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Why Microfinance Institutions Are Not Sustainable

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Why are some Microfinance Institutions not sustainable
Ghana Christian University College
SDM 201222101014
Introduction to Microfinance
Mr. Sam Quin
Word Count: 1273
Nov. 11, 2014

Table of Content Pg
Introduction 3
Definition of Terms 3
Sustainability of Microfinance Institutions 4
Why some Microfinance are not sustainable
Solution
Evaluation
Conclusion
References

Introduction
Microfinance has existed in various forms for centuries, and even longer in Asia, where informal lending and borrowing stretches back for several thousand years. However, the birth of ‘modern’ microfinance is said to have occurred in the mid 1970s in rural Bangladesh. There, in the midst of a famine, Dr. Muhammad Yunus, professor of economics at the University of Chittagong, was becoming disillusioned with the abstract theories of economics that failed to explain why so many poor people were starving in Bangladesh (Jacques, 2010).
Dr. Muhammad Yunus saw this challenge, determined to find a practical solution he lend money with zero interest, and Grameen Bank Project was born, it grew rapidly with more than six million borrowers as at 2006. Inspired by the success of the Grameen Bank, the 1970s and 80s saw rapid growth in the number of new micro-finance institutions appearing around the world, many of them started by NGOs and funded by grants and subsidies from public and private sources. The future of microfinance is hard to forecast, but several estimates suggest that 500 million to 1.5 billion people still lack access to financial services that could strengthen their economic situation and improve their life conditions (Jacques, 2010).
Additionally, 2.5 billion young people will become adults within the next ten to twenty years, and it seems uncertain whether the traditional working market will be able to absorb such demographic boom. The role of microfinance and other alternatives ways to encourage and assist auto-entrepreneurship are likely to remain important in the global economy (Jacques, 2010). Many of the microfinance institution are still doing fine, and the rest of them have fallen away. The purpose of this literature is to show the reason some microfinance are not sustainable.
Sustainability
According to Clough (2006), Sustainability is “a process that helps create a vibrant economy and a high quality of life, while respecting the need to sustain natural resources and protect the environment. It expresses the principle that future generations should live in a world that the present generation has enjoyed but not diminished (Pg, 1).” Sustainability could be also be defined as an ability or capacity of something to be maintained or to sustain itself. It’s about taking what we need to live now, without jeopardising the potential for people in the future to meet their needs.
Microfinance
According to Johnson (2007), Microfinance encompasses “the provision of financial services and the management of small amounts of money through a range of products and a system of intermediary functions that are targeted at low income clients. It includes loans, savings, insurance, transfer services and other financial products and services” (Pg, 2).
Microfinance Institution
Microfinance institutions fill a needed gap within the financial services industry by offering small loans, or micro-loans, to people unable to access conventional loan services. Microfinance institutions vary in size and function with some organizations focusing entirely on microfinancing, while others work as extensions of large investment banks Jacquelyn (2014).
Sustainability in Microfinance Institution
Operational sustainability accompanies the concept of operational self-sufficiency (OSS) which measures operating revenue as a percentage of operating and financial expenses, including loan loss provision expense and the like. If this ratio is greater than 100 percent, the MFI is covering all of its costs through own operations and is not relying on contributions or subsidies from donors to survive (Craig, 2006, Pg. 367).
Operational Self-Sufficiency in general includes all the cash costs of running a MFI, depreciation and the loan loss reserve. Sometimes donors will exclude the cash costs of funds from their analysis because “those MFIs that begin to access the commercial financial markets and pay the cost of capital would look relatively worse than other institutions with the same costs and outreach, but who have remained reliant on donor capital to fund their portfolio” (UNCDF, 2002, Pg. 20). This applies due to the fact that some donor fund dependent institutions do not have the same financing cost as commercial MFIs.
Why Some Microfinance Institution are not sustainable
According to Lena (2012), he quoted Mr. Franklin Belnye, head of the Banking Supervision Department at BoG, “in 2012 that inappropriate documentation, unqualified staff, inadequate financial projections submitted to BoG, a rush to establish branches and the offering of unattainable returns were among the challenges presented by MFIs in the country. He was quoted as having said, “In recent times, microfinance companies are springing up by the day. However, the rate of growth in the sector has brought to the fore the urgent need to strengthen its regulation and supervision to streamline its operations” (Par 2).
More than 30 microfinance institutions in the Ghana collapsed in the first quarter of this year as a result of their inability to sustain their operations. Customers with huge deposits with those institutions could not get a refund, as the owners could not be traced, or where they were traced, they failed to raise the requisite funds to pay the customers (Daily Graphic, 2013).
Microloans are more beneficial to borrowers living above the poverty line than to borrowers living below the poverty line. This is because clients with more income are willing to take the risks, such as investing in new technologies, that will most likely increase income flows. Poor borrowers, on the other hand, tend to take out conservative loans that protect their subsistence, and rarely invest in new technology, fixed capital, or the hiring of labor.
Microloans sometimes even reduce cash flow to the poorest of the poor, observes Vijay Mahajan, the chief executive of Basix, an Indian rural finance institution. He concludes that microfinance “seems to do more harm than good to the poorest.” One reason could be the high interest rates charged by microfinance organizations. Acleda, a Cambodian commercial bank specializing in microfinance, charges interest rates of about 2 percent to 4.5 percent each month. Some other microlenders charge more, pushing most annual rates to between 30 percent and 60 percent. Microfinance proponents argue that these rates, although high, are still well below those charged by informal moneylenders. But if poor clients cannot earn a greater return on their investment than the interest they must pay, they will become poorer as a result of microfinance, not wealthier (Aneel 2014, Par. 16).
Another problem with microfinance is the businesses it is intended to fund. A microfinance client is an entrepreneur in the literal sense: She raises the capital, manages the business, and takes home the earnings. But the “entrepreneurs” who have become heroes in the developed world are usually visionaries who convert new ideas into successful business models. Although some microfinance clients have created visionary businesses, the vast majority are caught in subsistence activities (Aneel 2014, Par. 17).
They usually have no specialized skills, and so must compete with all the other self-employed poor people in entry-level trades. Most have no paid staff, own few assets, and operate at too small a scale to achieve efficiencies, and so make very meager earnings. In other words, most microfinance are small and many fail – contrary to the United Nations’ hype that micro-entrepreneurs will grow thriving businesses that lead to flourishing economies.
Conclusion
In the end the concept of microfinance with its potential to generate profits surprised many. The huge number of poor people, completely forgotten by the formal financial market for such a long time, turned out to be viable customers of micro financial services and changed the paradigm of western countries. Microfinance will continue to provide attractive investment opportunities in the future if people from developed countries keep being on the lookout for new markets, products and investment opportunities in this field.

Reference
Aneel, K. (2007). Microfinance Misses Its Mark. Retrieved November 06, 2014, from Stanford Social Innocation Review: http://www.ssireview.org/articles/%20entry/microfinance_misses_its_mark/P195/
Clough, G. W., Jean-Lou, C., & Carol, C. (2006). Sustainability and the University. New York: The Presidency.
Craig, C., & Cheryl, F. (2006). Making Microfinance Work: Managing for improve performance. Geneva: International Labour Organization.
Jacquelyn, J. (2010). Role of Microfinance Institutions. Retrieved November 10, 2014, from Demand Media: http://www.smallbusiness.chron.com/role-microfinance-institutions-13233.html
Jacques, A. A. (2010). Micro World. Retrieved November 07, 2014, from Brief History of Microfinance: http://www.microworld.org/en/about-microworld/about-microcredit#history
Johnson, P. A. (2007). MICROFINANCE IN GHANA: AN OVERVIEW. Retrieved November 10, 2014, from Economic Web Institute: www.economicswebinstitute.org/essays/microfinanceghana.htm
Lena, P. (2012, December 31). Bank of Shuts Down 7 Microfinance Companies For Failure to Obtain Licenses. Retrieved November 06, 2014, from MICROCAPRITAL BRIEF: http://www.microcapital.org/microcapital-brief-bank-of-ghana-shuts-down-7-microfinance-companies-for-failure-to-obtain-licenses/
United Nations Capital Development Fund. (2002). Microfinance Distance Learning Course. New York: United Nations Publications.

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