Microfinancing is helping to transform developing nations, by making small but localised impacts on local people and economies around the world. We have all heard the saying –
Give a man a fish and you feed him for a day, but give a man the means to fish and you feed him for a lifetime.
This is exactly what microfinancing is all about. It is about equipping, liberating and empowering so that people can help themselves.
Typically up to US $1000 is lent on terms that could be 2-7% higher than the Libor rate, but as much as five times lower than what is available on the local market (The New York Times, October 2003). As with all loans lenders take into consideration a risk assessment and measure any loan according to its risk appetite – by their very nature microfinancers do not necessarily consider the latter to be of such importance on an individual basis. However, it must be remembered that lenders need to take into consideration the cumulative risk of making such loans, as no respectable lender wishes to acquire additional bad debts – especially in the light of the post-banking crisis of recent years.
Case Study; Rreshen Tyre Project – Albania 1995 – 1996
Although no direct finance was given in this case the principles worked in the same way. In 1995, Lightforce International (LFI), a not for profit NGO (Non-Governmental Organisation) identified a need in the north Albanian town of Rreshen. It appeared that there were no local suppliers in the town and when people wanted to buy new tyres they had to go to the nation’s capital Tirana (which although only 50km away as the crow flies could be a 6 hour round trip in those days due to a combination of atrocious road conditions and the convoluted route through the mountains). This presented an obvious gap in the market.
LFI decided to source the tyres from Tirana themselves and set up a logistics chain. Meanwhile a local man who had been vetted was charged with the responsibility of selling them and he was given the first batch of tyres with no payment required. As he sold them and wanted more he was required to pay increasingly a proportion of the cost price of the new tyres and make repayments for previous purchases until after five cycles he was both debt free and in a position to i) pay entirely for the purchase of new tyres and ii) keep all the profits for himself and use them to develop his business and support his family. Risk stayed within its appetite because if the beneficiary did not keep up with the schedule of repayments the credit would be withdrawn resulting in a minimal bad debt write off.
During its initial period of operation the venture met with relative success, but it was undone by the chaos of the Albanian Anarchy of 1997 when LFI were forced to pull all of its personnel out of Albania (albeit temporarily) for their own safety. When LFI returned they found that their centre of operations had been looted and whilst they continued operating on a scaled down basis in Rreshen for another year the project was ultimately abandoned as LFI began to focus on its new centre of operations just outside the coastal town of Lezhe.
Financial Graphic – Figures are representative not actual
The figures shown in GREEN represent the investment that LFI made in supporting the tyre project. At no point was this given as direct finance, rather it represents the total cost value of the tyres that were provided.
The Figures in RED represent the debt that the beneficiary owed at any point to LFI, the most important figure here is the cumulative total which steadily decreases to O after an initial increase during Cycle 2.
The figures in BLACK represent all payments that the beneficiary made to LFI for the tyres. Although labelled repayments they fall into two categories, namely debt repayments and purcahses for new tyres (part payments for Batches 2 and 3 and full payments from Batch 4).
At the end of Cycle 5 the debt was repaid and the beneficiary had a microbusiness, although it was still supported logisitically by LFI.
Source: Horton, R. (2013) Omega Support Services
Before completing the exercises go through the article and check the meaning of the underlined vocabulary (with a dictionary if necessary), including the idiomatic phrase as the crow flies and the phrasal verb write off.
1. According to the text how does microfinancing generally work?
2. What interest rate do micro financers charge and how does this compare to the interest rates of local suppliers?
3. What does the author mean by the ‘cumulative risk’ of micro loans? (Para 2)
4. What local need was identifed in Rreshen by LFI and what two key elements of the resulting Rreshen Tyre Project did LFI provide?
5. Why did the journey between Rreshen and Tirana take so long?
1. Microfinancing ‘is about equipping, liberating and empowering so that people can help themselves’. How does it aim to do this and how effective do you think it is?
2. How did the example in the case study differ from regular microfinancing (which would normally be provided by a financial organisation – eg a bank)?
3. How was the Rreshen tyre project supposed to work? It is advised that you refer to the Financial Graphic to help answer this question.
4. What factors led to the failure of the project?
5. Could anything have been done to try to avoid the problems that led to its collapse? What?
6. What lessons can be learnt from the failure of the Rreshen Tyre Project?
7. The Rreshen Tyre Project was designed to help establish a new local business and help a local worker and was administrated by a charitable NGO. Despite the failure of the project is this a good way to help people in poorer nations? Why / Why not?
8. Some critics of the Rreshen Tyre Project believe that it was ultimately counterproductive as no new capital was injected into the Albanian economy and money was just moved about. How far would you agree with this assessment?
9. In what way(s) could microfinancing be used to help poor people in the place you live or kick start the local economy? What safeguards would you put in place to try to ensure the success of such a project?
* You need to prepare these questions for conversation during your next online / face-to-face session with your tutor.