ENTREPRENEURSHIP NETWORK AND MICROFINANCE
Mohsen Rezaei Mirghaed
Imam Hossein Comprehensive University, Iran, Islamic Republic Of
E-mail: p.mohsenrezaei@gmail.com
Hasan Daliri
Golestan University, Iran, Islamic Republic Of
E-mail: hasandaliri@gmail.com
Hojatollah Hashem Beigi
Roudehen Islamic Azad University, Iran, Islamic Republic Of
E-mail: hhashembeigi@gmail.com
Submission: 25/10/2015
Revision: 08/11/2015
Accept: 11/11/2015
ABSTRACT
Banks and financial
intermediaries, as the highways of financing and absorption of savings, are
considered as the key players in promotion of welfare level in each society. In
Iran, due to structural deficiencies and international sanctions, a revision of
banking industry seems very essential. More specifically, via balancing of
financial intermediaries (based on the notion of resilient economy’s five-year
vision coined by the supreme leader of the Islamic Republic of Iran), banks
could be used as a tool for economic promotion as well as one of the basic
means of resilient economy. This study introduces the structure of the banking
industry in Iran and demonstrates its deficiencies. In this respect, a plan for
the structure of financial intermediaries is suggested for three purposes: (i)
facilitation of financing, (ii) reduction of transaction costs, and (iii)
enhancement of the welfare level in society. In this regard, a structure is
proposed, based on the entrepreneurial networks which will be realized via
measurement, consultancy, and monitoring systems. Furthermore, this study seeks
to reduce the credit default risk through increasing of the micro-insurance
share compared to the traditional systems of the financing.
Keywords:
Entrepreneurship
network, Microfinance, Financing.
1. INTRODUCTION
Based
on the objectives of the 20-year plan, Iran is to become the first economic,
scientific, and technologic power of its region till 2026. Due to the extant
sanctions, Iran’s economy currently faces some challenges to reach this goal.
In this situation, the supreme leader of the Islamic Revolution of Iran argued
the idea of resilient economy. Resilient economy is an economic model, which
provides growth, even in the time of economic pressure and sanctions, via
turning of the pressures to opportunities for growth. In better words, this
model suggests an economy, which, besides establishing international
interactions, uses the facilities free trade. Therefore, the economic safety
can be maintained in the time of environmental fluctuations (e.g. sanctions and
threats) and these fluctuations would have the minimal adverse impact in the
long-term (MASHOOF; MESHKANI, 2014).[1]
Resilient
economy shows how an economy would be able to withstand the impact of different
shocks, and how it would preserve itself safely against these shocks. Hence,
resilient economy is a discourse or economical/managerial model, which not only
protects the local economy against the international threats, but also provides
the country with strength to stand against the sanctions. In fact, resilient
economy is productive, opportunity creator, endogenous, and at the same time
exogenous (MOHAMIDI, 2013). Therefore, since the concept of resilient economy
has a multifold nature, it could not be defined using a single index. However,
it could be measured with some general qualifications such as low unemployment
rate, high productivity of labor, lack of bipolarity in society[2], high
social capital, diversification in export earnings, high economic growth rate,
etc (GUERRERO et al., 2014).[3] Given the
mentioned issues, it is explicit that the most important feature of resilient
economy, is mobilization of all capabilities of the country. The capabilities
in case used in the production, could function as a vaccination against
sanctions and lead to sustainable prosperity. The ability to convert existing
potentials to actual capabilities will require changes in business and economic
structures; among which financial sector (i.e. financial intermediaries) is one
of the most important parts.
The
latest economic crisis in the world, in 2007, originated from bank credits.
Hence, special attention should be paid to this sector. Moreover, the study of
the structure of the banking industry in Iran shows major weaknesses in this
sector (e.g. see MASHOOF; MESHKANI, 2014). One of the main weaknesses of the
Iranian banking system is related to high rate of accrued receivables. Table 1
indicates the receivable ratios in different bank sectors. This ratio, based on
the international standards, is around 5%; while this ratio is much higher in Iran.
Table 1:
Ratio of non-current receivables to total receivables
|
2007 |
2008 |
2009 |
2010 |
2011 |
2012 |
2013 (Nov) |
Commercial banks |
11.4 |
16.9 |
21.5 |
18.2 |
20.5 |
18.4 |
18.2 |
Specialized banks |
11.4 |
13.2 |
13.2 |
8.6 |
8.6 |
8.2 |
8.9 |
Public banks |
11.4 |
16.1 |
17.7 |
12.9 |
12 |
12.5 |
12.6 |
Non-public banks |
11.3 |
24.3 |
18.6 |
14.6 |
16.2 |
16.7 |
17.8 |
Source: Central Bank of Iran
One
of the other indicators which can show the functional weakness of Iranian banks
is the deposit to loans ratio (after subtracting of the legal reserve ratio and
banks funds cash). Table 2 shows this ratio for different banks. According to
this table, this ratio for most banks is more than the optimum amount of 85%.
In other words, Iranian banks grant more than one unit of credit for per unit
of deposit which they absorb, which implies the fact that banks are heavily
dependent on external, especially governmental, financing for granting the
credit.
Table 2: Ratio of loans to
deposit (after subtracting the legal reserve ratio and banks funds cash)
percentage
|
2008 |
2009 |
2010 |
2011 |
2012 |
2013
(Nov) |
Commercial-public |
109.6 |
102.9 |
104.5 |
98.5 |
81.8 |
78.5 |
Specialized |
163 |
162.1 |
235.7 |
213.7 |
228.9 |
220 |
Public |
118.8 |
123.9 |
152.3 |
141 |
131.8 |
127.8 |
Newly non-public |
- |
89.6 |
89.4 |
90.1 |
80.8 |
81 |
Non-public |
95.4 |
89.7 |
89.6 |
92.8 |
85.5 |
78.1 |
Completely
non-public |
95.4 |
89.6 |
89.5 |
91.2 |
82.8 |
79.7 |
Banking network |
113.3 |
102.5 |
112.1 |
109.5 |
99.8 |
95.5 |
Source: Central Bank of Iran
Based
the above indices as well as many empirical studies (e.g. see MASHOOF; MESHKANI,
2014), it could be concluded that the banking industry in Iran could not have a
favorable performance in increasing of the consistent welfare as well as the
improvement of the relative income in society. Nevertheless, due to the
deficiencies in the capital market of Iran, the financial intermediaries play a
key role in mobilizing of the savings towards the investment uses. In other
words, financial intermediaries function as a bridge between supply and demand
of the monetary resources. On the other hand, the pressure of the sanctions has
raised the importance of financing for individuals and enterprises.
The
empirical studies demonstrate the positive impact of microcredit and
microfinance systems on the welfare level of society[4].
However, there is a major problem to this issue. Receiving the credits in Iran
demands a high transaction cost as well as a guarantee. Even under these
conditions a large portion of credits granted by banks remained pending and
were never re-paid (Table 1).
All
of these factors could confirm the fact that the credit structure in Iran needs
general revisions. During this course of change, it must also be considered
that no welfare cost should be imposed to any of the related sectors, and
income distribution and poverty in the country should be directed towards a
desired position.
This
paper seeks to firstly identify the challenges of the banking industry.
Secondly it reviews some global examples of making adjustments in credit
policies for reduction of transaction costs. Finally, a local model for
microfinance with regard to the main objectives of this study is presented.
The
main contributions of the paper are as follows. The paper proposes a structure
for banking industry, based on microfinance systems and entrepreneur network,
specifically for countries with structural deficiencies and limited access for
international funds, like in Iran as the case study. Moreover, it proposes an
enhancement of entrepreneurial networks through changing the structure of Iran
banking industry and the communication between bank system and
micro-entrepreneurs
2. THE FUNCTIONAL STRUCTURE OF THE BANKING INDUSTRY AND
ITS CHALLANGES
Due
to the deficiencies in the capital market of Iran, the banking sector plays a
key role in mobilizing of the deposits and leading them toward investment uses.
Hence, in the structure of the macroeconomic of the society, the function of
the banking industry either in gathering of the deposit resources or in
granting loans is considered as crucial (AKBARI; DARABI, 2014).
The
overall function of the banking system includes three major economy’s sections:
the role of banks in the monetary market (determination of the profit rate),
the role of banks in the capital market, and the role of banks in conduction of
the fiscal funds. Inefficiency in any of these three sections could lead the
economic structure to a point far away from resilient economy in the times of
crisis and sanctions.
In
this regard, one of the most important tasks of banks is to collect the excess
liquidity in the form of deposits and lead them towards the best investment
projects. However, difficult economic conditions and the mal-function of
banking industry could exacerbate the poverty and inequality in a society. For
more clarification, we shortly examine the banks’ functional system in the
macro-economic framework, and then we can discuss how the deficiencies in the
market have caused inefficient allocation of resources and exacerbation of
poverty and inequality in society.
Banks
apparently, as economic units, tend to reach to the maximum profit. To fulfill
this aim, they seek to receive cheaper deposits and grant them with the highest
interest rates to the lowest-risk customers. However, uncertainty and
asymmetric information under the aegis of brokerage effects in economy would
cause the market to fail in efficient allocation of resource.
At
the first stage of lending the loans, the lender has very little information
about the borrower. Therefore, banks need to find a mechanism to reveal the
hidden information of the borrower to reduce the risk. The second stage is when
the lender doesn’t know how the borrower will use the credits in the future;
for example whether one will put as much effort as the time the whole capital
was their own.
The
third stage is the time of capital return. The lender might not be able to
assess the return of investment, and in this case, the borrower could be
tempted to hide the true rate of investment return. The unequal information
level of lender and borrower make all lenders (banks or other informal credit
institutions) to search for some ways to overcome the misuses and to stabilize
their expected profit. Moreover, the probability of misbehave is higher for
commercial banks than local informal institutions (ABEDIFAR, 2013).
Since
banks are not usually born inside the local communities, customers are not
inherently loyal to them (DE AGHION; MURDOCH, 2011). In addition, since banks
are not able to separate the high-risk from low-risk customers, they raise the
interest rates to increase their expected profit. In such situation, low-risk
customers who are usually more trusty and reliable have to go out of the credit
market (STIGLITS; WEISS, 1981) and the loans would mostly be taken by high-risk
customers.
The
outcome of this adverse selection would be definitely unfair and inefficient (DE
AGHION; MURDOCH, 2011). Receiving a
rendition money from the potential lenders could be a solution to secure the
repayment of the credits (The challenges would be discussed in the next
section).
After
credit granting, bank managers face some ambiguities which might affect their
economic performance. One of the most important ambiguities is moral hazards (ABEDIFAR,
2013). For example banks usually do not have sufficient information about how
hard a borrower tries to fulfill an investment projects; hence, they monitor
their customers to understand their hidden efforts.
Accordingly,
most banks in poor countries face high transaction costs of monitoring a large
number of small exchanges which are more costly than monitoring a big exchange
with a wealthy client. This issue makes banks more interested to loan to
wealthier clients. As mentioned, banks can secure the repayment of a loan by
asking for rendition money from a borrower; however poor clients even don’t
have that money to offer to the banks.
In
classic economic systems, credits don’t move towards poor people who become
poorer every day. The rich receive most of the credits instead (DE AGHION;
MURDOCH, 2011). After the implementation of the project, a borrower may “take
the money and escape” which happens in case the lender does not completely
monitor the profitability of the project. Even sometimes, the lender is not
able to force the lender to repay the loan in spite of complete awareness of
the profit level.
Therefore,
both ambiguities (i.e. the brokerage as well as moral hazards issues), could
cause the poverty and inequality to be increased for inefficient allocation of
resources. As mentioned earlier, banks, as economic firms, tend to receive
lower-cost deposits and grant them with highest rate of interest to less risky
customers according to their estimation.
Their
interest to reduce risk, on the one hand and asymmetric information in the
market, on the other hand, lead social welfare level to be decreased. In deposit section,
it is not interesting for investors to put their financial resources in banks
since the interest rates have been decreased. Depositors essentially seek to
enhance the value of their cash; hence they have to look for other substitute
markets.
However,
the substitute markets are different for the rich versus the poor depositors.
The rich investors usually go towards investing on durable assets (e.g. real
estate, currencies, and stock markets) to gain higher revenue, or they even
enter the market as informal creditors in the way that they collect the cashes
and pay more money comparing to banks interest rates.
On
the other hand, poor people, who usually have little information, are not able
to select the substitute profitable options, have to deposit in the banks or
change their cash into useable commodities. Therefore, the wealth gap between
the poor and the rich becomes deeper day by day. The situation is the same in
credits received section.
Banks
tend to reduce risks of uncertainty in the market, and they seek for customers
who are able to pay higher interest rates or can secure the repayment of a loan
by a guarantee (JAFARI MOGHADAM et al., 2014). It is obvious that the poor are
unable to pay high interest rates and they can’t receive credit from formal
sources (i.e. banks) for being inherently poor, not having durable assets, and
the existence of social rents.
Therefore,
they have to look for alternative ways of micro-finance. For example, the
credit market is divided into two groups: formal resources and informal illegal
sources. Most micro-finance sources for poor people are provided by informal
illegal sources with very high interest rates usually up to 100%[5].
Given
the above, the economy must find a solution to overcome this problem. Perhaps
the first and closest solution seems giving subsidies to the poor through state
banks. However, studies have shown that this approach could not be an optimal
solution to eliminate the vicious cycle of poverty[6].
Hoff
and Stiglitz (1998) argue that the long-term injection of financial sources
cannot cause the equilibrium interest rates to be decreased in the market
either (Case study in India and Thailand[7]). Therefore,
how the economy could solve this problem? In better words, how is it possible
to grant loans to the poor with regard to the fact that they are not able to
pay rendition money? How to reduce the cost of credit transactions? These
questions could be responded with microfinance systems
3. THE MICROFINANCE SYSTEMS
Microfinance
based systems[8] have been
created for eradication of poverty and income inequality since long ago, and
over the past decades, they have developed to the current position. There are
some basic ways for micro-financing. One of the simplest ways of which is to
use ‘rotating savings and credit associations’ (ROSCAs).
Such
associations have a simple structure by having a group of individuals who have
agreed to give their microcredits to a common fund in periodical courses (e.g.
monthly). Within each course, the collected money would be given to one of the
members (BOUMAN, 1983).
Such
associations seem to have a simple but efficient structure which has made it
quite fashionable around the globe. The lifetime of ROSCA is clear with a
pre-defined beginning and end. The accounting procedure is also quite
transparent and simple. The only challenge for the group would be ‘who should
receive credit from the fund?’.
The
answer to this question could be either predetermined or completely random, and
it needs to become determined in the beginning of each period, or even by an
auction[9]. It is
also obvious that in each of the above formats, information asymmetries cause
uncertainty about the behavior of the actors in the market and probability of
doing wrong by each of the contract parties[10].
Despite
such information asymmetries, researchers still believe that ROSCAs increase
utility and social welfare[11] of
societies[12] (HEVENER,
2006). In fact, ROSCAs reduce transaction costs in economy since they consist
of individuals who have close relationships and are accordingly aware of one
another’s credit potentials. In addition, they don’t have the loaning costs the
banks have (e.g. monitoring costs both before and after credit payment, or
rendition money).
In
sum, lower cost makes these associations more free to grant loans and enhance
efficiency accordingly (CHAMI; FISCHER, 1995, p. 362). Other advantages of such
associations include accessibility and flexibility. Low transaction costs
increase the speed of credit receiving by people and thus improve doing of the
transaction (SHANMUGAM, 1989, p. 360-361). Besides, important characteristics such as the amount of loan,
the time of repayment, the order of the courses, and the selection of the
borrowers, all depend on the users’
needs and decisions, and are therefore revisable (HENEVER, 2006).
Besides
developing countries, ROSCAs also exist in developed countries and have been
quite practical for microfinance of small projects (DEUTSCH; TOMANN, 1995;
SCHOLTEN, 2000). The inclusivity of these associations around the world
indicates their usefulness and efficiency. However, they have some limitations[13] which
made economy planners to modify the structure.
The
new structure was formed in the way that it provided some participants with the
possibility of more savings and some others with the possibility of more
borrowing. It became also possible to grant credit to more than one person at
one time. With this approach, ROCSAs have changed into an ‘accumulating saving
and credit association (ACSCAs) (DE AGHION; MURDOCH, 2011; BOUMAN, 1996;
RADERFORD, 2000).
ACSCAs
could be considered as a credit union with an important advantage: the savers
no longer need to borrow and the amount of loan could vary according to the
individuals’ needs[14]. These
associations collect the capital from those individuals who are able to save to
those people who are willing to do investment or use. Even though ROCSAs and
ACSCAs have some common characteristics[15],
their significant differences cause them to have a separate structure of
microfinance[16].
However
despite all the above benefits, the above associations have some disadvantage.
Adams (1995: 11) states that most of them are fragile and have weak capital
structure. They have limitations for access to external sources to provide
cash, and thus under the effect of inflation since they can’t share the
risks.
These
associations also face some challenges during their growth: Increasingly, they
lose their information advantages, are compelled to rely on first salaried
managers instead of volunteer ones and second sanctions and formal punishments
for guaranteeing and executing their contracts.
The
issues related to employees and brokers, transaction expenses and precautionary
rules, are increased in line with credit unions expansion (DE AGHION; MURDOCH,
2011, p. 128). But, what does modern microfinance add to this structure? And
how is it supposed to minimize structural weaknesses? Below, we will explain
how microfinance might be used as an instrument to sharing risks and mutual subsiding
of borrowers to each other to improve its efficiency, but also could increase
the group accessibility to external financial resources and re-establishing the
foundations of a professional management structure.
Modern
financing systems are organized to remove the weaknesses of the traditional
financing systems. Integrating the structure toward a modern system, i.e. group
lending, laid the foundations for microfinance. The above mentioned model
refers to a structure in which individuals can get together and form groups
taking out loans from a lender. The most important feature of this method is
that clients are capable of taking out a loan individually.
However,
if one member faces serious problems in loan repayment, all members be jointly
liable for a loan. The best example, in this case, is Grameen Bank that has
played a fundamental role in the development of Bangladesh. With all the merits
of group lending, here too, there are information asymmetry issues.
For
example, some of the ambiguous questions here include: Is it possible that the
group members conspire collectively with the lenders not to repay the loan? Is
there an advantage in not including the borrower group under punishment and
social sanctions? What would happen if the potential borrower population is
dispersed and therefore, local information is unavailable and accessing to it
is expensive?
In
sum, experimental studies indicate that group lending system causes the credit
rationing problems resulting from adverse selection. As mentioned above,
adverse selection occurs when lenders are not able to differentiate high-risk
borrowers from low-risk ones. However, if conditions are satisfied in a way
that lenders could classify borrowers according to their risks, and consider
different interest rates for each class, adverse selection would be avoided.
Studies
indicate that group lending with joint liability, can minimize this
inefficiency (GHATAK, 1999; LAFFONT; N’GUESSAN, 2000). The fact that groups are
encouraged to self-form can overcome the adverse selection problem through
group lending, in a way that potential borrowers can use their information for
finding the best partners. Since there is a joint liability for loans, forming
groups with low-risk members is better than with high-risk ones. Therefore, low
risk customers have the right to select and join other low risk customers.
High
risk borrowers, on the other hand, have no choice but to form groups with other
high risk customers. Considering the fact that investment projects run by high
risk borrowers fail more often than those run by low risk borrowers, high risk
borrowers usually have to repay the overdue repayments of their peers (as they
are using group lending).
This
way, other low risk borrowers are obligated to bear defaulting on the loans of
high-risk borrowers. This takes the risk from banks to high risk borrowers and
low risk borrowers bear lower interest rates. In addition, banks are currently
safer with regard to defaulting on their investments, therefore they can decrease
average interest rates for both high and low risk borrowers and still remain
profitable. Low interest rates in markets can encourage low risk borrowers and
stop them from leaving the market (DE AGHION; MURDOCH, 2011, p. 152)[17].
Another
serious problem in banking industry is moral hazards; when banks issue credits,
as the result of difficulty in monitoring the performance of borrowers, might
face moral hazards. Group lending with joint liability can minimize this
problem to a large extent. Stiglitz (1990) believes that group lending
alleviates moral hazard through encouraging borrowers.
Laffont
and Ray (2003) argue that group members are influenced by the efforts put by
the other members. That is to say that they would find approaches for punishing
individuals who had put less effort and have high risk potentials for the
group. Meanwhile, there is another concern; borrowers might be tempted to take
the revenues and flee away. Studies show that in these conditions also group
lending contracts functions better than individual ones.[18]
The
nature of group lending is delegating the liability from the bank personnel to
borrowers. Traditionally, bank lending staff choose customers, control their
performance, and guarantee contract enforcement. In group lending, borrowers
too share a part of this burden. The privilege for customers is achieving loans
with reasonable and right prices.
However,
in adverse selection, most of the customers do not aim at establishing a bank
just to take loans[19]. Another issue is group meetings which is the
core to group lending model. Here, combined approaches are taken. A criticism
is that attending the group meetings and monitoring group members might be
expensive (MURDOCH; DE AGHION, 2011, p. 180).
Yet
another issue is related to the fact that group lending functions through
delegating the liability from the bank to customers. This liability might bear
hidden costs. In addition, group lending can bring about additional risks for
risk averse borrowers; that is, here borrowers face not only the risk of
capital loss, but also their partners' capital loss.
However,
if monitoring the contracts are free, borrowers can take into the account the
moral hazards and alleviate them. But the fact is that for people who are too
close to each other, monitoring is expensive, therefore there is always a way
for incurring moral hazards. Accordingly, Madajewicz (2003) argues that the
advantages of group lending are moderated with its costs.
These
costs occur when borrowers are risk averse and monitoring is expensive.
Additionally, as financial indicators of capital loss increase with the loan
amount, monitoring costs also increase with the loan amount. There is another
problem in this structure; borrowers might conspire against banks and reduce
the banks' capabilities in monitoring social collateral.
Strong
social links act as a double-edged sword and, in some cases, not only can
increase loan repayment amounts, but also raise the possibility of collusion[20].
Nevertheless, Rai and Sjöström (2004)
believe that micro-lenders can make subtle changes in group lending, choose
better methods than group lending, moderate many current problems and make the
system more efficient.
One
of these methods is progressive lending in which bigger loans are promised to
individuals and groups with good performances[21].
This lending type, reduces the administrative costs per currency unit and
allows lenders to test first-time borrowers and detect the worst prospects
before increasing the loan size (GHOSH; RAY, 1997).
According
to previous studies, lenders play a third role which is crucial. Micro-lenders
can get more repayments through making bigger loans to borrowers who pay their
debts. This lending system increases the opportunity costs for non-payment and
consequently reduces the possibility of non-payment in future (DE AGHION;
MURDOCH,
2011, p. 209).
However,
microfinance institutions in the modern world use complementary approaches to
repayment guarantee. For example, one of the main assumptions in microfinance
is that most of the client are poor and have no property to guarantee their
loans. Therefore, they guarantee repayment through non-traditional methods such
as group lending. However, a number of microfinance institutions (e.g. BRI,
Indonesia) ask borrowers for guarantees[22].
It
might be the case that the market value of the above mentioned assets is not
equal to the whole loan value, but the subjective value of the asset for the
poor borrower is such that it lowers their tendency to non-repayment[23]. Another
approach is to design methods for developing financial assets and grant loans
to borrowers based on the created assets. This way, banks can take out from
savings account to lessen the possibility of full payment, and take advantage
of the acquired information about the repayment period for checking the
conditions of the applicants.
For
example, lenders observe the capability of lenders for making deposits in a
particular period and grant loans to the applicants based on their
observations[24]. Bangladesh
Collaboration Association adopted another method. They generalized loan
repayments instead of offering group loans.
In
other words, loans are offered to individual applicants, but group meetings are
still held and repayments are made collectively[25].
Therefore, even when there is no group lending, still mechanisms for acquiring
information from clients could be designed. Other alternatives include:
visiting the house or office address of the applicant (ZEITINGER, 1996) (by a
Russian institution); Providing a guarantor and confirmation of Rural Credit
Committee (by an Albanian institution); Churchill believes that troubled
families are mostly problematic borrowers, therefore, they study stable family
life as a signal[26] (CHURCHILL,
1999, p. 56).
4. FINDINGS AND CONCLUSION
To
propose a productive microfinance framework, reviewing the microfinance systems
used in Iran might be helpful. It is believed that financial experiences in
Iran could be classified as follows: first, using lessons from the conventional
banking systems for providing financial services to target groups; Interest
Free Funds are among the most important experiences included in this group[27].
The
second class is microfinance experiences in the form of cooperatives as
member-oriented organizations[28]; and the
third class is related to new microfinance approaches. On this basis, during
last years, three key plans are administered in Iran: 1) The plan for
supporting rural microfinance services; this plan was brilliant because of its
use of group lending models, and the repayment rates of credits paid without
asking for collateral; 2) Social Mobilization Plan and granting micro credits;
using chain guarantors, granting uncollateralized loans, using local
information, take advantage of the linkage between local organizations and
other local institutions and chose to organize collaborative groups. But its’
activity criteria was little and relied upon particular organizations for
financing; 3) Micro credit funds for rural women in which methods such as
group lending, peer pressure, dynamic incentives and social punishment are
used.
While
each of these plans have relative positive impacts, there are deficiencies and
weaknesses including: in spite of the fact that one of the most important
reasons of the income difference and uneven distribution of wealth within the
society is the inefficiency of saving structure, in the most of the above
models there is no mention of savings.
Additionally,
with regard to the target groups in the above plans, the endeavors made are
fruitless in comparison to market scope. It should be mentioned that most of
the plans are classified as small ones. In addition, the overall result of the
plans conducted in the state indicates that group approaches bring about better
results in comparison to individual methods (EBADI et al., 2008)[29].
Nevertheless,
to achieve resilient economy, no integrative and efficient microfinance system
has been put to practice that can be efficient in country level and be capable
to eradicate poverty and be resistant to sanctions and external shocks.
Therefore, the revision of the banking industry structure seems to be
necessary.
As
mentioned before, the emphasis on micro credit and microfinance as two distinct
concepts lead the planned systems to focus less on saving aspects and its
management. On the other hand, the history of credit systems in Iran and around
the globe indicates weaknesses. Moreover a successful system in one country
does not necessarily guarantee healing the weaknesses of other countries.
Therefore,
to reach a resilient economy we need to develop a microfinance system through
revising the financial intermediaries. Further, the researchers will try to
propose a productive and inclusive financing framework.
Preparing
a productive and inclusive financing framework requires a few key factors:
first, changing the structure of banking industry[30]
in Iran; second, communication between the banking system and
micro-entrepreneurs; and third, communication between consulter entrepreneurs
and micro-entrepreneurs.
In
the traditional financing systems, there is an interaction between
micro-borrowers and banks through which clients obtain credits using their
rents and the collaterals they can provide to banks. As shown in Figure 1, in
these structures banks as financial enterprises, tend to receive micro-deposits
with lowest prices and offer it to their best clients for maximum profit.
As
noted in section 2, as the result of asymmetric information, there are
deficiencies in all sectors which aggravates poverty and raises the possibility
of venerability of economy to shocks. As explained before, in the present
structure, the market fails to allocated resources optimally and is not able to
distribute wealth in the society properly. Therefore, modern financial systems
tried to find remedies for these deficiencies through removing collaterals and
guarantors from the system to help the poor in accessing credits.
Figure 1: the functional structure of traditional banking
industry
As
noted earlier, standard financing systems tried to eradicate poverty and
improve welfare in the society through removing physical guarantees and
reducing the possibility of defaulting on credits. The standard structure of a
micro-finance is summarized in Figure 2.
In
this structure, less attention is paid to collecting deposits and more focus is
put on granting credits. However, a few institutions such as Grameen Bank in
Bangladesh consider small mandatory deposits for individuals who apply for
loans. Grameen opens savings accounts for its clients, these accounts, however,
are shackled by the laws to the extent that they could be barely considered as
saving accounts[31].
These
plans mostly were mandatory saving accounts[32].
However, as mentioned earlier, in the financing section, individuals organize
correlated groups in which monitoring and social punishment systems substitute
for guarantees related to loans. Banks grant micro credits based on monitoring
and social punishment and the group, in return, is liable for repaying credits
to the banks.
In
this case, inter-group relations are especially important; leading the
relations to the right direction could result in defaulting on bank credits and
alleviating poverty in society. As noted earlier, while the current structure
is capable of alleviating moral hazards and averse selections in the market, it
suffers from deficiencies. In addition, it needs to be localized since
according to experimental evidences, the same structure which is administered
by Grameen has failed in some countries (WOOLCOCK, 1999). Scholars believe that
factors such as dependence to public financial resources (HOLLIS; SWEETMAN,
1998), preferential and controlled interest rates (HELMS, 2006), not paying
attention to education aspects to be used as productive (SNOW; BUSS, 2001;
BHATT et al. 2001), not considering institutional, social and cultural
conditions of the target group (GOETZ et al. 1996; WOOLCOCK, 1999) are regarded
as the main reason for unsuccessful microfinance plans (MOTAVASSELI; AQABABAIE,
2008).
Figure 2: Functional structure of banking industry in
traditional microfinance system
The
structure introduced so far is almost similar to Grameen Bank of Bangladesh
which focuses only on inter-group interactions. However, we need to note that
public businesses are based upon personal knowledge and have deficiencies which
will be explained later in the paper. Microfinance systems like Figure 2 are
able to compensate for one of people’s problems, i.e. microfinance.
But,
on what people expend their credits, if they access to it? Does covering their
living expenses mean improving their welfare? Can one guarantee that they will
choose a proper business? The answer, reasonably, is no. Unfortunately most of
micro-credit receivers lack enough economic knowledge and they are not capable
of using the credits for developing a long term business.
Therefore,
the microfinance-based market system will fail. The problem needs to be solved.
But if we assume that micro-borrowers are capable of developing businesses, can
they sell their products in the market?
Clearly,
micro-producers would face problems regarding marketing their products and
services. Therefore, even with a successful production, they will not be able
to sell their products as the result of the gap in the marketing system;
poverty circle would appear again and the microfinance-based system might fail
again.
On
the other hand, the system has no outcome for people who tend to obtain a
constant risk-free income from their currency excess. In other words,
traditional systems are not capable of satisfying the needs of depositors; and
as the result of industry structure, they cannot lead the outcome from currency
use to the macro-economy target markets.
Therefore,
the saving problem still exists for poor families, to the extent that scholars
such as Robinson (2001, p. 21) believe that deposit services are more valuable
for poor families than credit granting services[33].
Studies have revealed that poor families take avid interest in saving (BOSE,
1997). In other words, they save to leave up their minimum living conditions in
the long run. In addition, most families are not interested in spending all
their credits on high risk personal businesses and need a risk free constant
profit (DE AGHION; MURDOCH, 2011, p. 267).
However,
in many societies including Iran, low income households have not access to
secure institutions for saving money. Institutions like banks, in the long
term, make those families poorer rather than raising their incomes. For
example, in the economy of Iran, the real interest rates are negative as the
result of high concentration in deposit attraction market, severe financial
suppression in this sector as well as high inflation rate.
Therefore,
in this failed financial structure, depositors sustain losses rather than
making profits. In other words, instead of helping the poor to root out
poverty, banks punish the poor and get them caught in poverty more than before
(read more about this issue in section 2).
All
these cases prove that focusing on savings is highly important, while it is not
effective in distributing income as financing is. Therefore, according to the
above, the banking industry structure needs to be adjusted and be more
flexible. Figure 3 shows the researchers’ proposed model for a monetary system.
In the proposed model, banks can use the proposed system beside their
conventional approaches as the main creditors and the main attractors of excess currency
in the nation. The current system has other advantages in addition to focusing
on financing which include:
1- The
system puts prime focus upon making deposits.
2- It
focuses on using loans and repaying it.
3- Rising
employment is another important objective of the system.
As
mentioned earlier, the function and efficiency of banking industry reveals that
this industry needs to be conscious, in other words, with regard to collecting
public deposits and allocates a substantial portion of the welfare of the
applicant families to itself, the present industry cannot help the welfare of
the society, to the extent that regarding the high concentration of risk free
deposits and attracting them, it aggravates poverty through paying lower
interest rates than inflation rate. From the institutional perspective,
collecting deposits is easier that granting credits. More importantly, here all
the risk is posed upon depositors and the information asymmetries faced by
bankers during making loan, are removed.
One
of the limitations of banks is that collecting small deposits, beside other
legal expenses, bears more transactional costs per currency unit in comparison
to large deposits. Therefore, banks tend to remove poor depositors from their
systems (DE AGHION; MURDOCH, 2011, p. 272).
For
these conditions, more flexible deposit attraction and alleviating financial
suppression is proposed; banks need to be able to compete with each other to
attract more deposits to level up the interest rates in national economy.
Reasonably, increasing the interest rates can improve the conditions of
micro-depositors or at least prevent any financial loss in inflation
conditions. In addition, banks can use the acquired information from depositors
as a signal for granting credits to them. This way, banks will be able to
reduce their dependence on external resources, they can also act as a lever for
controlling inflation and managing currency in due conditions.
Figure 3: Proposed structure for banking industry based on
microfinance systems and entrepreneur networks
On
the other hand, financing sectors requires extensive modifications. Most of the
micro borrowers will not be able to use the received credit resources
efficiently as the result of lack of knowledge, and therefore they will not
only be incapable to get rid of poverty, but also be indebted after receiving
the credit. Unable to use their credits inefficiently, they will mostly spend
their credits on living expenses.
Therefore,
the current system needs external orientation to lead micro borrowers toward
small businesses. The proposed structure is shaped based on entrepreneurial
networks and consulting approaches. According to the above structure, as in
group lending models, individuals are positioned in correlated groups with
definite interactions. These structures will remain stable as there are
face-to-face relations and trust links among the members (PRINZ, 2002).
In
this structure, in addition to the correlated inter-member interactions, there
are series of interactions between each correlated group with large-scale
entrepreneurs based on purposeful structures. We call this “inter-network
interactions”.
Experimental
studies show that entrepreneurial networks play a crucial role in innovative
firms (ZALI et al., 2011) the quality and quantity of occupational and
professional outcomes of entrepreneurs, managers and experts (DOUGHERTY, 2001;
JAFARI MOGHADAM et al., 2014) to the extent that we can claim that the more an
individual obtains social and interactional skills, the more success he
achieves (BARON; MARKAM, 2003, p. 13). These studies show that there is a positive
relation between networking and business success (WOLFF; MUCK, 2009). In
addition, entrepreneurs need to link their organizations with the networks (RAUCH;
FRESE, 2000; SALAMZADEH; KAWAMORITA KESIM, 2015).
Improving
the network-building skills among entrepreneurs will improve the legitimacy of
their businesses and therefore result in a more successful behavior in the
field of entrepreneurship (BATJARGAL, 2010, p. 12, as cited in PESQUEUX, 2013).
To guarantee the entrepreneur and small business behaviors, powerful network
links are needed to be established between them.
Therefore,
we need to establish entrepreneurial network behaviors in the proposed system (JAFARI
MOGHADAM; SALAMZADEH, 2016). Based on this network a multi-dimensional network
is created which includes banks, depositors, rural home businesses, large-scale
entrepreneurs, and consulting institutions. This network tracks the process of
collecting micro-deposits, their proper application through consulting, and
marketing and cooperating with large-scale experienced entrepreneurs (MARKOVIC;
SALAMZADEH, 2012).
In
the implementation process, mutual interaction between them will help the
success of each party and the performance of the whole network. Indeed,
entrepreneurial network is a monetary system. This system needs to be developed
by an institution based on a regular processes and well-constructed economical
contracts. In the above system, each institution plays a role:
-
Large-scale entrepreneurs can play role in marketing
and buying from small businesses; they can even supply them with primary
requirements. This way, large-scale entrepreneurs are capable of minimizing the
expenses of small business interactions.
-
Institutions that provide consultation on training,
guiding, and providing information about markets and their characteristics as
well as their future, can play a role for small and rural businesses and guide
them through spending bank credits based on their own experiences.
-
Network manager can be chosen from the consulting institution
or large-scale entrepreneurs or even from banks (the manager can also be
selected from other institutions than these three institutions). The manager is
responsible for monitoring and enforcing the designed strategic prospect.
This
system helps active groups in the system, such as traditional microfinance
models, do not get separated like islands and leads their activities through a
particular direction. In addition, the numerous problems resulting from moral
hazards and adverse selection could be overcome through developing inter-bank
information interactions, marketing groups and large-scale entrepreneurs. The
information acquired by marketing groups and large-scale entrepreneurs from
individual borrowers can be used as a signal to be indicative of the
possibility of defaulting on credit by borrowers which helps banks reduce
credit risks.
Other
innovations could be designed in the financing context to minimize risks.
Experimental studies show that low income individuals are more vulnerable to
economic fluctuations, will fall into severe depression and will be unable to
repay their debts, if unforeseen events unfold. Therefore, as systems who aim
at improving the conditions of the low income, microfinance-based
systems need to minimize the vulnerability of the poor to economic shocks.
One
of the most influential solutions which is used in modern finance systems as a
solution for mitigating risks, is micro-insurance[34].
Through arranging insurance systems, new business activities could be
guaranteed and the risks of non-repayment resulting from unpredictable events
could be minimized. Therefore, designing a system for offering micro-insurances
could be used to guarantee and reduce the possibility of defaulting on the
received credit by small businesses.
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[1] Based
on Islamic Republic of Iran Parliament Reports, No.
12546 by Tari, F., Seyed Shekari, Kh., Kaviani, Z. (2012), “Resilient
Economy 1 and the elements”, No. 12546
[2] Class difference (made by
differences
in people’s income) should not divide people into two groups of rich and poor.
Poverty prevents people
participation in the public programs. In such situation, disappointed poor
class show no resilience
against the pressures imposed from the outside.
[3] We should differentiate
between a resilient economy and a developed economy. It implies that every developed economy
cannot be a resilient economy, because a resilient economy, is an economy which
not only keeps the characteristics of an efficient economy, but also protects
its
independence. A
resilient economy must try to have an effective role in the global economy, in a way that
every sanction against the country imposes some risks to
the global economy (TARI
et al. 2012)
[4] For
example Hossain (1998) found that the income of the households who have taken
loans from the Grameen bank in Bangladesh is 43% higher than those who haven’t
in the rural areas. Credits have also been demonstrated to have a positive
influence on food production in Nicaragua (Carter, 1989). In Bolivia,
solidarity Bank has been able to have positive effects on
developing employment
and income (Hulme and Mosley, 1997). Ellis (2002) also found the positive
impact of microcredit on employment in the two countries of Peru and Uganda.
(See Sengupta, and Aubuchon, 2008 for a review)
[5]
Why these rates are so high? As mentioned, these informal illegal sources are
exclusive and the poor, who don’t have a guarantee to get credit from banks,
have to get credit from them. The illegal sources also reduce the risks of
transaction in this way.
[6] Braverman
and Guasch (1986) argue that first, subsidy banks dominate over informal
sources of microfinance (which the poor are dependent on them); second,
interest rate cause a mechanism for rationing based on which more efficient
projects receive credit. Subsidy system, on the contrary, remove this function
of rationing. Hence, less efficient projects can also receive microfinance.
Third, the continuous flow of capital transfer by government reduces the
incentives for bankers to collect public deposits. Fourth, the state banks are
put under some political pressures to grant loans to certain people in certain
times. This issue causes the elimination of incentives for creating powerful
economic institutions in society.
[7] It issue increases the illegal creditors in the
market. Moreover, competition costs among the illegal creditors makes the
interest rates to be increased.
[8] At the
beginning of this section, it is necessary to distinguish between microcredit
and microfinance, based on the size and amount.
Microfinance generally refers to small amount of money (there is no
single definition of microfinance). Microfinance is that credit which is used
for decreasing poverty or running a small business (usually in the form of
self-employment). In respect to the conditions of granting the credit in
microfinance, it is a kind of credit is easily accessible, its conditions are
flexible, and the contract can be simply adapted to local situation.
Microfinance is beyond micro-credits and includes loans, savings, and
microfinance institutes (MIF). The topics that must be considered in
microfinance is how these financial sources provided by the above institutes are
being used, and how the credits are given to people (especially poor and
economically vulnerable people) to create employment for them.
[9] Read De
Aghion and Murdoch, 2011, p.117 for a review
[10] For
example when the order of taking money from the fund is pre-set, the member who is at the end of
the line may
tend to violate from the contract for monthly payment of a
specific amount of
money. Since one person is always the last one, this procedure cause the
fragmentation of credit associations, in a way that all members go out of the
association (Besley, Coate, and Loury, 1993, pp. 795-797). The other challenge
is related to those people who have already received money from the fund, how
can one guarantee that they pay back the money up to the last period? Radford
(2000) argues about
the most common concern in sustainability of such associations
that is the people who
receive money within early stages of the fund may tend
to escape.
[11] For
more information, read Besley et al. (1993); Besley et al. (1994); Callier (1990); Calomiris and Rajaraman (1998);
Krahnen and Schmidt (1994)
[12] For
example, Besley et al. (1993) concluded that both forms of ROSCAs, including random and biding, enhance economic utility comparing to the
primary autarky stage. Moreover, Besley et al. (1994) identified that
ROSCAs are preferred to the financial markets
in case of being
accessible for all people.
[13] The
first limitation of these associations is that the size of the fund and the
individuals’ contribution rate over the life cycle of the community are not
flexible. The second problem is that rotating savings and credit associations,
use the local financial sources, but they don’t have a systematic way to
mobilize and transfer those sources outside the particular group (De Aghion and
Murdoch, 2011, p.117). Many people use these associations for saving and not a
tool for receiving credits.
[14] However,
this type of financing has historical roots, as pioneered in the 1850s by Friedrich Raifeissem who had a similar
program in a village in Germany. It was later expanded to Italy, Japan, Korea,
Taiwan, Canada, and also America (Adams, 1995)
[15] They
are both independent and voluntary associations with specific goals, member, structure,
and rules. They also have similar regulatory structure for the poor and the
wealthy. As financial institutions, both are independent without
any external
monitoring on them.
Therefore they are independent from legal and financial structure
of their countries. In
fact, the policy of no
external intervention
on ROSCA and
ASCRA let them
expand faster and more flexible.
Some people criticize ROSCA and ASCRA models for their limited lifetime
comparing to other permanent credit unions,
whereas these
unions tend to become formal after a while, they have higher
administrative
expenses and they are more exposed to external risks. In addition, the capability of replacing risky
members with new members is low with these permanent credit
unions. On the
contrary, the flexibility as well as instability of ROSCAs and ASCRAs let them make new strategies in
accordance with contingencies.
[16] Firstly,
ROSCAs members do not
have to wait for their turn for receiving a loan, and there also no need to increase
the interest rate to
take a loan. Secondly, all the participants in the union – either the savors or
borrowers- are considered as stakeholders, and the key decisions would be made
based on their votes. Thirdly, the same as ROSCA participants, they also have
some common links and
interests, which enables them to
ensure the contracts by some punishment and social forces (De Aghion and
Murdoch, 2011: p. 120). In ROSCAs, financial sources are rotating mode as soon
as they are formed which makes their dissolution completely automatic. The
lifetime of such associations have been rarely more than one year and they lack
a legally registered structure. Furthermore, no protection would be done for
available financial sources.
On the contrary, in ACSCAs, financial sources would be
accumulated and distributed based on member’s viewpoints. Sometimes they never
get closed and they also have a recorded and documented legal structure. The
legal sources need protection and the group assets would be put in the banks. In ROSCAs , a single
loan would be given to each member (unless members have more than one share).
Granting a loan would be done automatically and under specific regulations.
Therefore necessity would not change the priority of giving a loan. The amount
of credit received is based on the degree of one’s deposit. The loan repayment
period is quite short such that inflation does not have an impact on it. On the
contrary, in ASCRA, members are able to receive multiple loans, and decision
making would be made by the members, thus emergency can change the priority of
granting the loans. The interaction between credit and savings are not balance,
and a big loan may be given to someone with little savings. The repayment
period might be short or long and it would go under inflation effect.
[17] Note that in this method,
borrowers form groups with other borrowers and have enough information about
other members. Therefore, the adverse selection issue is solved. But, what if
this assumption is rejected; i.e., we assume that the conditions in a society
is such that individuals have not enough information about other members of the
society, can we claim that group lending might improve the welfare of the
economy? Aghion et al. (2000) introduce the concept of limited
liability and argue that in this case, the conditions of both high and low risk
borrowers are better than in individual lending.
[18] For
further information see Besley et al. (1994) De Aghion (1999); Laffont and Rey (2003); Rai and Sjöström. (2004).
[19] For example regarding a small credit plan in Bolivia,
Ladman and Afcha (1990) conclude that finding potential
borrowers to volunteer for leading their own group is difficult.
[20] Laffont and Rey (2003) argue that group lending functions better than individual
lending only if borrowers do not conspire.
[21] Indeed, the fact that an
individual knows he can take loans from an institution only once, raises the
possibility of overdue loan repayment. Experimental results show that most
borrowers tend to take more than one loan from a bank (Pulley, 1989). The same
reason, will increase the willingness of individual clients to repay faster and
in due time.
[22] Experimental studies show
that most people have acceptable assets to be used as a guarantor.
[23] Read more in Ray (1999)
and Benjamin and Lendgerwood (1999)
[24] Observations include the capability of managing credits
and regular deposit-making functions. Experimental studies show that the above
features correlate highly with the characteristics of a committed borrower. For
example, Grameen Bank follows a similar policy. To read more, see de Aghion and
Murdoch (2011, p. 225).
[25] This
scheme has significant advantages; first, lenders can use social label
avoidance as a motivating factor for
individual borrowers for loan repayment without providing a guarantor (Rahman,
1999). Meanwhile, public repayments remove the possibility of such disrespects.
Second, a part of transactional expenses by the bank staff will be reduced through holding meetings with a
group of borrowers in particular times and places. Third, groups are useful
resources for acquiring some information about borrowers engaged in fraudulent
behaviors and put proper pressures on them. Fourth, group meetings can
facilitate training and learning. Fifth, the welfare of clients will increase
through this methods. And finally, maintaining transactions in public repayments
can improve internal monitoring and
minimizing fraud (de Aghion and Murdoch, 2011, p. 228).
[26] For further information about
other mechanisms see Churchill (1999).
[27] For further information see
Mohajerani et al., (2002).
[28] For
further information see Najafi (2006).
[29] For
further detail about these plans see Aqababaie (2007). To read about the weaknesses
and strengths of each plan see Ebadi et al. (2008).
[30] In the
first step, we need to take into the account that banking knowledge includes
various scientific layers as for the nature of modern banking industry. The
first layer is macro economy. On the other hand, since banks are economic
enterprises, entrepreneurship, human resources, modern banking approaches,
making use of information technologies could be taken as the second layer for
banking knowledge. Psychology and sociology include the third modern banking
knowledge layer. To attain an advanced banking system, banks need to have full
constant communication with the first, second and the third layer.
[31] For further information
see de Aghion and Murdoch, (2011, p. 252).
[32] The
importance of saving aspect led Grameen make some modifications in the rules and regulations of
Grameen 2 and collect cheap savings to
three or four-fold the credits granted to their clients. This has resulted in
decreasing Grameen’s dependence on external resources.
[33] There are opposing views about
savings; one view assumes that low income families are not capable of saving
and show slight tendency toward it. In other words, in this level living
requirements for the individual is more important that saving ones. Therefore,
according to this view, granting credits is more valuable than offering saving
services.
[34] Micro-insurance is the process of protecting low-income population against
possible risks for regular premium payments proportionate to the likelihood and
cost of the risk involved (CHURCHILL, 2006).
Institutions
such as Grameen Bank and Self Employed Women's Association have provided
insurance services for a long time. Today, organizations such as International
Labor Organization and the African Micro-credit have taken this responsibility.
Among the most important insurances include health insurance, life insurance,
rainfall insurance etc. For further information see Brown and Churchill (1999,
p. 2000) and Murdoch (2002).