[Viewpoint] Microfinancing growth

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[Viewpoint] Microfinancing growth

The government’s plan to set up a microfinance institution means that poor and low-credit small business owners can now have easier access to banking services. The public institution aims to raise a fund of about 2 trillion won ($1.66 billion) over the next decade based on corporate donations and dormant bank accounts to finance loans to small entrepreneurs and self-employed businesses in difficult times. Individuals can borrow as much as 100 million won for up to five years at an interest rate of around 5 percent.

It is a kind of hybrid microloan model based on microcredit that has in recent years gained impetus in the global market as a financing option for the low-income and low-credit class. However, some experts worry the model, which is largely successful in relatively underdeveloped countries, may only exacerbate the country’s already-swamped market of self-employed businesses and small entrepreneurs.

But I am of a different opinion.

The biggest problems of small entrepreneurs in our country are that most of them fail to make profits in heated competition and a general lack of competitiveness.

The microcredit system aims not to funnel fresh funds and add more self-employed small businesses to the already saturated market. It will help competitive ones breathe new life into the market.

Microfinance may have originated with underdeveloped societies, but it has become widely popular in the mainstream banking industry as it’s been modified to fit developed markets as a source of new growth.

We, too, must take interest in building and developing a microfinancing model tailored to meet our socioeconomic demands amid serious unemployment and wealth gap problems.

But there are issues to be hammered out to make the new type of loans a successful and sustainable financial option for the low-income borrowers and not a policy fiasco for President Lee Myung-bak’s administration.

First of all, lending rates must be more realistic. The benchmark around around 5 percent interest is far below current market rates.

The government has probably come up with the low yield, considering the fund largely depends on charitable input by corporate and institutional investors. But the yield cannot cover debt expenses as well as commissions for the institutional intermediaries.

Under the current interest form, the fund cannot flow on its own and will probably demand more subsidies from corporate investors and the government.

But it is too naive and risky to design a financial instrument based on hopeful interest and support from the government.

The fund should initially start off with low lending rates but eventually ratchet up to realistic levels by developing a self-sustainable mechanism.

Lastly, there needs to be a stricter line between the central fund that allocates the loans and the local funds that actually extend the financing.

The classification of central and local entities appears to emulate the relationship between the headquarters and local branches of a bank.

But the two institutions are fundamentally different.

A local branch of a bank will face serious personal and financial disadvantages from headquarters if it fails at its mandate, whereas the only way to control a local fund via a central fund is to reduce the amount of the allocated money.

However, that device is also not effective enough when we take into account the pressure from local communities.

It is important to separate the local funds from the central fund and guarantee the independent management status of locals.

The money for the local funds to loan out must be provided by the central fund with the premise of compensation that would secure the binding responsibility of the local fund. This would constitute a fundamental basis for maintaining the soundness of loaned assets of local funds.

*The writer is a business administration professor at Chung-Ang University.
Translation by the JoongAng Daily staff.

by Park Chang-gyun

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