During the last economic and financial crisis that started in August 2008, the Portuguese economy was caught in the middle of a period of adjustment during which “was already facing up to the need to correct its fiscal and external imbalances within a phase of low growth with pro-cyclical policies” (Torres, 2009, p.55). This period started in the second half of 1990’s with the accession to the Economic and Monetary Union (EMU) and was characterized by an economic boom which was followed by a slump. As a matter of fact, Blanchard (2007, p.1), two years before the crisis, stated that “the Portuguese economy is in serious trouble: Productivity growth is anemic. Growth is very low. The budget deficit is large. The current account deficit is very large.”
Although, from 1995 to 2001, Portugal was in a catching-up phase benefiting from positive wealth effects of EMU (lower interest rates which supported the increase of the domestic demand), the current account deficit rose drastically and the unemployment rate fell to about 4% (figure 1). The reason behind the increase in the current account deficit was, indeed, the low level of unemployment which boosted the nominal wages to increase more than the labour productivity provoking a huge raise in unit labour cost and a decline in competitiveness. Moreover, the indebtedness of households and non-financial enterprises was increasing because of the elimination of the exchange rate risk, the access to the euro bond market, and the lower interest rates, both nominal and real, set by the European Central Bank (Blanchard, 2007).
As result, from 2000 to 2003, savings dropped and investments increased, therefore the current account deficit slightly decreased. The Portuguese economy slowed down and then contracted in 2003.
The subsequent slump was the result of the large imbalances built up during the phase of boom. For instance, the high levels of consumption were not counterbalanced by the supply which had to deal with low productivity growth and increasing unit labour costs. As a matter of fact, figure 1 shows a combined upward trend of unemployment and current account deficit between 2003 and 2005, and the attempt to reverse it through the budgetary consolidation process re-assumed by the socialist majority government elected in 2005 (Blanchard, 2007) (Torres, 2009).
To sum up, table 1 and table 2 offer an overview of the macroeconomic imbalances during the phase of the boom 1995-2000 and the one of the slump 2001-2007.
Table 1. Macroeconomic evolutions, 1995-2001. Source: Blanchard (2007)
Table 2. Actual and projected Macroeconomic evolutions, 2001-2007. Source: Blanchard (2007)
The growth rate was rather high in the timeframe 1995-2000, then, since 2001 it started falling in the subsequent years. The current account and the budget surplus were in deficit over the whole observed period and the productivity growth started to be very low since the year 2000 causing the raise of the unit labour cost.
It was important to describe the macroeconomic situation of Portugal prior to the crisis in order to explain, in the next sections, how those problems have been aggravated since 2008. In fact, the phase of slump was prolonged by the financial crisis occurred in 2008.
II. Policy Responses Prior to analyze the European and Portuguese policy responses to the major financial crisis that the whole world is facing since 1929, it is essential to point out what kind of crisis our society is dealing with. The main cause of the crisis may be ascribed to the crisis of derivative market in the United States. In particularly, it started from the so-called ‘subprime mortgage crisis’ which was the result of a speculative bubble in the housing market in the United States. Starting from the United Stated, it has spread by causing ruptures across many other countries in the form of financial failures and a global credit crunch.
“The main (systemic) Portuguese banks seem not to be particularly exposed to the so-called financial toxic assets and, unlike in Ireland or Spain, there was no speculative bubble in the housing market in Portugal nor is there a subprime segment in the credit to the housing sector.” (Banco do Portugal, 2008 as cited in Torres 2009)
However, according to Torres (2009, p.56):
Portugal, a small economy fully integrated in economic and financial terms, is particularly affected by the global financial crisis and economic recession. This is not so much due to the international exposure of the Portuguese banking sector (the Iceland syndrome) but primarily to the country’s long protracted correction of its fiscal and external imbalances, which worsen its creditworthiness and aggravate the costs of servicing the debt and the country’s perceived risk of insolvency (an Argentinean type of problem, without the risk of a currency crisis as long as the eurozone remains in place).
One of the main consequences of the financial crisis was, indeed, the credit crunch. During the last decades, the European banking system has changed from a system where the bank was the intermediary for investments between families and factories, into a new system where there are large money-centre banks which play the role of the intermediary amongst regional banks, in other words, they distribute funds among regional banks. The banking crisis has occurred in Europe because of two related reasons. The large money-centre banks that provide the backbone of the inter-bank lending market are undercapitalised. With their low capitalisation, they are vulnerable to even small swings in market conditions. Any liquidity problem, thus, turns almost immediately into a solvency problem. Because of this vulnerability they did not trust each other, thus paralysing the inter-bank market.
2.1 European Policy Responses
For the Euro-area countries, the monetary policy is unique and conducted by the European Central bank (ECB). Since the atmosphere of mistrust, caused by the crisis, was no longer confined to the interbank market, but it was also spreading among ordinary citizens and consumers, the European policy-makers figured out that one possible solution was to put into effect measures which contain two elements in order to restart the interbank lending: support for the liquidity management of banks and bank re-capitalisation. The first element concerns the extraordinary measures taken at European level and the second one the bank rescue measures adopted at national level.
As a matter of fact, firstly, the ECB has been reducing the rate for its main refinancing operations from 4,25% to 1,5%, in the timeframe October 2008 – March 2009, in order to prevent contagion by providing short-term liquidity support on the interbank markets. Such interest rate cuts have provided significant relief to the highly indebted Portuguese economy (Torres, 2009). However, if Portugal could have managed the monetary policy on its own, probably it would have set a lower interest rate which combined with the initiative for strengthening financial stability (discussed in detail in the next section) could have led to the reestablishment of bank lending standards at pre-crisis level. In other words, the upward trend of the credit diffusion index, starting in the last quarter of 2008, could have continued to increase instead of contracting in 2009 (figure 3).
Moreover, a dramatic reduction in real interest rates is the main channel through which fiscal consolidation can increase demand in the short run. Since this is not the case for Portugal, as the nominal interest rate is determined for the eurozone as a whole, “while a deficit reduction is needed, it would be unwise to expect it to lead, by itself, to higher demand and lower unemployment â€¦ or â€¦ to a boom in investment, and through capital accumulation, to a substantial improvement in competitiveness” (Blanchard, 2007, p.8-9).
Secondly, the ECB has promoted coordination and cooperation between national supervisors through the European System of Central Banks’ Banking Supervision Committee. As result, the promoted cooperation engaged both the Euro-area and the European Union (EU) in an expansionary coordinated anti-cyclical fiscal stance (Torres, 2009, pp. 56-59).
To further improve the EU coordinated approach, the European Commission’s response was to launch the European Economic Recovery Plan (EERP) whose strategic aims is to avoid a deep recession by promoting “a counter-cyclical macro-economic response to the crisis in the form of an ambitious set of actions to support the real economy”. The plan consisted of an immediate budgetary stimulus amounting to 1.5% of EU GDP, “a number of priority actions, grounded in the Lisbon Strategy, and designed at the same time to adapt our economies to long-term challenges, continuing to implement structural reforms aimed at raising potential growth” and a set of EU guidelines to be followed by the member States (European Commission, 2008).
According to Bénassy-Quéré et al. (2009, p.39), out-of-ordinary methods are used in a financial crisis because:
the traditional transmission of policy rates to lending rates is hampered by the dysfunctional state of money markets. This happens at two levels: first, the interbank rate (the rate at which banks lend liquidity to each other) diverges from the central bank’s policy rate because banks fearing counterparty default price risk accordingly; second, the spread between the commercial banks’ lending rate and the interbank rate increases both because of higher risk premiums and because banks seek to increase their profits.
According to Meier (2009, p. 6), a switch to unconventional policy may be motivated by the severe turmoil in credit markets. With the financial sector in crisis, policy rate cuts are not only constrained by the zero bound, but may also be less effective than during normal times. The reason is the sharp tightening of credit conditions, as lenders have curtailed loan supply and certain sources of capital market funding have all but disappeared. Indeed, such dislocations can provide a rationale for launching unconventional policies even before interest rates hit the lower bound. In sum, unconventional monetary policies serve both as a complement and as an extension of standard operations centered around the setting of short-term interest rates. One of the unconventional actions is the so-called outright asset purchase, a technique to decrease the discrepancy between interbank and lending rates.
Furthermore, Meier (2009) provides a categorization of such operations, distinguishing between qualitative easing, as sterilized interventions that do not involve an increase in the central bank”s balance sheet, and quantitative easing, as unsterilized interventions implying an increase in base money. Unlike the US and the UK, in the Eurozone the direct purchase of government debt instruments is forbidden by art. 101 of the EC Treaty, therefore quantitative easing is not contemplated. Figure 2 shows how liquidity provisions and out-of-the-ordinary policies, adopted by ECB, Federal Reserve (FED) and Bank of England (BOE), increased the size of the central bank’s balance sheets. Assets hold by the ECB are about 50% lower than FED and BOE because they executes quantitative ease operations (Bénassy-Quéré et al. 2009, pp. 42-44).
2.2 Portuguese Policy Responses
With the financial crisis Portugal has re-focused its economic policy from budgetary consolidation to an anti-cyclical budgetary policy effort to support households, investment, employment and, last but not least, to strengthen financial stability (MFAP 2009 as cited in Torres 2009).
At the end of 2008, to guarantee stability of the financial system and to safeguard the household’s deposits held by credit institutions, the Portuguese government, following the trend of the other member states, decided to save two banks: the Banco Português de Negòcios (BPN) and the Banco Privado Português (BPP). In particular, BPN was nationalized and BPP was granted a guarantee for a bank loan provided by a group of banks. Although the dimension of those banks was small, the government “feared that the potential loss incurred by many small depositors could generate a run of bank depositors in general, putting at risk the stability of the financial system” (Torres, 2009, p.61).
The second measure to strengthen financial stability was taken in October 2008 when the Portuguese Ministry of finance and public administration announced the endorsement of the Initiative for strengthening financial stability (ISFS) in order to respond to the substantial external shock, to which it was being subject, due to severe liquidity restrictions in international financial and money markets. The ISFS was aim to enhance conditions for credit institutions’ access to liquidity in financial markets and was based on granting State guarantees for the financing of credit institutions.
According to MFAP(2008), this Initiative:
(i) Enhances the confidence in the domestic financial system;
(ii) Permits timely intervention adapted to market conditions;
(iii) Is temporary, remaining effective only while market conditions have not returned to normal;
(iv) Safeguards the interest of depositors and taxpayers;
(v) Allows the shareholders and managers of banks to be held accountable whenever necessary and fosters the adoption of good corporate governance principles, in accordance with best international practices;
(vi) Safeguards the interests of the market in general and a level playing field among competitors, in particular.
According to Torres (2009, p. 60), the aim of the coordinated guarantees on new issuance of bank debt was to address funding problems of liquidity-constrained but solvent banks. Thus, this initiative was a viable and less costly source of funding to allow banks to issue new debts.
A third measure was to take advantage of the increased flexibility of the Stability and Growth Pact (SGP) to pay outstanding state debts under the form of a program for the extraordinary settlement of the state’s debts to suppliers (Council of Ministers Resolution no. 191-A/2008 of 27 November as cited in Torres 2009).
However, in my opinion the results of those initiatives were rather limited. I can, indeed, argue that, in Portugal, bank lending standards are tightening. In support to my opinion, figure 3 provides an evidence: the largest observed swing occurred from the last quarter of 2007 to the last one of 2008 when the diffusion index dropped sharply to the minimum observed value, representing the credit crunch. To evaluate the effects of the ISFS it is sufficient to look at the trend starting from the last quarter of 2008, the upswing lasts for only a quarter to stabilize at the level of about minus 45% compared to the pre-crisis conditions.
The 19th of January 2009, the Portuguese government updated the Stability and growth Program for 2008-11. Following the EU guidelines concerning EERP, the government incorporated in the SGP program the Investment and Employment Initiative Program (IEIP), as fully consistent with the National Reform Plan for 2008-2010 (within the framework of the Lisbon Strategy), as it also aimed at contributing to addressing the country’s structural weaknesses. The draft law creating the IEIP was composed of five structural measures including several projects or actions to support households and businesses next to those aimed at combating the rise in interest rates and in the price of raw materials and food products and credit restrictions, which had already been envisaged in the state budget for 2009.. The IEIP was expected to have a budgetary impact of about 0.8 per cent of GDP in 2009 (about 0.5 increase in expenditure and 0.3 reduction in revenue in percentage of GDP).
The five measures were:
modernization of schools;
fostering renewable energies, energy efficiency and energy transmission infrastructure;
modernization of technological infrastructure and new generation broadband networks;
special support to economic activity, exports and SME;
protecting employment and strengthening social protection (Torres, 2009).
1). Higher investment in human capital help to avoid the risk of depression of productivity performance. In Portugal the educational attainment of the working-age population is low and the intergenerational educational mobility has been sluggish. Furthermore, the international student performance survey (PISA) shows that Portuguese students are below the OECD average (figure 4). To increase efficiency, the smallest schools have been closed and changes to the teachers’ timetable are allowing a more efficient allocation of human resources. Moreover, upper-secondary education has been diversified to incorporate technical and vocational courses (OECD 2009).
and 3). Portugal might take advantage of the temporary increase in spending under the recovery plan to promote a leap forward to new competitive ‘green’ goods and technologies. There is a clear case for the world, and for the EU to maintain its leadership in the process, and even more so for a small country like Portugal, to address climate change and the financial crisis at the same time by building up a competitive basis for sustainable development (Torres, 2009, p.66).
Activity collapsed at the end of 2008 under the weight of the global economic crisis. The huge decline in external demand was caused by the falling activity in a number of Portugal’s major export markets, particularly Spain which accounts for about 25% of portuguese total exports. Moreover, insufficient harmonization of regulations with major trading partners seem to have impeded trade, particularly in services. Despite the government’s announcement of additional revenue measures the deterioration in economic activity without further reductions in government outlays, or a more rapid economic upturn, means that the budget deficit could rise above 4.5% in 2010 and to increase further in 2011. The deterioration in economic activity was partly caused by the administrative burdens on business. Starting, running, and closing a business have been hampered by onerous regulation, including a cumbersome licensing regime that has weakened competition and, thus, productivity growth throughout the economy (OECD, 2008, 2009a, 2009c; European Commission 2009). Figure 5 provides evidence that Portuguese burden on business in the form of regulation are higher than EU average.
Productivity growth has been sluggish during the last decade, lagging behind the OECD average with a decreasing trend since 1990 (figure 6), partly on account of labour market rigidities such as high employment protection and insufficient human capital accumulation. Those weaknesses have led to a further widening of the large productivity gap with respect to the Eurozone. The protection of workers against individual dismissal has been the most restrictive in the OECD, with very cumbersome procedures, as clearly highlighted in figure 7. The new legislation put forward by the Portuguese government is aimed to significantly simplify dismissal procedures. However, protection of regular workers against dismissals will remain more restrictive than in the average OECD country. Therefore, it is essential to enforce the reform measures because tighter credit conditions, weak exports, and subdued internal demand depressed business investment in 2009 and led to a labour shedding and an increase in the unemployment rate which is projected to reach a double-digit rate in 2010 (OECD , 2008, 2009c; European Commission 2009).
According to Blanchard (2007), Portugal is today in a scenario of ‘Competitive disinflation’, defined as “a period of sustained high unemployment, leading to lower nominal wage growth until relative unit labor cost have decreased, competitiveness has improved, the current account deficit has decreased, and demand and output have recovered”.
If we look at the Real Effective Exchange Rate (REER) of a country, an instrument which can be used to assess price or cost competitiveness relative to the position of the country’s principal competitors, it is easy to notice that Portugal has substantially lost competitiveness against Germany since 1995 (figure 8). A rise in the index means a loss of competitiveness taking into account productivity changes via the movement in comparative unit costs (Hugh, 2009). Therefore, as this trend is going on since 15 years it is hard to invert it without huge efforts and structural reforms.
In the context of the budgetary policy, in 2008, Portugal has also taken action to reduce taxes through the cut of one percentage point of the VAT rate, the creation of a general corporate income tax rate of 12,5% and the reduction of advance income tax payments for SME (State Budget, 2009).
Nevertheless, the fiscal position has deteriorated significantly in 2009 reflecting weaker economic conditions, lower revenues and spending rises to support the economy. Fiscal stimulus measures focusing on public investment, support to companies and exports and social assistance will directly increase the budget deficit (OECD, 2009a, 2009b).
Torres (2009, p. 65) argued that:
In a small open economy like Portugal, fiscal policy has limited effectiveness with regard to influencing aggregate demand. This applies even more to the current environment of financial distress and uncertainty, where banks will try to de-leverage and households to save. Moreover, the Portuguese economy is already particularly exposed due to its fragile financial position, as reflected in its accumulated external imbalances, which puts at stake the market’s confidence in the sustainability of public finances. Given the risks involved for the costs of servicing the debt and ultimately for its solvency and permanence in EMU, it seems essential for the government to credibly pre-commit to medium-term budgetary objectives. It thereby signals its determination to pursue fiscal consolidation in spite of the temporary stimulating measures adopted within the EERP and to ensure that those exceptional measures do not mark a departure from budgetary sustainability.
Moreover, external debt has been high and rising (figure 9) and, thus, leading Portugal to become “the third eurozone economy to undergo a long-term credit rating reduction, to AA minus, by Standard
Definitions And Functions Of Micro Finance Economics Essay
Microfinance is viewed to be a cure against poverty in the world. In each country and region having diverse demographics, microfinance is being utilized to combat poverty. It is a quite recent concept in banking and financial sectors.
Microfinance is to allot very small loans to poor people with the aim of aiding them to start their own enterprises so as they can come out of poverty. That is microfinance is not a hand out, instead it is a hand up that permit the poor, mostly women, to attain continuous financial triumph.
The Journal of Microfinance describes it as what “is arguably the most innovative strategy to address the problems of global poverty” (Woodworth and Woller, 1999). The General Secretary of the United Nations, Kofi Annan, stated in 2002 that microcredit is a critical anti-poverty tool and a wise investment in human capital (Annan, 2002).
“Microfinance has evolved as an economic development approach intended to benefit low-income women and men. It refers to the provision of financial services to low – income clients, including the self employed” (Ledgerwood, 2000).
Microfinance is defined as formal scheme designed to improve the well being of poor through better access to saving and services loans (Schreiner, 2000).
The word “microcredit” was not existent before the seventies. But now it has turn out to be a buzz-word among the development practitioners. It is normally characterized as making small loans available directly to small-scale entrepreneurs to enable them either to establish or to expand micro-enterprises and small businesses. Microcredit is normally applied to target groups that would otherwise not qualify for loans from formal institutions. This includes the majority of those living below the poverty line (Commonwealth Secretariat, 2001).
Microcredit differs from microfinance in that microcredit refers to very small loans for unsalaried borrowers with little or no collateral, provided by legally registered institutions. Currently, consumer credit provided to salaried workers based on automated credit scoring is usually not included in the definition of microcredit, although this may change. Whereas Microfinance typically refers to microcredit, savings, insurance, money transfers, and other financial products targeted at poor and low-income people.
Microfinance is a highly common way of lending as lot of people require to borrow money rapidly and in little amount. In the case of macro loans, banks enquire about the person’s credit history and people have to pass through lots of procedures before the approval of the loan amount.
CHARACTERISTICS OF MICROFINANCE According to (Murray, U and Boros, R, 2002), there are many activities and characteristics are included in microfinance. Some are:
Small amounts of loans and savings.
Short- terms loan (usually up to the term of one year).
Payment schedules attribute frequent installments (or frequent deposits).
Installments made up of both principal and interest, which is amortized over the course of time.
Higher interest rates on credit (higher than commercial bank rates but lower than loan-shark rates), which reflect the labor-intensive work associated with making small loans and allowing the microfinance intermediary to become sustainable over time.
Easy entrance to the microfinance intermediary saves the time and money of the client and permits the intermediary to have a better idea about the clients’ financial and social status.
Application procedures are simple.
Short processing periods (between the completion of the application and the disbursements of the loan).
The clients who pay on time become eligible for repeat loans with higher amounts.
The use of tapered interest rates (decreasing interest rates over several loan cycles) as an incentive to repay on time. Larger loans are less costly to the MFI, so some lenders provide large size loans on relatively lower rates.
No collateral is required contrary to formal banking practices. Instead of collateral, microfinance intermediaries use alternative methods, such as the assessments of clients’ repayment potential by running cash flow analyses, which is based on the stream of cash flows, generated by the activities for which loans are taken.
MICROFINANCE CLIENTS? Microfinance is established as an efficient way to eradicate poverty by offering financial services to those poor people who cannot reach or are ignored by banks and financial institutions.
HOW DOES IT WORK? Poor people have necessary skills and knowledge to start their own enterprise, the only thing is that they do not have resources (especially finance) to do so. Thus microcredit helps them to accomplish their vision by providing them with micro loans. According to Ahmad (2000), it is acknowledged that people living in poverty are innately capable of working their way out of poverty with dignity, and can show creative potentials to improve their situation when an enabling environment and the right opportunity exists. It has been noticed that in many countries of the world, micro-credit programmes, give access to small capitals to people living in poverty.
Microfinance is an promising tool for economic development, poverty lessening, empowering of low income communities and giving a new role in micro-entrepreneurship (Mondal, p.1-3). The MFIs take into account the need of their customers concerning micro loans so as they can carry on their enterprises.
There are two types of microfinance borrowers; Micro borrower and Micro entrepreneur. A micro borrower has mind like capitalist who is intend to gain profit while doing business. Therefore a micro borrower gets finances from MFIs, and after reimbursing, they will obtain finances again but only if the purpose is to earn profit and not any entrepreneurial achievement. In contrast, a micro entrepreneur funds his business and brings modernism, originality and distinction from others (Mondal, p.3).
Microfinance bestow empowerment to women. Misra (p.3) describes empowerment as a strength to the people and self governance. He quoted “Empowerment builds self-reliance and strength in women, preparing them towards gathering the ability to determine the choice of life. This adds to the command over resources outwit insubordination and signify their social role.”
According to PREM,WB (2002,p.11), “Empowerment is the expansion of assets and capabilities of poor people to participate in , negotiate with , influence, control, and hold accountable institutions that affect their lives.”
MICROFINANCE INSTITUTIONS A microfinance institution (MFI) is an organization that offers minor loans to the needy people. The framework of the loan differs from organization to organization as every institution has their own procedures and conditions to supply credits. Nevertheless, the core purpose is to grant financial assistance to the underprivileged.
When talking about MFIs, we can think about non-governmental organizations (NGOs) which also provide loan facilities to the poor. During the 1990s, many NGOs were converted into formal financial institutions so as to access and on-lend client savings, as a result improving their outreach.
There are also other kinds of microfinance institutions such as credit union or cooperative housing society. These organizations are different in every country (Rehman, 2007). Nowadays even commercials banks are moving towards the concept of microfinance. They are doing this to attract new clientele who wants to start a business but does not have enough funding to do so.
CHARACTERISTICS OF MFIS Formal providers are sometimes defined as those that are subject not only to general laws but also to specific banking regulation and supervision (development banks, savings and postal banks, commercial banks, and non-bank financial intermediaries). Formal providers may also be any registered legal organizations offering any kind of financial services. Semiformal providers are registered entities subject to general and commercial laws but are not usually under bank regulation and supervision (financial NGOs, credit unions and cooperatives). Informal providers are non-registered groups such as rotating savings and credit associations (ROSCAs) and self-help groups.
Ownership structures: MFIs can be government-owned, like the rural credit cooperatives in China; member-owned, like the credit unions in West Africa; socially minded shareholders, like many transformed NGOs in Latin America; and profit-maximizing shareholders, like the microfinance banks in Eastern Europe. The types of services offered are limited by what is allowed by the legal structure of the provider: non-regulated institutions are not generally allowed to provide savings or insurance. (www.cgap.com)
ISLAMIC MICROFINANCE Accepting or paying interest while lending or borrowing money is forbidden according to the Islamic law. However the borrower will share the profit that he will obtain from his business with the lender.
Money is not an asset for earning profit (Duhmale, Sapcanin, p.1). Islam emphasizes on social, ethical, moral factors for distribution of wealth and guide towards social and economic justice. Islam encourage profit rather than interest because earning profit evolve productive activity and involve in profit and risk sharing between lender and borrower (Dhumale, Sapcanin, p.1-2). The purpose of Islamic microfinance is to provide small loans to poor people without interest. This concept benefits the borrower as microfinance interest rates are relatively high.
There are several means to proceed with the interest-free microfinance but we will talk about three of them which are:
MUDARABA (Participation Financing)
Here deal takes place between the lender and the borrower. No interest will be charged, however profit will be shared by both the loan provider and the borrower. According to Zaher, Kaber, ” Mudaraba is a trust based financing agreement whereby an investor(Islamic bank) entrusts capital to an agent(Mudarib) for a project. Profit will be shared on an agreed ratio and the contract is similar to a western type of limited partnership where one is injecting money and the other one controls the business. In case of losses, the lender receives no return and the borrower no recompense for his work (Segrado, 2005, p.11).
According to Segrado (2005), ” Two parties provide capital for a project which both may manage. Profits are shared in pre-agreed ratios but losses are borne in proportion to equity participation”. As we can see, here it is not established on profit sharing but depends on evaluation and administration competence and part in business.
Here the lender will purchase goods and sell them to the borrower after adding a reasonable profit. The lender will stay the proprietor of the goods until imbursements are cleared. Dhumale, Sapcanin (p.10) describe Murabahah as “the Murabahah contract is similar to trade finance in the context of working capital loans and to leasing in the context of fixed capital loans”.
MICROCREDIT AND POVERTY ALLEVIATION THE GRAMEEN MODEL The terms “microfinance” and “micro credit” were not on screen before 1980s 0r 1990s (Robinson, 2001). It all started with the return on Muhammad Yunus to Bangladesh after teaching in the U.S for a few years.
In 1974, during a trip in a relatively poor village in Bangladesh, Muhammad Yunus came across Sufiya , a stool maker, who had to borrow money from a local lender so as to buy raw materials. She had to repay the lender with high interest rates which sometimes exceeded the initial amount. After repayment, she was left with practically nothing to meet her basic needs. Dr. Yunus was disappointed by what he saw and lent a small amount of money to 42 rural basket-weavers. He found that his action encouraged them to work more and they were enthusiastic to repay their loan (Roy, Mark A, 2003).
After two years, there came the establishment of the Grameen Bank where Dr. Yunus introduced the “Grameen Model” which is now the buzzword in the world of microfinance. Since its start in 1976, it has grown to over 1084 national branches in over half the villages of Bangladesh. The concept of this model is to provide loan facilities to poor people, especially women, so that they can carry out their small enterprises and manage their livelihood (Roy, Mark A., March 2003).
The procedure of the “Grameen Model” is that borrowers should form a group of five members. After the loan application, the first two people will obtain the loan. If they repay their loan successfully, then the other two members will get their loan amount. The last member will be granted the loan when the previous two members clear their debts. If this group was a good payer, therefore they will be eligible for future loans. However, if one of them fail to pay the loan, the whole group will be disqualified for further loan (Rehman, 2007).
As we can see, the approach of group lending is applied. This approach has many advantages. Firstly, members of a group are acquainted to each other, therefore if one is absent in the group meeting, another one can pay its installments. Furthermore in South Asia, especially in Bangladesh, there exists some kind of social pressures. If a member of a group does not repay his loan, he will be pressurized by the other members and also his neighborhood will get to know about it. So he will have to make an effort to repay his loan to avoid this kind of situation (Sengupta, Aubuchon, 2008).