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Introduction Dhirubhai Ambani International Model United Nations 2019 Forum: GA2: Economic and Financial Issue: Improving microcredit systems to help eradicate poverty Student Officer: Sahil Rane Position: Deputy Chair Introduction More than 3 billion people live on less than $2.50 a day and an estimated 1.3 billion live in extreme poverty, making do with $1.25 or less daily. Economists have been trying to come up with various innovations in order to counter poverty; microcredit is one such innovation. Microcredit is used to describe small loans granted to low-income individuals that are excluded from the traditional banking system.1 It extends financial opportunities to the poor by providing more reliable financial services. The microcredit sector is a dynamic and fast growing sector with annual growth of over 9% in the global portfolio of loans and the number of active borrowers including a growth rate of up to 50% in some countries like India.23 Financial inclusion, today, is extremely important for the progress of a country; it is the provision of financial services to all in an equitable manner and for affordable costs. Financial inclusion has great potential to help improve the standard of life that people enjoy in Less Economically Developed Countries (LEDCs) by promoting investment in business ventures. Globally, 1.7 billion adults remain unbanked, yet two-thirds of them own a mobile phone that could help them access financial services. This further emphasises the necessity of financial inclusion and the scope for the use of technology in microcredit.4 Furthermore, the World Bank has identified financial inclusion as an enabler for 7 of the sustainable development goals.5 Most financial institutions do not provide financial services to the poor because of perceived high risks, high costs of transaction, and the inability of the poor to provide collateral for loans. All of the above being obstacles that microfinance institutions must overcome. Today, promoting financial 1("Story of the microcredit") 2("Microfinance Barometer 2017: global trends of the sector...") 3(Pti "Microfinance industry clocks over 50% growth in Q2" 2018) 4("Financial Inclusion on the Rise, But Gaps Remain, Global Findex Database Shows") 5 ("Overview") ● Research Report | Page 1 of 20 Dhirubhai Ambani International Model United Nations 2019 inclusion has been a developmental theme in several countries around the world especially in Asia and the Pacific helping to achieve balanced economic growth. The impact of financial inclusion on the poor includes better access to credit and working capital, risk management, asset building and increase in income.6 For many centuries, microcredit has existed in various forms; however, the birth of modern microfinance is said to have occurred in rural Bangladesh in the 1970s. This is when Dr. Muhammad Yunus founded the Grameen Bank, one of the most prominent microfinance institutions in the world. It worked on a model that was the complete opposite of the conventional banking system. He played an important role in the development of microfinance institutions. He promoted the idea that anybody could become an entrepreneur thus promoting private ownership. The Grameen Bank gives credit to those in need in Bangladesh without any collateral and has thus transformed the conventional banking system replacing it with microcredit. After the Grameen Bank was founded, several microfinance institutions followed. Many of them were started by NGOs (Non-Governmental Organizations) and funded by grants and subsidies from public and private sources. They proved the concept that the poor could be relied on to repay their loans and hence that microfinance was a potentially viable business.7 During the 1990s, the microfinance institutions began to realize that they could not continue to grow at such rates while continuing to rely on grant funding. As a result, many began to restructure themselves to attract commercial investors, adopting more formal business practices and working to improve their efficiency and sustainability.8 Slowly focus moved away from the NGO structure towards promoting a sustainable industry that could provide financial services to the poor at fair prices while offering a reasonable return to commercial investors. The end of 2008 had channelled nearly $15 billion of foreign investment channelled into micro-finance institutions.9 In recent years, micro-finance has been the subject of various innovations and experiments from leveraging the hugely popular mobile banking industry for the purpose of micro-finance, where mobile phones are used to send and receive money, to diversification in loan methodologies such as machinery loans.10 6(Elmer "Financial Inclusion and Microfinance" 2016) 7("Story of the microcredit") 8ibid 9ibid 10ibid ● Research Report | Page 2 of 20 Dhirubhai Ambani International Model United Nations 2019 Microfinance has received a major boost due to the involvement of several NGOs and microfinance institutions (MFIs). Several Self Help Groups (SHGs) have also been created where people having homogeneous backgrounds form groups of around 20 each and pool money, which is then lent to the needy in the group. It is an efficient and unique approach for financial intermediation through self-management. The Peer-to-Peer Lending Model has begun to gain popularity. This approach helps to reduce the operational costs in the MFI model. Peer- to-Peer lending, also known as P2P Lending, is a financial innovation, which connects verified borrowers seeking loans to investors. Peer-to-peer (P2P) lending enables individuals to obtain loans directly from other individuals, cutting out the financial institution as the middleman. However, P2P lending comes with its risks. People who consolidate consumer debt through peer-to-peer lending sites tend to wind up with even more overall debt when they begin to use credit cards freed up by their loans. Alternative channels are being developed in order to provide an alternative way to distribute financial services to the poor. Certain delivery channels offer the possibility of massive outreach to people in remote locations. Alternative channels also help in reducing cash in the financial system to provide more transparency, be less vulnerable to fraud risk, and be safer for the client. Alternative channels will also lead to dramatic cost reduction. The current model of microfinance is extremely human-resource intensive, with labour costs sometimes accounting for almost half of operating expenses. Microfinance institutions want to come up with alternative channels to reduce their dependence on branch staff and create a more personalized system involving a transactional service inspired from cell-phone banking. However, this is still in its early stages and has not been developed yet.11 Microfinance has a great social impact and helps to empower women thus reducing gender inequality. As of October 2011, the Grameen Bank had 8.349 million borrowers, 97% of whom were women. With 2,565 branches, it provides services in 81,379 villages, covering more than 97% of the total villages in Bangladesh.12 It gives high priority to women and works to raise the status of poor women in their families by giving them ownership of assets. It also makes sure that the ownership of the houses built with Grameen Bank loans remains with the borrowers, i.e., the women. Microfinance services lead to women’s empowerment by positively influencing women’s decision-making power and enhancing their overall socio-economic status. By the end of 2006, microfinance services had reached over 79 million of the poorest women in 11("Accelerating Financial Inclusion through Innovative Channels 10 Obstacles for MFIs Launching Alternative Channels— and What Can Be Done About Them") 12 ("About Grameen Bank") ● Research Report | Page 3 of 20 Dhirubhai Ambani International Model United Nations 2019 the world. As such, microfinance has the potential to make a significant contribution to gender equality and promote sustainable livelihoods and better working conditions for women. Moreover, microcredit has a great social impact helping to reduce gender inequality. Considering the large number of people disconnected from financial services it is essential that steps be taken to improve microcredit systems in order to eradicate poverty. Definition of Key Terms Alternative Channels According to the International Finance Corporation, “For much of its 30-year history, microfinance has been limited to the standard branch-and-loan-officer model of delivering credit.” Alternative channels refer to non-traditional, or alternative, ways of distributing credit and other financial services to the poor.13 Debt Trap A debt trap is a situation in which a borrower is led into a cycle of re-borrowing, or rolling over, their loan payments because they are unable to afford the scheduled payments on the principal of a loan. These traps are usually caused by high-interest rates and short terms. Any time a person borrows money there are two basic elements to the loan: the principal and interest. A debt trap occurs when a borrower is unable to make payments on the loan principal; instead, he or she can only afford to make payments on the interest.14 Financial Inclusion Financial inclusion is the pursuit of making financial services accessible at affordable costs to all individuals and businesses, regardless of its net worth. It means that individuals and businesses have access to affordable financial products and services that meet their needs (transactions,
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