. Appreciating the riches flowing into the country as a result of this resource, the country begins to focus entirely on this sector of the economy neglecting the others: resource movement effect. In the long-run, this leads to much overspending, an appreciated currency that prevents other exports from reaping benefits, and a loss in competitiveness in most other sectors of the economy.

Chile has been able to avoid this economic infection for the most part, allowing the country to enjoy increased government savings, growth, and countless business and trade opportunities. Chile deserves a strong applause for its ability prevent the natural resource curse, as this is a plague that numerous countries have fallen victim to each decade.

Chile’s previous Bachelet government with Minister of Finance Andrés Velasco strengthened fiscal prudence and protected its currency. The Chilean sovereign wealth fund accumulates high levels of savings during eras of high copper gains and then uses these surpluses to protect the country during times of lower copper prices. As of 2008, these sovereign wealth funds had accumulated over $20 billion, which Chile then used in 2009 to protect the country from suffering from the global recession.

This economic prudence and future planning is the strongest image of saving for a rainy day that international economics and finance has seen for a long time. Chile’s copper sovereign wealth fund has allowed it to avoid falling victim to the natural resource curse and Dutch Disease and enjoy much economic development and growth, which is projected to be 6% this year.

Our question remains, how does this growth impact the standard of living among Chileans? Or rather, what is the relationship between this economic development promoted by copper and Chile’s social development?

-Statistics and Information from the CIA World Factbook

Below are the results of our needs assessment survey of 195 small businesses in Santiago, Chile. The survey consisted of asking the businesses what were their biggest challenges, and focused specifically on 11 topics: Accounting, Relations with Suppliers, Marketing, Customer Relations, Competition, Employee Management, Legal Issues, General Business Organization, Planning for the Future, Technology, and Other. 

When asked on a scale of 1 to 7 which of the 11 topics were the most challenging, the top three were Planning for the Future, Accounting, and Customer Relations.  

The survey then proceeded to ask which topics/challenges were the most important for the small business.  The top three for most important were: Accounting, Customer Relations, and Technology.

Based on this survey, and 7 focus groups we decided to make classes on Planning for the Future, Accounting and Customer Relations.  

While the survey showed that Technology was also very important to the businesses, we decided not to choose this topic for two reasons: 1) We did not have access to computers for all of the small business owners we were going to be teaching, and 2) Learning about computers and technology is something that we are sure all of the business owners WANTED to learn about, but realistically do not NEED, and would not be able to adequately utilize.  We decided to instead focus on more practical and immediately implementable subjects instead.

Below is a copy of our preliminary presentation to the Manager of Microfinance about our Needs Assessment.

Veronica Pugin

While small business development is not limited to microfinance, microfinance is often credited for providing the seed capital for micro-businesses to grow. With 1,974 microfinance institutions (MFIs) globally signed up with MIX Market (the number one source of financial and social performance data on MFIs) serving 91.8 million microcredit borrowers as of 2009, the microfinance industry’s financial services are broad and varied, yet the most fundamental service has been microcredit (also known as microloans) to the poor who are traditionally rejected by banks.

The theory of microcredit is that the poor can invest this small loan into starting or growing a small business to increase their family income and ultimately raise their family out of poverty. While the theory of microcredit is logical, there is little proof of its ability to eradicate poverty. Since the 2008 Innovations for Poverty Action/Financial Access Initiative Microfinance Research conference, the effects of a simple microcredit have been under serious question as they lack proof and evaluation.

For a microcredit to actually promote poverty eradication, it must lead to business growth for the owner in order to increase revenue and ultimately increase the family income. Based on the Needs Assessment we completed with over 250 small business owners in Santiago, Chile, we noted that significant enough business growth to remove them out of poverty is often times not achieved for a number of reasons such as a lack of business training, a lack of a business plan, family emergencies, formalization barriers, etc.

The most striking obstacle to business growth noted was the business owners’ struggle for market access. Not only does this revelation provide valuable insight for learning about the challenges of small business owners in the developing world, but it also reveals a fundamental limitation of microcredit working on its own.

Lack of Market Access

The idea of microcredit is that using the loan the small business owners will be able to ultimately sell more products or for a higher price in order to increase revenues. This works under the assumption that there is enough demand in the market to absorb the new or improved products. The most important reality that challenges this assumption is the fact that much of the developing world’s cities are divided up by class, meaning that the poor all live together in a poor community, such as La Florida in Santiago, Chile.

What this means is that the small business owner is trying to increase their revenue in a community with little disposable income and as a result little demand for their product. Yes, they can increase their revenue in their own community, but it is unlikely that it will be to the level that is needed to overcome poverty. The gravity of the issue is that microcredit is often done on a massive-scale utilizing group-lending. This leads to the community of the poor simply tossing around the few dollars worth of cash around to each other, never actually accumulating new wealth. The opportunities for these small business owners lie outside of their community, in areas with more money to be spent on their products. Why don’t they access these new markets? This expansion holds a price tag and risk factor that is too high for even microcredit to cover most of the time. What ensues is a cycle of poverty at the community level that can only be broken by branching out.