Role and Impact of Micro Finance Institutions

Role and Impact of small Finance InstitutionsINTRODUCTIONThe strong economic growing is bound to create barter opportunities and in that locationfore it leave alone reduce unemployment. The evidence provided by the Labor Force Survey 2005 (First two quarters) clearly delays the fact that economic harvesting has created employment opportunities. Since 2003-04 and until the last half of 2005-06, 5.82 one million million new jobs fork out been created as against an average job creation of 1.0-1.2 million per annum. Consequently, unemployment rate which stood at 8.3 shargon in 2001-2002 dec linaged to 7.7 percent in 2003-04 and stood at 6.5 percent during July-December 2005.The rising pace of job creation is bound to increase the income levels of the people. Agriculture, housing and construction, IT and telecom sphere of influence, and SME atomic number 18 the sectors, which have created relatively more jobs. The estimation of pauperisation line enables the policy makers to further identify and group the population into various distress bands such as extremely suffering, vulnerable and non- sorry etc.The current growth grade however need to be strengthened to arrest the current growth in meagerness levels. Macro stabilization, governance reforms and re-profiling of external debt stock have created prospects for growth in future. The establishment has indicated its willingness to speed up the pace of structural reforms to meet the major challenges ofReducing poverty,Improving governance and administration,Improving the fiscal and balance of payments positions, recumboring investor confidence,Achieving higher(prenominal) growth on a sustainable basis, andImproving social indicators.1.1 MICROFINANCE SECTORMicrofinance in Pakistan is relatively a new sen snipnt as compared to some other(a) countries in the region. The NGOs and agrestic Support designs has been the major tacticer in the sector since early 1980s covering about 5% of more than 6. 5 million unequal households in the earth. Recognizing littlefinance as an important poverty alleviation tool, the Federal Government has adopted a littlefinance policy that mainstreams the concept of sustainable microfinance, recognizes the private sectors role in poverty reduction and encourages its entry into beveling with the short. It has enacted a legal framework, the MFIs (Micro Financing Intermediaries) Ordinance 2001, for establishing Microfinance chamfers in private sector and too facilitated cheek of Khushhali Bank, a unrestricted private breachnership, with partner off objective of substantially increasing outreach of microfinance operate in the medium term and giving a model institution to the private sector to follow.The MFIs Ordinance 2001 screen alia stipulates the functions, capital requirements, ownership structure, terms and conditions for establishing Microfinance Banks/Institutions in the verdant, audit and disclosure requirements and winding up p rocedures. The readinesss of the ordinance are applicable on microfinance institutions mobilizing speechs from public to finance their operations. The operations of NGOs and other course of studys providing micro ac point of reference entry and allied service through and through sources other than public deposits/savings are not covered at a lower place the ordinance. The framework allows establishment of three categories of formal microfinance banks in the country viaNation wide MFBs token(prenominal) paid-up capital of Rs.500 millionProvince wide MFBs minimum paid-up capital of Rs.250 million andDistrict wide MFBs minimum paid-up capital of Rs.100 million1.2 EVOLUTION OF MICROFINANCE IN PAKISTANThe microfinance movement in Pakistan followed a unparalleled evolutionary path over the last decades. The proceeding paragraphs present the three tuition phases of the sector. Each phase represents entry of new institutional forms and structures in the Pakistani microfinance se ctor. Some of the highlights of this 30 year old history are as followPhase-1 1970s, Government directed credit. The use of finance (mostly credit) as a maturement tool has a history in Pakistan in the form of government directed/subsidized credit schemes particularly in agrarian areas. In youthful years Small Business Finance Corporation (SBFC), Youth Investment Promotion Society (YIPS), Self Employment fascinate (SES) and lily-livered Cab Scheme are typical examples. While SBFC and YIPS represent a direct institutional intervention through use of public funds and institutional structures, SES and Yellow Cab schemes represent indirect government pressures on financial institutions, both public and private to engage in politically motivated directed credit. In the last two initiatives, the government literally forced commercial financial institutions (mostly public sector) to provide concessionary financial backing in particular to unemployed youth and business start-ups. T he give defaults associated with these schemes affecting the financial institutions profitability has been extensively reported in the popular press.Phase 2 early 1980s to mid nineties philanthropy of finance. The ontogenesis of the Pakistani microfinance sector is usually traced to two pioneering development institutions The Aga Khan Rural Support Program (AKRSP) and the Orangi Pilot Project (OPP).The early pioneers was naturalised in 1982 by the Aga Khan Foundation (http// www.akdn.org/), AKRSP was the first Integrated Rural Development Program of its kind, outside the government domain. It has focused its development interventions on the Northern Areas of Pakistan. The later mean solar day Rural Support Programs (RSPs), initiated by the government, were inspired by the AKRSP model of hobnailed development. The first heavy(a) scale practical implementation and conceptualization of development frameworks such as social mobilization and group lending methodology can be tra ced to AKRSPs microfinance model initiated in 1982.While AKRSP pioneered development service provision in the rural, agrarian frontiers of north Pakistan, OPP took up the challenge of tackling urban poverty in the biggest slum settlement in Pakistans port city and commercial capital Karachi. OPP was anchor by Akhtar Hameed Khan, considered to be the father of rural development in Pakistan. OPP was established in 1987 and its development operate include housing, sanitization and education.The RSP model, AKRSP formulated and implemented corporate development approach path whereby rural population was organized into Village Organizations (VOs) and the needs prioritized by these community organizations were provided for through a wide range of development services such as education, health, sanitation as well as financial services (microfinance). AKRSP endeavored to develop human, social and financial capital of the communities it worked with. This integrated approach was replica ted by government initiated development organizations called Rural Support Programs (RSPs). By 2004, RSPs were working with more than 43,000 community organizations comprising of more than 1,000,000 households.Sarhad Rural Support Program (SRSP) was the first RSP to be established in 1989 as a replication of AKRSP model in the North-West Frontier Province of Pakistan. In the same year a Pak German development project was restructured as an RSP and renamed as Balochistan Rural Support Program (BRSP). Later on Punjab Rural Support Program (PRSP) was also launched by the Government of the Punjab province.The establishment of content Rural Support Program (NRSP) (www.nrsp.org.pk) in 1992 has a special significance. While SRSP and BRSP had provincial focus, NRSP was meant to be the largest national RSP with development interventions including a very manque microfinance program all over Pakistan.The rural focused microfinance operations of NRSP have expanded into urban areas as well und er its Urban Poverty succour Program (UPAP).With the above mentioned perspective, the microfinance strategy during the early 1990s has certain common elements the word micro credit was used instead of microfinance symbolizing provision of yet loans (and compulsory savings) as a social service equivalent to other development needs such as education, health, sanitation etc. Microfinance best practices as we know them today were still in their formative stages and had not crystallized into a coherent set of principles and frameworks make up at the international level.Phase-3 late 1990s till the present entry of the specialist MFI. The later part of 1990s saw the entry of regulated financial institutions such as commercial banks and leasing companies in the microfinance arena. Mostly urban based microfinance only programs also came up in major cities of Pakistan. Regulatory structures started taking shape, spawning a new microfinance institutional structure The Microfinance Bank ( MFB).1.3 VIABILITY OF PROPOSED MICROFINANCING BANK (MFB) IN THE COUNTRYIn the light of the above scenario the establishment of the proposed micro financing bank (MFB) in the country raises many doubts about its potentiality to reduce poverty, sustainability to survive in the long run, and opportunity cost of resources diverted from other potential projects towards the MFB.The banking sector in the country has a long history of poor targeting and high default rate in the economy. The past experience of cooperative societies in the country is also that of a disaster. Million of rupees were lost in these schemes on the name of credit. Mainly their borrowers as well as defaulters are from the high-income group and influentials in the society.An evaluation of the pilot project for micro financing of the National Bank of Pakistan (NBP) for the future establishment of the proposed MFC is also not very encouraging. The bank does not have any mechanism to identify the poor regions and poore st in the country to provide micro credit. There are no poverty profiles that can indicate, which regions are the poorest and which villages or localities are severely impoverished in polar provinces of the country. Therefore, the loans are mainly provided on the basis of subjective criteria which increase the chances of poor targeting of the scheme.Similarly, the bank does not have the experience, culture and environment for providing microcredit to poor in the country. The procedure for credit and collateral requirements of the bank is so complicated that it not only excludes the poorest from the scheme but it also increases the chances of leakage in the scheme. In fact, during a field chaffer by the author in one of the pilot project areas in Sindh, it was observed that the bank borrowers are paying extra charges/commission for receiving the inputs from the bank recommended dealers.Ironically, there is neither women staff nor woman borrowers in the pilot project area of NBP, wh ereas one major objective of the program is the empowerment of women through micro financing and women should be 33% among the borrowers.Other major NGOs providing micro financing in the country are Agha Khan Rural Support Program (AKRSP), National Rural Support Program (NRSP), Sarhad Rural Support Program (SRSP), Orangi Pilot Project (OPP), SUNGI Development Foundations, Kashf Foundation (Kashf), Sindh Agricultural Forestry Workers Cooperative Organization (SAWFCO), Thardeep Rural Development Program (TRDP). Moreover approximately international presenter agencies like OXFAM and Save the Children Fund (SCF) also provide providing microfinance through intermediary NGOs in antithetical parts of the country (www.spdc.com.pk)1.4 PROBLEM STATEMENTStudies illustrated that poverty exerts a significant impact on education, health place, savings and the real GDP. For example the evidence on reducing photo however, is somewhat clearer. The provision of micro credit has been found to stre ngthen crises coping mechanisms, diversify income earning sources, build assets and improve the status of women (Hashemi et al, 1996)H0 Micro financing has not decreased the poverty.H1 Micro financing has reduced the poverty.This hypothesis suggests that as micro financing affects poverty in a positive manner, as a result, education, health status, saving and real GDP of the household has a positive relationship with the micro financing.The existing evidence on the impact of micro credit on poverty is not clear-cut. There is a work that suggests that access to credit has the potential to significantly reduce poverty. (Khandker, 1998) On the other hand, there is also a query which argues that micro credit has minimal impact on poverty reduction, (Morduch, 1998)Being a finance student the motivation was previous research which was very broad but not specific to the chosen statement. A broader perspective was present but the absence of narrower contexts compelled me to strive this research. The study has many aims. The main purpose was to delivery the problem of poverty and apply it to the national scenario. Efforts are directed to utilize and process all available data, avoid bias and error, and generate important results.1.5 objective OF THE STUDYThe specific objectives for the study are outlined as follow1. To assess the role and impact of micro-finance institutions on the livelihood of poor.2. To assess factors that hinders the rural poor from participating in Micro finance Institutions3. To draw conclusion and give some policy recommendations for the successful implementation and development of micro financing programs.Rest of the project is organized as follows. In chapter two we have provided literature review, in chapter three we have defined data and methodology, in chapter four the results have been explained and in chapter five we have concluded the project with some recommendations.CHAPTER NO.2LITERATURE REVIEWIn the past few years there is an increase in research in the area of Micro Financing. Micro finance or micro credit, by providing weensy loans and saving facilities to those who are excluded from commercial financial services has been promoted as a key strategy for reduction or combating poverty. Access to these facilities is seen as away of providing the client that are economically active with opportunities for self trust through entrepreneurship, cushioning them against economic shocks, and providing a mean of social empowerment for poor women and men in their communities. Yet although microfinance programs are often driven by a moral imperative to alleviate poverty, the extent to which they are able to reach the poor with their services and likely economic and social impacts continue to be issues of debate.Binswanger and Landell-Mills (1995) states that constraints in relation to suppliers.i.e. Private Banks excludes the poor because small transactions are unprofitable. Providing financial services to the poo r and women is not easy. Many borrowers are not credit worthy and dont have profitable projectors. Thus, that the need for micro financing is an undeniable fact.According to Yanor, Benjamin and Pipren (1997), the issue that should be raised in this context is the magnificence of the informal sector in LDCs economy and its constraint to develop by lack of credit. On top of that, Salad vine and checkering (1991) confirmed this fact by noting that, the informal sector which contributed about 35% to 65% and 20% to 40% to employment and GDP in most LDCs respectively, is constrained by lack of credit.The provision of micro credit has been found to strengthen crises coping mechanisms, diversify income earning sources, build assets and improve the status of women (Hashemi et al, 1996)Coleman (1999),in his study of a village-banking program in Thailand, advances the literature by expanding on this concept to control for self-selection biases and introduces both observable village characteri stics and village fixed effects to control for program placement bias. Utilizing data on 455 households, including participating and non-participating households in give-and-take villages where a village bank is already offering micro credit, and selected future participants and non-participants in control villages that have been identified to receive a village bank program but have not yet actually received funds, Coleman uses a disagreement-in-difference approach that compares the difference between income for participants and non-participants in program villages with the same difference in the control villages, where the programs were introduced later.Zaman (1999) explored the relationship between micro credit and the reduction of poverty and vulnerability by focusing on BRAC, one of the largest micro credit providers in Bangladesh. He concluded that micro credit contributes to mitigating a number of factors that contribute to vulnerability, whereas the impact on income poverty is a function of adoption beyond a certain loan threshold and to a certain extent contingent on how poor the household is to start with. His empirical compend also suggested that micro credit has the greatest on female control over assets and also on her knowledge of social issues controlling for a drove of other characteristics.The Need For Micro-FinancingAccording to Khandker (1998), the alleviation of poverty requires diverse measures. The most important being those, which expand the income and employment opportunities of the poor, enabling them to enhance their living standards providing the poor with access to financial services is one of the many ways to increase their income and productivity.Micro financing programs are authentic to fill this gap. The rural poor in LDCs are in desperate needs of credits, microfinance programs are supposed to make available this credit needs and keep the poor to increase their living standard. want of saving and capital make it difficult for many poor people who want jobs in the formal and informal sectors to become self employed and to undertake productive employment generating activities, providing credit seems to be a way to generate self-employment opportunities for the poor.In this regard, MFIs in relation to other financial intermediaries has special role and distinguishing peculiaritys which are given as followsThe primary objective of MFIs is to address the credit needs of those who are willing and ready to reduce their chronic poverty by attractive in farming and small scale production and service activities (Getahun, 2001).Besides provisions of credit facilities, MFIs render managerial, tradeing technical and administrative advise to borrowers by reaching borrowers at there place of work.(ibid)MFIs do not require collateral to extend credit in cash or kind to provincial farmers and small entrepreneurs. Instead peer group-leading scheme, character based loans and the anticipate of subsequent loans is main motivations for repayment (Marguerite, 2001).Saving requirement is introduced as a compulsory feature of lending activity and this saving requirement seems to serve as a motivator for repayment of loan since borrowers choose to repay the loan than losing the amount they salve (Getahun, 2001)2.2 Country Experiences on Micro-financing2.2.1 Experience of BangladeshWhy it is that micro-finance becomes a great concern for the whole world as an instrument for poverty reduction in rural areas? It seems because it has recorded success in countries where it has been implemented Abiy (2000). A brief look at this success stories is as follows.One of the most successful countries often mentioned in the development of microfinance is Bangladesh. Micro finance organizations like Grameen Bank, Bangladesh Rural Advancement Committee (BRAC), Proshika (PK), Association for Social Advancement (ASA), largest 20 credit NGOs (not including Grameen Bank), and Bangladesh Rural Development circuit ca rd (BRDB) are operating in the country mentionedFor instance, the Grameen Bank, which was established in 1983 as a challenge to existing collateral-based financial system, has had a promising result. It operates exclusively for the poor on the promise that rural people, who won too little land, support themselves as farmers, can never the less make productive use of small loans and repays them on time. The bank also promotes social development by making the poor accountable to individually and socially. Such intermediation improves productivity and income of the poor. This, in turn, also improves their loan payment rate and hence contributes to the Grameen Banks financial Viability. As the result it is the most successful credit program for poor and this may be seen from the outreach status and loan recovery so that the banks loan recovery rate has consistently remained above 90 percent Pit and Khandker (1998).2.2.2 Experience of some African Countries formalised micro finance insti tutions in Africa is a more recent phenomenon. The 1950s and 1960s led to a proliferation of rural leading programs that focused on the provision of subsidized credit by government development banks. After this period in 1980s, the replication of Bangladeshs Grameen Bank began to be tested using primary donor funds to provide credit to a wide number of solidarity group members (Paxton and Fruman, 1998).For our purpose, however, we will look only two countries Kenya and Burkina Faso- the former representing relatively densely live region and the latter is less densely populated.For example, in Kenya KREB (Kenya Rural Enterprise Bank) is a micro finance institution serving the poor in rural and urban areas of Kenya. It was established as an intermediary NGO to provide financial and technical assistance to NGOs in Kenya that are involved in developing or promoting the development of micro and small enterprises.Since 1990, KREB has successfully transformed grants from its development p artners into loan capital for nearly 30,000 businessmen and women. It has been able to do so at a positive return since 1994. KREB has distributed over Kenyan shilling 300 million each year since 1995 and has never run short of new customers.The PPPCR (Le project de forwarding du petit credit rural) has been particularly innovative in adopting the Grameen style of group lending to the conditions in Burkina Faso. Certainly the sahelian region represents one of the most challenging environment for micro finance due to the combinations of failed prevails efforts low population density, poverty and illiteracy. To overcome some of these obstacles, PPPCR has departed from a pure Grameen replication and has adapted its own financial services and organization.Like the Grameen Bank, PPPCR has grown quickly, but cannot be compared in member of clients. By the end of 1994, PPPCR had served 10,000 clients, and two years later it had reached about 25,000 clients. Despite all of the prudent mod ifications of the Grameen model to the Burkina Faso context, the provision of micro finance services has proved to be quite costly in the Sahel. The reasons for these high costs are more cerebrate to the environment (low population density, poor infrastructure, poverty, illiteracy etc.) than to the methodology of group lending itself. The PPPCR has experienced greater efficiency in the past couple of years as it continues to learn from its early experience achieves economies of scale.Generally, the results in this study have shown that none of the institutions have been able to cover the cost of subsidies despite in roads towards financial viability. Most of micro finance institutions limit their ability to achieve high volumes of loan advances and savings. In sum, the most important lesson is that a wide variety of market niches exist in the field of micro finance.In a more recent study, James et al, (2001) estimated the impact of an urban credit program in Zambia on business per formance and on a range of indicators of household well-being. They found that borrowers who obtained a second loan experienced significantly higher average growth in business profits and household income. The Bolivian experience indicates that all the institutions studied had, on balance, positive impacts on income and asset levels. (Mosley 2001)In Pakistans context, Khan (2001) estimated the economic impact of the support program on rural households. He concluded that the economic impact of the support program on rural households is substantially large and probably makes a significant difference to the households close to the poverty line. However, he qualified this conclusion by arguing this conclusion holds particularly for those rural households that infix on a sustained basis over a long period. However, international experience strongly suggests that microfinance projects do not reach all segments of poor. so far the minimal or no collateral requirements potentially exclude the poorest from the schemes. In Bangladesh, for example, only one forth of all microfinance clients is among the hard-core poor. The UNDP report (2000) claims that the hard-core poor having few assets are reluctant to take on the risks of credit, and when they do, it is usually for emergencies and consumption, not for production. Extending financial services to the poorest requires innovations which go beyond those that have been developed so far.Morduch (1999) argued, The promise of micro finance should be kept in context. Even in the best of circumstances, credit from micro finance programs help find self employment activities that most often supplement income for borrowers rather than drive fundamental shifts in employment patterns. It rarely generate new job for others, and success ha been especially limited in regions with highly seasonal income patterns and low population densities. The best evidence to date suggests that making a real dent on poverty rates will require incr easing overall levels of economic growth and employment generations.Micro finance may be able to help some households take advantage of those processes, but nothing so far suggests that it will drive them. The experience of micro finance in Pakistan is not that different from other countries, it is generally recognized that the present micro financing framework is characterized by low coverage (an inability to reach the poor), targeting inefficiency (the poorest are left out, inadequate of support (insufficient loan sizes), a low degree of ease of lack of self financing ( habituation on donors).Rodriguez-Meza (2001) studies strategic defaults in microfinance. More specifically, he evaluates the effect of different contract designs on borrower repayment behavior for both individual and joint liability contracts. Rodriguez-Mezas model shows that lenders willing to grant loans large enough for borrower to achieve their optimal level of investment may face sustainability problems, as b orrowers may find it optimal to default under these circumstances. He finds that clients can default on their loans even when they have the ability to repay due to the absence of perfect collateral. His results have serious implication for the viability of MFOs and their role in economic development.In addition to these studies, practitioners, donors and academics interested about the negative effects of client exit on the overall sustainability of MFOs have conducted several descriptive studies on the issue (Hasan and Shahid, 1995) Khan and Chowdary, 1995 ASA, 1996 Kashangaki, 1999 Maxima Bali, 1999 Painter and MKNelly, 1999 Simanowitz, 1999 Wright et al, 1999 Churchill, 2000 Kuwik and Mashaba, 2000 Churchill and Halpern, 2001 Schreiner, 2001.Overall, they found that most people are pushed out of MFOs, especially in Africa, due to adverse push factors, such as client maturity and aspiration, also play a role in pulling clients away from MFOs, especially in Latin America and Asia, where the micro finance industry is more developed and competition is more intense.The governments goal of poverty reduction is to be realized through a comprehensive approach that takes into account the interaction of economic, social and governance proportions. The approach is outlined in the interim poverty reduction strategy paper (IPRSP).Expenditure and budgetary allocations for poverty reduction measures have been enhanced. The poverty alleviation program of the government has five elementsSmall infrastructure projects,Social safety net,Food support program,Improving social indicators andExpanded access to MF and skills development services through grassroots Organization such as NGOs and village organizations.Greater private sector involvement in poverty reduction is envisaged. The social action program phase two (from January 1997 to June 2002) aims to improve access to basic social services like primary education, primary health care, population welfare services, potable w ater, sanitation and middle schooling. The government has also responded to growing unemployment, with a series of scheme including the mass self employment program. The incidence of poverty is to be reduced from 33% of population to be target kevel of 15.1% be end 2008.To enhance outreach of MF, the government has adopted a comprehensive approach to address issues and constraints through a semiconductive policy framework, appropriate supervisory and regulatory infrastructure, institutional capable of outreach to the poor and finally, investments in social intermediation and basic infrastructure. The government has plans to restructure DFIs.Emphasis will be placed on good governance, sustainability, and public private partnership, community based services delivery through NGOs, Pro-poor focus and gender concerns. This strategy complements the effort of the PPAF and other MF suppliers and provides the basic for a concerted effort to enhanced outreach in a grossly underserved market. Gender focus will be emphasized in the strategies and underlying activities in various government programs. A permanent commission on the status of women has been formally announced to protect womens rights. The IPRSP also recognizes the gender dimension of poverty and proposes reform of discriminatory laws and measures to coordinate policies. Within the IPRSP framework, a review and modification of economic and social policies to incorporate gender perspectives is planned. Strengthening of gender central points in federal and provincial women development departments and identification of targets for the implementation of the National Action Plan (Ministry of Women Department) have been envisaged.On the basis of the literature reviewed, we have developed the following conceptual framework.Fig 2.1 DEVELOPMENT OF CONCEPTUAL FRAMEWORKPovertyMicro financing in education, health status, savings and real GDP qualified variable Independent VariableP= f (EDU, HS, SAV, RGDP)Where,EDU = Educ ationHS = Health StatusSAV = SavingsRGDP = Real Gross Domestic Product.CHAPTER NO.3DATA METHODOLOGYThis part of the report illustrates the methodology that will be used to conduct this study. The conceptual framework for the study is depicted in Fig 2.1. We want to study the dependence level of the dependent variable and its association with the independent variables. Pool regression analysis is a well recognized methodology to analyze relationships and dependence among different variables.The research instruments used in this study were ordinary least square multiple regression analysis, Granger causality test. In view of the limited time frame of the study the sample size was restricted to thirty one. This study was descriptive in nature and deals with the most important and alarming issue of Micro financing.REGRESSION ANALYSISIn statistics, regression analysis is a collective name for techniques for the modeling and analysis of numeri