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CHAPTER TWO
LITERATURE REVIEW
2.1 Introduction
Microcredit and microfinance are relatively new terms in the field of development, first coming to prominence in the 1970s (Robinson, 2001) and (Otero, 1999) prior to then, from the 1950s through to the 1970s, the provision of financial services by donors or government’s was mainly in the form of subsidized rural credit programs. These often resulted in high loan defaults, high lose and an inability to reach poor rural households (Robinson, 2001)
The 1990s “saw accelerated growth in the number of microfinance institutions created and an increased emphasis on reaching scale” (Robinson, 2001) , 1990s was referred to as “the microfinance decade” (Dichter, 1999). Microfinance had now turned into an industry[Robinson, 2001].Along with the growth in microcredit institutions, attention changed from just the provision of credit to the [microcredit],to the provision of other financial services such as savings and pension [microfinance]when it became clear that poor had a demand for these other services.
2.2 Micro finance service in rural areas of Uganda
Microfinance is “the provision of financial services to low-income poor and very poor self-employed people”[Otero ,1999 where these financial services generally include savings and credit but can also include other financial services such as insurance and payment services[Ledgerwood,1991].Microfinance as “an attempt to improve access to small deposits and small loans for poor households neglected by banks”[schreiner&colombet ,2001],Therefore ,microfinance involves the provision of financial services such as savings, loans and insurance to poor people living in both and rural settings who are unable to obtain such services from the formal financial sector.
Micro-loans is a financial innovation which originated in developing countries where it has successfully enabled extremely impoverished people to engage in self-employment projects that allow the poor and voiceless to generate income, begin to build wealth and exit poverty. Micro-credit was invented in Bangladesh during the famine of 1974, when Professor Yunus studied the lives of the poor 13 entrepreneurs in Bangladesh. Yunus began by loaning to groups of women an equivalent of $30 to forty two basket weavers to help them purchase bamboo. Upon the advice of banks and government, he carried on giving out micro-loans and in1983 formed theGrameen Bank. The program proved thatsmall loans could not only quickly improve lives of poor people, but were paid back with interest and on time. By 1997, there were 1.8 million poor borrowers in 22,000 out of 68,000 villages in Bangladesh with 830 millions credits worth every month (Micro-credit Summit 1997, Yunus 2004).
Consequently, MF emerged in the 1970‟s as an alternative to the Development Finance Institutions in delivering financial intermediation to the poor and voiceless. The design of the financial services offered by microfinance institutions (MFI) were largely based on the mechanisms of informal sector self-help groups such as ROSCAs , but came to prominence afterthe Grameen Bank and BRAC in Bangladesh which were modeled on the social support of group solidarity in helping the poor households to exit their unfortunate condition of poverty.
In Uganda, micro-credit institutions includemoney lenders, small banks, MFIs and MDIs like Uganda Finance Trust Ltd, FINCA Uganda, Faulu Uganda, BRAC Uganda, and Pride MF Ltd among others. Other micro credit institutions include; several companies limited by shares and a large numberof credit NGOs, companies limited by guarantee, cooperatives and credit unions according to theDirectory ofMicrofinance Institutions in Uganda. There are also many other informal financial services such as simple reciprocal arrangements between relative/friends, neighbors, savings clubs and Rotating Savings and Credit Association (ROSCAs) and systems ofcooperative business finance. These informal support systems are hinged on the social network arrangements where members regard each other as a source of support for development.
2.3 relationship between microfinance services and business growth
The MFI subsequently provides different services to a client, most commonly in the form of a loan. These services lead to the client modifying her/his microenterprise activities which in turn lead to increased or decreased microenterprise income. The change in microenterprise income causes changes in household income which in turn leads to greater or lesser household economic security. The modified level of household economic security leads to changes in the morbidity and mortality of household members, in educational and skill levels and in future economic and social opportunities. Loans are delivered following the minimalist approach where the requirements for loans are not often difficult to meet by customers; little collateral, character and co-signing for loans between members. These loans are usually loans within the savings of the member (Schmidt, 1997).
Microfinance provides a wide range of financial services to low-income clients, including self-employed and low earning individuals who are working in informal sectors. The core objective of microfinance is to create a favorable environment for the low income self employed and near-poor households in which they have permanent access to an appropriate range of high quality financial services, including not just credit but also savings, insurance, and general banking services. Microfinance provides a comprehensive range of financial services to the “unbanked people” working in informal sectors which best fits their needs and affordability. Group Lending is independent variable in the model. This method of providing small credits to the poor is most use by microfinance that provides loans without collateral. The interest charge isaround not much different from that of commercial banks but far lower than interest charge by individual by money lenders (Natarajan, 2004). Individual Lending is independent variable in the model. This is the lending of loans to individuals with collateral. Besley and Coate (1995), say despite the advantages of lending to groups, some members of the group may fail to repay their loan. Montgomery (1996) stresses that this method of lending avoids the social costs of repayment pressure that is exerted to some group members.
The MFIs offer Enterprise Development facilities by assisting people, individually and in groups to access financial services to start and grow enterprise which can sustain them and their families above the poverty line. This is mainly done through the provision of access to micro credit services for building up self-employment, in form of loans at interest free, low interest and market rates [Rogaly, 1999] .Making inexpensive credit available to the rural poor has been key to breaking the vicios circle of low capital, lowproductivity, and low saving thus overcoming poverty.
They also offer loans for consumption and Asset Development which help beneficiaries to build up asset bases for their families or consume certain products that they would not consume if they were earning low income [transport, meals , and weddings].This may be enhanced through encouraging of saving especially using low or no fee small deposit savings accounts .Saving is at least as important , if not more so , than loans in the efforts to help household to accumulate resources [shreiner and morduch ,2001].ack of access to finance has been identified as one of the major constraints to small business growth ( Lawson, 2007). The reason is that provision of financial services is an important means for mobilizing resources for more productive use. The extent to which small enterprises could access fund is the extents to which small firms can save and accumulate own capital for further investment (Hossain, 1988). However, small business enterprises find it difficult to access formal financial institutions such as commercial banks for funds. The inability of the Small rural business to meet the standard of the formal financial institutions for loan consideration provides a platform for informal institutions to attempt to fill the gap usually based on informal social networks, and this is what gave birth to micro-financing.
Many impact studies of micro finance have focused on educational status [Chowdhury and Bhuiya in 2004].studies the impact of a micro finance program, Bangladesh Rural advancement committee [BRAC]poverty alleviation program in Bangladesh and found that both member and non-member groups of BRAC had improved education performance through micro finance trainings. However, the BRAC member household benefited much more than poor non-member households .Furthermore, girls gained more than boys .The effects of micro-finance on childhood education were examined by two micro finance programs in South India-one with direct bank-borrower credit , the other with group-mediated credit. This showed that loans to women, through women’s groups, had significant positive impact on schooling and literacy for girls, whereas it remained mainly unchangeable in the case of boys [Holvoet, 2004]. Many SMEs owners or managers lack managerial training and experience. The typical owner or managers of small businesses develop their own approach to management, through a process of trial and error (Anderson, 1993). As a result, their management style is likely to be more intuitive than analytical, more concerned with day-to-day operations than long-term issues, and more opportunistic than strategic in its concept. Although this attitude is the key strength at the start-up stage of the enterprise because it provides the creativity needed, it may present problems when complex decisions have to be made. A consequence of poor managerial ability is that SME owners are ill prepared to face changes in the business environment and to plan appropriate changes in technology. Majority of those who run SMEs are ordinary lot whose educational background is lacking. Hence they may not well equip to carry out managerial routines for their enterprises (King and McGrath, 2002).
Education and skills are needed to run micro and small enterprises. However lack of basic skills in business management and entrepreneurship is a major drawback in the growth and development of rural business sector (Sessional paper of 2005) the integration of entrepreneurial training into the country’s education system, exposure of potential rural entrepreneurs to modern business management skills and creation of an environment that permits rural business to emerge and flourish, has been a major challenge Research shows that majority of the lot carrying out micro and small enterprises in Kenya are not quite well equipped in terms of education and skills. Study suggests that those with more education and training are more likely to be successful in the business sector (King and McGrath 2002). As such, for small businesses to do well in Uganda, people need to be well informed in terms of skills and management. Rural business in ICT appear to be doing well with the sprouting of many commercial colleges offering various computer applications. Further, studies show that most of those running small business in this sector have at least attained college level education (Wanjohi and Mugure, 2008).
The informal sector for example has proved that it can be a factor that can boost economic growth in uganda once empowered. In this sector, practical skills need to be developed at low cost and with financial support; various types of small scale technology could be developed for labour-intensive enterprises that could absorb hundreds of young job seekers. However, those who run the businesses in this sector lack adequate business skills mainly attributed to low levels of education. It is not sufficient to know how to produce a high quality product. The producer must also know how to sell it effectively and how to control the financial side of the business and in doing that the entrepreneur must be skilled in business. K-rep research paper Series No 24 (1995).
Access to good finance goes hand in hand with providing the appropriate skills and vocational resources to utilize the finances. This not only includes the development of new skills and vocations, but also strengthens existing skills that the micro finance recipients possess- leading on to more eligible economic development (khandker, 2005).
Leadership Training systems,Identification and nourishing good community leaders helps in bringing the community together and in giving a representative voice to the community in articulating its needs and wishes. Many micro finance programs have leadership training components built in them. Good leaders instill discipline among the borrowers, leading to better financial management ( khandker, 2005).
The success of micro finance programs greatly depends on the degree of networking incorporated into the program both within the community in which it operates external agencies and institutions that can help its development. Building the training program capacity as well as instituting governance structures in its management is dependent on the links it develops, and in the information and transparency it incorporates into the training program. Good networking and information gathering system also leads to better informed decisions and understanding market operations (khandker,2005).The developmental and implementation of a micro finance program facilitates, and is facilitated by, organizational and operational systems that are set up as a part of the training program of micro finance institutions. They include community based organizations, peer groups etc. as well as systems of operation to manage the micro finance program. A good organizational/ operational system also leads to better financial sustainability.
Micro-credit through MFIs is perceived by many development scholars as a financially sustainable instrument meant to reach significant number of poor people who most are not able to access financial services from commercial banks. Credit enables the poor to boost their businesses, agriculture production and able to meet the household daily needs. In developing world like Uganda, millions of people are suffering from poverty and its crippling effects (Lotter 1998). One of themajor barriers to escaping poverty is the lack of sufficient access to credit by the poor (Ledgerwood et al 2002). As a result, the poor especially in rural areas adopt mitigation and survival strategies as a way of coping with the hemorrhage of poverty (Songsore 1992). He further argues that generally credit plays a crucial role in the expansion and development of productive forces. It provides adequate savings and creditfacilities to individual households. Credit enables peasants to expand and develop income generating activities, and supporting payment of other necessities like food security, education, and water and health charges. In addition, Johnson and Rogaly (1997) have demonstrated that availability of credit for micro enterprises can have positive effects on the individual income and that of the household. Thus, access to financial services play an important role in the fight against poverty and enhancing business growth in rural Uganda.
The rate of failure of businesses in Uganda is also one of the highest in the world. This means that there is high rate of new enterprises but also high business failure rate of newly formed enterprises. Accordingly, Rukunga (1999:16) and Mogale (2007:346), the failure rate could be due to low operating capacity (unpreparedness) of micro-entrepreneurs to take on business ventures professionally. They argue that people go into business by choice; others are forced into business by circumstances such as poverty and unemployment. For example according to the New Vision edition of Tuesday, September 30th 2008, 80 percent of Ugandans end up in business by accident with little or no prior preparation: due to high unemployment levels, copy and apply syndrome and unplanned retirement orretrenchment. Thus, even where the poor have access to micro-credit, the greatest question is do the poor have the capacity to use the credit (the level of preparedness), prioritization of income generating activities, how to management and monitor business progress
Micro-credit services through MFIs across the globe and particularly in the third world countries have experienced explosive growth since the 1980s, and have been discovered to have the potential to alleviate poverty among the marginalized poor populations especially in the rural areas. Micro-credit is an essential input to increase productivity at household level. Many scholars in the development field argue that MC globally improves the borrowers‟ well being; boost income levels and increase employment of household members Okurut et al (2004). However, there are many variables which influence the extent of success at individual, households, organization and environmental level, for example, who are initially targeted, the borrowers‟ skill level, gender relation in the household and the external support available to the borrowers.
According toNavajas et al (2000), the professed goal of micro-credit is to improve the welfare of the poor. However, Berger (1989) observed that microfinance tend to stabilize rather than increase income and tend to preserve rather than create jobs. In addition, Mosley and Hulme (1998) in their study of 13 MFIs in seven developing countries concluded that household income tended to increase at a decreasing rate, as the debtors income and asset position improve.Other scholar such as Diagne and Zeller (2001) in a study in Malawi suggested that microfinance did not have any significant effect on household income. Equally so, Ross (2002) asserted that the arguments developed above do not necessary imply thata few individuals are not about to rise above their previous condition. Nevertheless, the transformation claimed by the advocates of 23 micro-credits is exaggerated. Thus, the impact of micro-credit on household income remains only partial and contested. On one end of the spectrum are studies arguing that micro-credit has very beneficial economic and social impacts of the household. While on the other end of the spectrum are scholars who contend against such optimism. Given the fact that there is a knowledge gap in the reviewed literature, the impact of access to and utilization of micro-credit program on the households remains a critical area of study.
2.4 Other factors affecting business growth in rural Uganda
Access to micro-credit by women is also regarded as enhancing women‟s participation in economic development and there by elevating the socio-economic status of women, Mayoux 1998 and Pitt and Khandker 1998). Mayoux (1998) holds the exposition that microfinance is an entry point in the context of a wider strategy for women‟s economic and socio-political empowerment. Other gender lobbyists have also advocated credit targeting women because of higher levels of female poverty and women‟s responsibility for the household well being (Alejo 1993). The assumption is that increasing women‟s access to micro-credit enables women to make a greater contribution to household income. Kuntala and Samanta (2006:288) also argued thatwomen‟s access to credit does not only empower women, but also opens new opportunities to master financial skills and create economic enterprises. To illustrate this, I will focus on Yunus (2004) with the Grameen Bank, which is the pioneer of micro-credit, and has provided finance for non-agricultural self-employment activities and served over two millions borrowers, of whom 94 percent were women with a loan repayment rate of over 90 per cent by 1994. Women are much more likely than men to repay loans and to devote their earnings to serving the needs of the entire family.
Mayoux (2000, 1998) argued that micro-credit is much more than access to money; it is about women gaining control over the means of making a living. It is about women achieving economic and political empowerment with inwomen‟s lives at household, village and country level. The challenge that remains however is whether or not women have access to credit or not and whether they have control or not over credit utilization and proceeds from credit at household level. Some studies such as Kuntala and Samanta‟s (2006) in their study of rural women in India show that the participation rate of women in cooperative and microfinance is 16 lower than for men. In addition, recent research on micro-credit in South Asia has also shown that the availability of credit can increase women‟s work burdens, and that men often control the income generated by the credit that women receive. Further, Songsore (1992) while writing about cooperative credit Union movements in North Western Ghana points out that most men in the region do not like their spouses to have financial autonomy as in their view; it erodes the position of control by men. This implies that there is no universal evidence to suggest that women‟s access to credit translates into women‟s empowerment in the household.
Zeller (2001) argue that insufficient access to credit by the poor just below or just above the poverty line may have negative consequences for small rural business and overall welfare. Access to credit further increases SME’s risk-bearing abilities; improve risk-copying strategies and enables consumption smoothing overtime. With these arguments, microfinance is assumed to improve the welfare of the poor. In many developing countries, many loan takers have been proven to have much benefit as they get credits.
Studies undertaken by Chaliand (2003) a on the impact of micro-credit programmes on household income show that participants of such programmes usually have higher and more stable incomes than they did before they joined the programmes. Some practitioners still have reservations about the findings of those studies. Moreover, not many micro credit programmes can afford to undertake impact assessments because they are generally expensive and time-consuming. There are serious disagreements among experts on the validity methodologies used in some of the published studies. In some cases, even the more rigorous studies have produced inconclusive results (Chaliand, 2003). Chijoriga (2000) revealed that there are limits to the use of credit as an instrument for poverty eradication, including difficulties in identifying the poor and targeting credit to reach the poorest of the poor. Added to this is the fact that many people, especially the poorest of the poor, are usually not in a position to undertake an economic activity, partly because they lack business skills and even the motivation for business.
In addition, the administrative structures governing these institutions are commonly either fragile or rudimentary, and often involve large transaction costs. A study by the Organization for Economic Cooperation and Development (OECD), for example, found that many specialized agricultural institutions were not designed to serve as financial intermediaries. The success of financial intermediation at any time depends significantly on how efficiently the transaction is completed. If the transaction costs, combined with high interest rates, require that the operation in question generate profit margins of the order of 30% to 50%, it is not clear that this would be economically beneficial (Chijoriga, 2000). It is not surprising that in many micro lending operations, trading activity – with quick turnover and large profit margins – dominates. In many cases, micro-credit programmes have been stand-alone operations.
According to Coleman (1998) social network refers to the manner in which ties and their emergent properties trust and norms can constitute a resource for the members. In this respect social ties are critical for economic prosperity and sustainable development which is formed out of repeated social interactions between individuals and groups such as gift circles, credit associations like SACCOS and ROSCAs, Atterton (2007), Coleman (1998) and Putman (1993). Networks help to overcome some of the disadvantages of peripheral location by serving as means of economies of scale: sources of support, information and knowledge (Granovetter 1973). The various relationships and associations among individualsaffect individual attitudes and perceptions towards utilization of small loans. As a result, social ties such as group solidarity enables the property less and voiceless to access credit for MCIs. In addition, the existence of social relations in the form of indigenous networks and norms of association are seen as substituting the physical collateral like land titles which the poor lack, in the selection of loan beneficiaries and loan disbursal and recovery (Mayoux 2001). The assumption here is that social networks are inherently positive and beneficial with the horizontal norms accrued to general trust and information which can be used by MCIs.
2.5 Conclusion
The growing competition of MFIs and other credit lending institutions has forced microfinance institutions to become more concerned with client’s needs, thereby providing quality services like; training credit user, loan and business empowerment so as to enhance its growth. The trainings are offered by officers (loan/credit officers locally called “Musomesa” meaning teacher) from lending institutions such as FINCA, BRAC, Faulu Uganda. Most MCIs andMFIs offer knowledge and skills in business management and loan servicing to clients before extending financial services to clients. The knowledge and skills offered to clients mainly focus on credit servicing, MFIs rules and regulation businessmanagement and business investments planning among others.
