Factors influencing borrower’s behavior and decision making patterns in the success of a micro finance model

Borrowing behaviour

Factors influencing borrower’s behavior and decision making patterns in the success of a micro

finance model—A case study on the remote areas of Karachi, Pakistan

Submitted by:

Mirza Raza AliStudent, M Phil ProgramInstitute of Business Management (IoBM)

Karachi, PakistanDirector, Finance and PlanningNewports Institute of Communications & Economics (NICE)

Karachi, PakistanTel.: 0092-21-34547417, Cell: 0092-300-2267677

Factors influencing borrower’s behavior and decision making patterns towards micro financing

models—A case study on the remote areas of Karachi, Pakistan

ABSTRACT

In the developing world, Micro Finance Institutions (MFIs) offer various financing modes for customers who, generally, are neither well-aware nor apprised about such modes and related financial obligations Moreover, MFIs emphasize on safeguarding the lender’s interest due to risk exposure However, it must also be realized that borrowers’ perspective has a

significant impact in the success of any micro financing model Realizing the importance of the borrowers’ perspective for a successful and sustainable financing model, the research reviews major factors that influence the behaviors and decision making patterns of borrowers towards micro financing The case study research was adopted by selecting respondents from three remote areas of Karachi, the largest metropolitan city of Pakistan The study evaluated prevailing

educational, communal, economic, political, and cultural circumstances and its impact on the borrowers’ behavior A low literacy rate, depriving economic conditions, extreme political involvements and pressures, inflexible and unsupportive communal and social norms, strong cultural differences amongst population living in remote areas coupled with low awareness and slow market penetration strategy of MFIs have restrained the growth of micro financing amongstits potentially strongest target market in Pakistan The MFIs may also facilitate the borrowers to establish strategic alliances on profit sharing basis with the educated middle income classes, hence enabling both the parties to effectively run small and medium sized businesses The research provides a comprehensive insight to the MFIs in Pakistan for addressing the borrower’s concern and realigning their vision and mechanisms to suit the borrower’s needs and

The success of microfinance institutions (MFIs) in developing ingenious financial

products and services for their clients relates to the local dynamics of the customers, which varies from nations to nations The formulation of any microfinance model for a specific

population involves a comprehensive study ranging from basic information of customer

demographics to the complex issues involving behavioral and psychological aspects Therefore,

it is imperative that MFIs, while developing financial products, consult behavioral economists and consumer psychologists along with the potential customers to adequately visualize the possible repercussions and implications for achieving desired results It would be an added value

to have collaboration with anthropologists and sociologists to better comprehend the impact of financial products on the livelihood of clients We have observed, particularly in the developing world, that the potential and existence of microfinance is substantial but unregulated Although microfinance is largely studied in the context of financial economics, but other facets involving diverse yet complex nature of borrowers’ dynamics must also be considered for evaluating the overall economic impact of micro financing

In Pakistan, the amount and scope of research on micro financing issues has been limited

to the economic aspects of borrowers However, researchers have not yet explored the social, political, communal and cultural perspectives of borrowers, which have a key influence in shaping their interests, attitude and perceptions towards micro financing models The literature review explores the success of micro financing models in the developing countries like

Bangladesh, India, Sri Lanka, Bolivia and Zambia MFIs in Pakistan must understand the

challenges and issues restraining their success through intense academic research, which would

their customers Such a study would evaluate the level of knowledge and interest about micro financing prevailing in the lower income groups The awareness of micro financing may

encourage the poor people to empower themselves and contribute towards the economic

development of Pakistan

LITERATURE REVIEW

In the new millennium, the world is experiencing rapid progression in technology and human development for attaining high efficiencies and long term sustainability In its efforts for making the world a better place to live in, nations worldwide have also realized the increasing poverty levels due to wealth concentration and its inequitable distribution, especially in the developing world The increasing poverty may hamper the process of growth and development inall spheres Therefore, it becomes imperative that the populations in lower income groups should

be involved in the economic activity by empowerment approaches Since the poor may not be engaged in formal financial services, therefore, emergence of microfinance institutions took place dealing with micro credit schemes, savings and insurance plans to uplift the economic lifestyles of the lower income groups

Brau & Woller (2004) comprehensively reviewed over 350 articles and compiled the available literature on microfinance They defined microfinance as the term that “refers generally

to such informal and formal arrangements offering financial services to the poor” (p.4) They

emphasized that the motivation behind the microfinance movement was poverty alleviation Not

only that, but microfinance offered the potential to alleviate poverty while paying for itself and perhaps even turning a profit—“doing well by doing good.” This phenomenon formed the basis

decades have seen serious efforts worldwide to formalize financial service provision to the poor, specifically in the 1980s Today, the microfinance industry has turned to a global movement of poverty alleviation informed increasingly by a commercial/finance paradigm.

Mutua et al (1996) discussed that the emergence of microfinance industry has revamped the historical stereotyped image of poor from non-consumers to consumers of financial services

as it has evolved effective ways of cost-effective services resulting in huge “social investment” for the poor

Khandker (2005) examined the impact of microfinance activities on poverty reduction in remote areas of Bangladesh The results revealed that micro financing increasingly helps in poverty reduction with an emphasis of increased entrepreneurial activities amongst females in rural areas, thus, improving the overall economic situation of the country

The products of Microfinance Institutions (MFIs) are quite similar to those of formal financial sector institutions, however, methodologies may vary, but the fundamental services of savings, loans, and insurance are the same Nourse (2001) observed that project lending to small business enterprises and development has been the mainstay of MFIs He argued that MFIs should not limit their services to credit products but may expand their horizon of financial

services to include savings and insurance services for the lower classes He further discussed thatMFIs should offer flexible and customized lending services for the lower income groups rather than strict and uniform loan products for all income levels Endorsing this concluding assertion

of Nourse (2001), Eyiah (2001) developed a model of small manufacturer contractors and MFIs

in developing countries that provides a customized lending pattern for small enterprises

In order to evaluate the impact of microfinance institutions in developing countries, various studies have been undertaken using Bangladesh as a role model The massive

microfinance program launched by Grameen Bank gained a lot of popularity worldwide because

of its economic impact and female empowerment in rural areas

McKernan (1996) found that such a microfinance initiative resulted in a strong positive impact on entrepreneurship and female empowerment, while Pitt and Khandker (1998) find that

it had an enormous influence on the welfare and economic uplift of lower income groups,

especially women in villages One interesting study on impact of MFIs on female empowerment

in Bangladesh was conducted by Goetz & Gupta (1996) They found that microfinance program participation did not have a statistically major impact on female empowerment, rather, the conclusion disclosed that major fractions of females’ loans were controlled by male relatives, thus, restricting females’ capacity manage their micro financing activities

Mosley (2001) analyzed four programs in Bolivia and proved that assets and income increased subsequent to the poverty levels, but micro financing may also enhance susceptibility

in case of over-leveraging by borrowers Bolnick and Nelson (1990) observed that MFIs have an encouraging influence on small and labor intensive businesses, but it may vary across different sectors

Copestake et al (2001) assessed the impact of microcredit schemes in Zambia He found that borrowers who were offered two loans witnessed high income and profitability scales, as compared to the ones with single loans, who actually suffered because of collection mechanisms

of MFIs

Wydick (1999a) studied that borrowers belonging to high income level benefit with the credit services of MFIs In another study, Wydick (1999b) formulated a theoretical framework toevaluate the economic transaction between future returns to schooling and the current return to child labor in Guatemalan household enterprises He found that micro credit enhances the

possibility that children will attend school; however, in situations of moral risk, the cost of schooling may over shadow the benefits of child labor Using the same Guatemala data set in a subsequent study (2002), Wydick also studied that speedy improvements in job creation after initial credit access were followed by extended intervals of inactive job creation Anderson et al (2002) analyzed 147 MFIs and concluded that microfinance initiatives promote environmental awareness and common pool resource stewardship Woller & Parsons (2002) estimated that a microfinance program in Portoviejo, Ecuador contributes $480,000 per year in direct and

induced economic benefits to the local economy

Mosely & Hulme (1998) studied 13 MFIs in seven countries (Bolivia, Indonesia,

Bangladesh, Sri Lanka, Kenya, India, and Malawi) and developed an "impact frontier" defining the inverse relationship between outreach (depth of poverty reached) and impact

Kevane & Wydick (2001) evaluated that attracting poor females to small business

financing seems to acts as a substitute in favor of poverty reduction and child welfare

Specifically, female entrepreneurs create lesser employment opportunities than male

entrepreneurs Majority of the impact assessment studies cited above, with one noted exception, provide ample evidence of positive impacts of microfinance Thus, it can be said that micro financing can be viewed as a useful mechanism for cost-effective financial services to low income groups aiming towards poverty alleviation and creating a positive economic impact

Pakistan, being a developing country having an important strategic position in the region and possessing innumerable natural resources is still struggling in terms of poverty alleviation measures A nation, whose major population lives below the poverty line, can be empowered using microfinance tools and enhancing its awareness amongst the poor people It is however,

imperative that MFI products must take into consideration the perspective of borrowers while developing a product and ensure a successful MFI model

State Bank of Pakistan (SBP report, 2011) reveals that there are a total of 8 Micro financebanks having 737,343 borrowers with almost 34% market share Specialized MFI borrowers are 524,163 having the market share of 27%, whereas, 553,993 borrowers are under rural support program having 31% market share Other NGOs enjoy the remaining market share in micro financing

After reviewing the literature on the positive impact of micro financing in developing countries like Bangladesh, Zambia and Bolivia, it can be inferred that such initiatives can also encourage small and medium sized profitable business establishments in the rural and remote areas of Pakistan The phenomenon of micro finance is yet to attract the attention from the low income groups, mainly because of lack of its awareness and non existence of such products which provides relief to the borrowers Unfortunately, the researches on social, communal and cultural aspects of borrowers in Pakistan have not been undertaken extensively The MFIs in Pakistan need to extensively explore the borrowers’ dynamics for realizing their needs and matching their expectations The academia in Pakistan may facilitate the MFIs in producing relevant research work in understanding the broader social paradigms of borrowers, which may actually lead to the success of micro financing in a huge untapped target market of micro

financing in Pakistan

METHODOLOGY

In order to achieve the desired objectives, qualitative research method will be used to investigate the significance of borrowers’ behavior in the success of MFI model Within the framework of qualitative research, case study approach is adopted to conduct the research Yin

(1984) defines the case study research method as an empirical inquiry that investigates a

contemporary phenomenon within its real life context, when the boundaries between

phenomenon and context are not clearly evident, and in which multiple sources of evidence are used (p.23) The case study method is adopted in exploratory topics to signify a specific issue, which is to investigate the significance of borrowers’ behavior in the success of MFI model The Case Study Research approach was adopted because the research was conducted in the specific remote areas representing lower income groups in the most populated and largest metropolitan city of Pakistan, Karachi The city of Karachi comprises a diverse

The sample size was drawn from three towns of Karachi, which included Landhi,

Korangi, and Orangi Town These towns mainly comprise lower income populations with a diverse mix of sub populations having different culture, political, ethnic as well as strong

communal background, whereby; each community has their own sources of obtaining funds Theaforementioned areas are distributed among different cultures having dominance of different ethnic and political groups within the three localities, mainly dominated by Urdu speaking (migrants from Indian sub-continent) and Pukhtoons from the province of Khyber

cultural background However, Classified Group ‘B’ has the dominance of Pushto speaking community Pushto speaking community is referred to those families, which migrated from different parts of Khyber Pakhtoonkhwa province Major reason of migration to Karachi was in search of job and business opportunities.

A sample size of 150 respondents (30 from each town) was selected on the basis of representation from the lower income groups Based on further cultural classifications, 15

respondents each from Urdu and Pushto speaking cultures were selected respectively from each

of the three towns It means that 75 respondents each belonging to Urdu speaking and Pushto speaking cultures were selected respectively from the three towns

The responses were gathered through closed ended questionnaire with few open ended questions to study the prevailing behavior of population The questionnaire was also translated into Urdu and Pushto languages to ensure respondents’ understanding and to gather maximum input from the respondents The questionnaire probed into five broad social dimensions

reflecting the behavioral characteristics and decision making patterns of respondents including educational, communal, cultural, political and economic facets The questionnaire also evaluated the level of awareness about MFIs, availability and accessibility to MFIs, and impact of

Government support to MFIs amongst lower income populations The data was tabulated and analyzed through qualitative analysis of the gathered data, which reveal the behaviors and decision making patterns in lower income populations towards regulated microfinance

institutions

ANALYSIS

The analysis is based on different factors influencing the borrower’s behavior towards a successful MFI model These factors are interdependent and have a major impact on decision making of the respondents The borrower’s behavior is derived from their educational, cultural, economic, political and communal facets These facets have a sound influence on behavioral and attitudinal aspects of individuals An in-depth analysis in each of the broad parameters revealed the following:

respondents can read some sentences of English

It also reflects their lack of intellect to understand the complexity of any micro finance model, which creates skepticism in understanding the phenomenon of repayment based on principal amount, mark up and other hidden charges It was also revealed that rules and

regulations set out by the Micro Finance Bank or Micro finance Institution, which is majorly written in English language, is not understandable by the borrowers They are totally dependent

on the information provided by the representatives of MFIs or MFBs or unstructured institutions.The borrowers are keen to obtain fund in any way to establish their businesses without having in depth information about the compounding rate of interest, schedule of charges, installment framework and redress in case of delinquencies They are only required to sign the undertaking

to be eligible for the loan