Essay Example on Microfinance: Alleviating Poverty Through Financial Inclusion

Microfinance refers to providing financial services in limited amounts to low-income individuals and SMEs where commercial banks shun away from extending credit to them because of their low economic status (Basel Committee of Banking Supervision, 2010). The industry started in 1970 with the main aim of alleviating the conditions of the underprivileged in the society. Since then, the industry has encountered tremendous growth. However, its global success, unfortunately, has not had the same reflection in the Caribbean. In comparison with Latin America and Asia, Microfinance in the Caribbean is still immature, & Chalmers, 2001). The under-development mainly attributes to the deficiencies in the institutional structures and policy guidelines. The main deficiency is the absence of robust financial regulations overseeing micro-financing activities.

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With efforts to strengthen microfinance activities in the Caribbean, particularly in the English-speaking nations, in 2011 the Multilateral Investment Fund of the Inter-American Development Bank under its Caribbean Microfinance Capacity Building project requested an investigation and the results were documented (Vogel & Schulz, 2011). This paper will discuss the findings of the investigation. I will attempt to discuss three queries. The first one relates to whether transparency of interest rates should be a requirement in the non-prudential regulations. The second question relates to if the Central Bank of Trinidad and Tobago should govern the credit unions' prudential regulation and supervision. Lastly, I will discuss three recommendations for credit unions to evade delinquency and default of loans amongst self-employed individuals.

To start with, in my view, transparency of interest rate should a requirement in the non-prudential regulations. Non-prudential regulations can cover many windows in microfinance regulation including interest rates. The main reason why there should be an increase in interest rate transparency is to safeguard the poor clients' interest who mostly have low financial literacy levels, which limits their informed judgment on the riskiness of their microfinance projects (Ragbir, 2014). Transparency will increase visibility in terms of the real cost of borrowing instead of the institutions taking advantage and charging interest on the loan's original value rather than 'reducing' balance.

Also, having interest rate transparency in the non-prudential regulations will regulate the imposition of interest rates caps in such a way that these caps do not hinder a free market operation or decrease the micro-financing supply to the underprivileged. Cambodia is an example of a country that has a leading practice policy for interest rate guidelines where there has been similar adoption by other countries. The National Bank of Cambodia states that the interest rate computation method must be on a 'reducing balance'. All MFIs with licenses in Cambodia do not target to apply interest rates as a completive tool to entice clients. Having no interest rates caps or restrictive usury laws will boost the optimum serving of clients.

Also, having interest rates non-prudential guidelines will support and stipulate a standardized way for computing and communicating the charges for the interest rates to customers and the public. Currently, all microfinance institutions (MFIs) in the Caribbean operate in a fixed interest rate environment. They are set too low to let MFIs to cover their high operating costs profitably or exploit customers' willingness to pay higher than the rates in the market. The thriving informal money lending sector which charges higher interest rates than market rates supports the assertion (Ragbir, 2014). If there is more transparency in the charges for interest rates, there will be replacement of the fixed interest rates.

Lastly, having the non-prudential guideline on interest rate transparency will promote fair competition in the market. Funded microfinance and state-owned institution are common in the Caribbean. They utilize state funds to compete with the well-developed private MFIs that use commercial sources to finance their operations. It deprives a free market force operation and disadvantages the private MFIs in micro-financing supply since they can lend at lower interest rates thereby attracting more customers. An example of a country that took note of this and made rectifications to boost microfinance industry growth was Ghana were it took a shift to not directly subsidize credit program but instead prioritize policies that support growth and sustainability of all MFIs (Ragbir, 2014).

On the second question regarding whether the Central Bank of Trinidad and Tobago should govern the credit unions' prudential regulation and supervision, I fully agree and is in support of the initiative basing on the following reasons. One main reason is that as a result of the rapid technological advancement, credit unions have continuously been indulging in riskier activities to thrive and survive thereby requiring more formal and vigorous supervision (Williams, 2005). Currently, there is no adequate legislation to govern these credit unions under the Cooperative Development Division. Trinidad and Tobago have to consider shifting focus and embrace that formal arrangements for credit unions' prudential regulation are suitable since the Central bank is well-equipped with the right resources and expertise to handle the legislation.

Also, currently the staff at the Cooperative Development Division in the Labor Ministry are overwhelmed with the responsibility of overseeing the functions of many types of cooperatives. The employees who are only 52 in number supervise the operations of about 128 credit unions and also 119 other cooperative types (Vogel & Schulz, 2011). The inadequate staff and resources demonstrate a need to relieve the Cooperative Union's duties to sufficiently execute their roles and responsibilities while still maintaining quality. The Central Bank will be a suitable institution to take up the role of overseeing the enforcement of the prudential guidelines by these credit unions.

Also, there is a potential conflict of interest that exists since the responsibilities of the Cooperative Development Division in the Labor Ministry is not only to regulate these credit unions but also to promote them. In recent years, there has been a failure of four major credit unions and they were forced to be liquidated (Vogel & Schulz, 2011). It demonstrates a lack of sufficient segregation of duties and raises the need to ensure that institutions' roles do not conflict in any way. The recommendation to bring the credit unions under the Central bank will relieve the Cooperative Development Division duties that conflict with the agenda of promoting these institutions thereby striking a balance and achieving objectivity.

Also, the transfer of responsibility of governing credit unions to the Central bank has been a successful venture in other developing and developed countries and it can be a good benchmark to kick-start the initiative. For example, in 2002 the United Kingdom brought the responsibility of overseeing credit unions under the Financial Services Authority which also regulates commercial banks (Williams, 2005). Also, in 2005 parliament passed legislation to transfer regulation of credit unions in Jamaica (Williams, 2005). Although there have been few hiccups, the oversight function by these central banks continues to be successful with the implementation of specific credit union legislation to set it apart from commercial banks' prudential guidelines since the two types of institutions have different features.

Also, the oversight by the Central Bank of Trinidad and Tobago will allow for the adoption of a two-tier legislation system that fits the credit unions' environment perfectly. The approach will factor into consideration the size and the overall risk level linked to a specific credit union which makes it ideal for credit unions in Trinidad and Tobago. This type of regulatory regime will accommodate the small credit unions' position and also effectively oversee activities of the larger ones based on the riskiness of their operations (Williams, 2005). The central bank will be ideal to support such a regulatory framework for credit unions since they have credible expertise having dealt with commercial banks with reasonable capacity and resources.

For the move to be successful, all stakeholders in the Credit Union Movement, Cooperative Development Division in the Labor Ministry, the Central bank, and the Credit Union Co-operative League should engage in constructive dialogue to provide credibility. Also, there should be a clear definition and segregation of duties of all institutions to avoid overlapping and redundancy. The amendment of the Financial Institutions Act should be objective and incorporate greater details on how to effectively supervise the credit unions in such a way that there is the maintenance of a resilient and robust financial system in Trinidad and Tobago.

On the last question, the Labor Forced Survey indicates that the number of people in the labor force was 6,735 out of which 6,178 were in employment with 4,760 being employees and 845 being self-employed while the rest were working as unpaid family workers (Government of Anguilla Statistics Office, 1999). This translates to a percentage of 9.2% self-employed personnel out of the total population of 9,213 in Anguilla. Most of these self-employed individuals rely on micro-finances to fund their business expansion for growth purposes. Given that their income is not steady and very unpredictable especially because the majority are low to medium-income earners, they tend to either make their loans go into delinquency or in worst scenarios become defaulters owing to the fact they are unable to repay the loans completely. It forces the micro-finances to either write-off most of these non-performing loans or incur costs trying to recover the loans.

However, there are practical solutions that the micro-finances can implement to avoid loan delinquencies or defaults. One main way is to implement group lending instead of individual lending. Advancing credit to a group of borrowers will lead to borrowers' superior performance and better loan repayment rates since the group can work together and support each other to optimize the effect that the loan can have on each individual (Saloner, 2007). The group members are responsible for choosing new members and other members repaying the loan on a timely basis since they serve as guarantees of a member's loan.

Another major solution is adopting a proper and adequate loan appraisal system. The micro-finances should ensure that they maintain a quality portfolio by avoiding onboarding customers that are risky and highly likely to default. It involves carrying out sufficient due diligence of the client by carefully diagnosing the borrower as well as his business. This will assist in determining the appropriate credit limits after collecting and analyzing the information. It will specifically be advisable to advance credit to the businesses that are older than one year since most businesses are more likely to fail within the first year of operation (Korankye, 2014).

Conclusion

Lastly, the micro-finances should adopt proactive monitoring and follow up system of loan repayments and the client. The loan officers should receive adequate training on how to relate with the customers and also make instant follow up after missing one payment. The officers should visit the client's homes or businesses to assess the general state of affairs, establish borrower'...