CHAPTER 9: FINANCE AND DEVELOPMENT

BY GROUP 1:
Aclera, Queen Alleah Rose
Eria, Jericho
Meneses, Trixie Ann
Queriones, Prince John Michael

Introduction
Financial systems are usually there to transform short-term liability into long-term asset. For example, demand deposits
can be transformed into long-term loans. Finance is a driver of sustainability. However, to achieve sustainability through
finance, it is necessary to rebuild and adapt the financial systems to the specifics of sustainable development. Moder
financial systems can be described as one-dimensional, focusing on ensuring the economic security of transactions.

Financial system intermediaries between the flow of funds belonging to those who save a part of their income and those
who invest in productive assets. It mobilizes and usefully allocates scarce resources of a country. A financial system is
complex, well integrated set of sub systems financial institutions, market, instruments and services which facilitates the
transfer and allocation of funds efficiently and effectively. The economic development of any country depends upon the
existence of well-organized financial system. Financial system plays a very crucial role in the functioning of the economy
because it allows the transfer of resources from savers to investors.

Finance
According to Investopedia, Finance refers to the management of money and other assets, such as investments and
credit. It involves making financial decisions, such as how to invest money, how to finance a project or business, and
how to manage risks. Finance is essential for individuals, businesses, and governments to achieve their financial goals
and objectives.

Historical Background:
Finance has a long history that dates back to ancient civilizations, such as Mesopotamia, where people developed
systems of credit and debt. Over time, finance evolved to include banking, insurance, and stock markets. Today, finance
is complex and globalized, with a focus on promoting inclusive and sustainable development.

Finance on the context of development:

Finance in the context of development refers to the use of financial resources and instruments to promote economic
growth and development. This involves the mobilization and allocation of financial resources to productive uses, such as
investment in infrastructure, education, and health, which can help to increase productivity and reduce poverty. It also
includes the provision of financial services to households and businesses, such as credit, savings, and insurance, which
can help to reduce financial vulnerabilities and increase access to economic opportunities.
Financial Intermediaries
 Banks
 Insurance companies
 Pension funds
  Investment funds (e.g., mutual funds, hedge funds)
 Microfinance institutions
 Stock exchanges
 Sovereign wealth funds

Roles of finance
 Link Savers-Borrowers
- Finance serves as an intermediary between savers and borrowers by channeling savings from individuals
and institutions to those in need of funds.
 Screen and Monitor Payments
- Finance also plays a role in screening and monitoring payments to ensure that they are made on time and
that the borrower has the ability to repay the loan.
 Smoothen Consumption
- Finance enables individuals and households to smooth their consumption by allowing them to borrow to
meet their current needs and repay the loan over time.
 Manage Risks
- Finance helps to manage risks by providing insurance and other risk management tools to individuals and
businesses.
 Manage Payment Systems
- Finance plays a critical role in managing payment systems, including the transfer of funds between
individuals, businesses, and governments.
 Mobilize Savings
- Finance mobilizes savings from individuals and institutions to support productive investments, such as
infrastructure projects and new businesses.
 Allocate Resources
- Finance allocates financial resources to productive uses by providing capital to businesses and
governments for investment in productive assets, such as machinery, equipment, and buildings.

Finance and governance

Good governance is essential for creating an enabling environment for finance to play its role effectively in promoting
economic development.
Let us briefly recall the characteristics of good governance:
Accountability, Transparency, Rule of law, Participation, Responsiveness, Consensus orientation, Equity and
inclusiveness, and Effectiveness and efficiency

Three important dimensions of governance related to finance

Transparency: This refers to the openness and accessibility of information related to financial transactions, policies, and
regulations.
Accountability: This involves ensuring that those responsible for financial decisions and policies are held responsible for
their actions and decisions.
Rule of law: This refers to the legal framework and institutions that govern financial activities and ensure that they
operate in a fair and equitable manner.
Finance and governance
Sound legal system – This refers to the laws and regulations that govern financial activities in a country.
Corporate Governance – This refers to the set of principles and practices that guide the management and control of
companies.
Comply or Explain – This is a principle of corporate governance that requires companies to either comply with a
particular rule or explain why they have chosen not to do so.

Microfinance
What is Microfinance?
Microfinance is the provision of a broad range of financial services such as deposits, loans, payment services, money
transfers, and insurance to poor and low-income households and, their microenterprises. Microfinance services are
provided by three types of sources:
 formal institutions, such as rural banks and cooperatives;
 semiformal institutions, such as nongovernment organizations; and
 informal sources such as money lenders and shopkeepers.
Microfinance is a type of banking service provided to low-income individuals or groups who otherwise wouldn't have
access to financial services. Microfinance services are provided to them because most people trapped in poverty, or
who have limited financial resources, don't have enough income to do business with traditional financial institution.
Microfinance allows people to take on reasonable small business loans safely, and in a manner that is consistent with
ethical lending practices.

History of Microfinance
 Muhammad Yunus (born 28 June 1940) often considered as the father of Microfinance, is a Bangladeshi social
entrepreneur, banker, economist and civil society leader who was awarded the Nobel Peace Prize for founding
the Grameen Bank and pioneering the concepts of microcredit and microfinance.
 Upon the creation of microcredit by Bangladeshi social entrepreneur Muhammad Yunus in 1983, microfinance
was simultaneously created. In 1983, Yunus established Grameen Bank in Bangladesh. The goal of Grameen
Bank was to initially provide small loans to entrepreneurs.
 Yunus’ vision for microcredit was inspired when he witnessed women who made bamboo stools in Bangladesh
making two cents a day. He decided that if the women were able to fall back on a loan, they would be able to
improve their margins and gain a more substantial profit. After issuing them a loan of $27, following the group
model, the women were able to repay the loan and keep their business running.
 Microfinance’s aspect of a savings account can also tie into microcredit; creditors may choose to include a loan
covenant. The loan covenant states that the borrower must set aside a portion of profits in a savings account
with the financial institution to be held as collateral until the loan is paid. Thus, it provides some protection for
creditors, and if the loan is repaid, the borrower would’ve earned savings interest on the money that was
deposited in the savings account.
 In 2006, Yunus received the Nobel Peace Prize for his efforts with Grameen Bank ". The bank currently
oversees i2,500 operational locations and employs about 22,000 individuals. Furthermore, there are currently
10,000 microfinance institutions. According to him, "efforts through microcredit/microfinance to create economic
and social development from below.
 According to Yunus, poverty means being deprived of all human value. He regards micro-credit both as a
human right and as an effective means of emerging from poverty: “Lend the poor money in amounts which suit
them, teach them a few basic financial principles, and they generally manage on their own”.
Roles of Microfinance
Microfinance comprises several services, including but not limited to, microcredit, microsavings, microbanks,
microremittances, microguarantees, money transfers, and microinsurance. Since microfinance specifically targets the
poor and economically excluded, it provides these people with new financial opportunities to initiate or maintain income-
generating activities, thereby increasing their income and well-being, and effectively reducing income inequality.
Microfinance provide financial services and substantial flows of financing to the economically marginalized populations
often neglected by the formal financial sector.
Because of these factors.
 Lifecycle needs – such as weddings, funerals, childbirth, education, homebuilding, widowhood, and old age,
 Personal Emergencies – such as sickness, injury, unemployment, theft, harassment or death.
 Disasters – such as fires, floods, cyclones, any natural disasters and even man-made events like war.
 Investment opportunities – expanding a business, buying land or equipment, house renovation, etc.
First, the poor are vulnerable to income fluctuations and hence are exposed to risk. Second, they are unable to access
conventional credit and insurance markets to offset this. Most formal financial institutions do not serve the poor because
of perceived high risks, high costs involved in small transactions, perceived low profitability, and most importantly,
inability to provide the physical collateral generally required by such institutions. Most poor and low-income households
continue to rely on meager self-finance or informal sources of finance.
Providing efficient micro-finance to the poor is important for many reasons, First, efficient provision of savings, credit
and insurance facilities can enable the poor to smoothen their consumption, manage risks better, gradually build assets,
develop micro-enterprises, enhance income earning capacity, and generally enjoy an improved quality of life. Second,
efficient micro-finance services can also contribute to improvement of resource allocation, development of financial
markets and system, and ultimately economic growth and development. Third, with improved access to institutional
micro-finance, the poor can actively participate in and benefit from development opportunities.

Contribution of Microfinance to Financial Sector Development and Growth

Microfinance has been acknowledged as one of the most important development policy innovations in the world and an
important instrument of organizations to fight poverty worldwide. MFIs’ social aspirations commonly include poverty
reduction, job creation, gender empowerment, economic growth, social inclusion, and eventually contributing to social
development. Microfinance has the capacity to increase self-employment and create microenterprises in developed and
developing countries. With the assistance of microfinance, households are able to expand opportunities for more
income accumulation, thus allowing people to provide for their families. Having access to credit can help rapidly stop
poverty, disrupt the cycle of poverty by making money available, and facilitate potential business opportunities. Families
may save and even invest in better housing, healthcare, and education, making the positive impacts more sustainable
and lasting. Through the help of microfinance, entrepreneurs in developing countries and impoverished communities
may survive, operate, and even thrive to create more employment opportunities for others. Participation in a
microfinance program is associated with higher levels of consumption, better nutrition, improved standards of living, and
growing economies.
With regard to poverty alleviation, microfinance creates employment and generates income, thus stimulating social well-
being among the poor segments of society and serving as an important tool for poverty reduction in both developing and
developed economies. Microfinance services such as microcredit have been shown to improve the living standards of
people, increase income and generate employment through entrepreneurship, and smoothen seasonal consumption in
various economies in the developing world.
Microcredit
What is the distinction between Microfinance and Microcredit if you may ask.
Microfinance encompasses a broad offering of financial services for low-income communities, while microcredit
specifically means small loans for people below the poverty line.

What is Microcredit?
Microcredit is a common form of microfinance that involves an extremely small loan given to an individual to help them
become self-employed or grow a small business. These borrowers tend to be low-income individuals, especially from
less developed countries (LDCs). Microcredit is also known as "microlending" or "microloan." Most microcredit schemes
rely on a group borrowing model, originally developed by Nobel Prize winner Muhammad Yunus and his Grameen
Bank.

How Microcredit Works

The concept of microcredit was built on the idea that skilled people in underdeveloped countries, who live outside of
traditional banking and monetary systems could gain entry into an economy through the assistance of a small loan. The
people to whom such microcredit is offered may live in barter systems where no actual currency is exchanged. The
structure of microcredit arrangements frequently differs from traditional banking, wherein collateral may be required or
other terms established to guarantee repayment. There might not be a written agreement at all.
In some instances, the microcredit was guaranteed by an agreement with the members of the borrower’s community,
who would be expected to compel the borrower to work toward repaying the debt. As borrowers successfully pay off
their microcredits, they may become eligible for loans of larger and larger amounts.

Micro-loan Terms
Like conventional lenders, micro-financiers must charge interest on loans, and they institute specific repayment plans
with payments due at regular intervals. Some lenders require loan recipients to set aside a part of their income in a
savings account, which can be used as insurance if the customer defaults. If the borrower repays the loan successfully,
then they have just accrued extra savings.
Because many applicants cannot offer collateral, microlenders often pool borrowers together as a buffer. After receiving
loans, recipients repay their debts together. Because the success of the program depends on everyone's contributions,
this creates a form of peer pressure that can help to ensure repayment.
For example, if an individual is having trouble using his or her money to start a business, that person can seek help from
other group members or from the loan officer. Through repayment, loan recipients start to develop a good credit history,
which allows them to obtain larger loans in the future.

Role of Microcredit in our Developing Society

Three pillars of sustainable society development; economic, social, and environmental development depend to large
extent on solving resource constraints of our population. Access to financial resources is one of the significant resource
constraints for rural people. Microcredit which emerged from Bangladesh has the potential to ease the financial
constraints of people especially the poor. Microcredit offers small loans to poor people who have less or no collateral
and are often ignored by the conventional banking system. Positive impacts of microcredit on poverty alleviation,
employment generation, women empowerment, curbing rural outmigration, food security, better health and education,
climate change adaptation, and green entrepreneurship are extensively documented in the literature. Hence, microcredit
can be used as a tool to achieve sustainable society development through the economic, social, and environmental
development of these areas.

Microsavings
Microsavings is a form of microfinance where organizations and financial institutions encourage individuals to save
money. Microsavings accounts are similar to traditional savings accounts, but are designed for small deposits. These
accounts are often characterized by no minimum deposit amount, no service fees and flexible withdrawals.

One example of microsavings that is prevalent today is the Rotating Savings and Credit Associations (ROSCAs).

ROSCAs are common in developing countries and among migrant groups in developed countries.

Countries Version of ROSCAs

India Chit Fund

Nigeria and Ghana Susus

West Africa Tontines

Bolivia Pasanaku

China Hui

Indonesia Arisan

Philippines Paluwagan

— It is a common fund to which individuals contribute a set amount on a regular basis (usually monthly), while one
member withdraws the funds at each meeting.

Two types of ROSCAs

 The Random ROSCAs
 The Auction ROSCAs

The Random ROSCA is the first type of ROSCA, it is a familiar to the regular PALUWAGAN of Filipinos, wherein a fund
is formed by contribution of those who agreed ion the microsavings and every agreed time, they would take the pooled
amount.
The Auction ROSCA is a second type of ROSCA, wherein a bid is tendered by those who want to pool their money. The
one who bids the highest would be the first to receive the total amount, and so on. Auction ROSCA allows those with
urgent needs to receive funds earlier than those with less urgent needs. However, the bud amount will be deducted from
this total amount to be received by the members of the ROSCA

ISLAMIC FINANCE
In a study made by Suseno in 2018 it was found that macroeconomics factors, the level of employment, and GDP per
capital have the most significant influences on financial inclusion in Islamic banking countries. Other non-economic
societal factors such as information technological advancement and corruption level do not significantly influence
financial inclusion.

The Islamic finance model has its foundation and origin in the Quran and in the Sunna (the sources of sharia or the
Islamic Law). Its application is bound by a conventional body of rules and regulations as well as the historical, social,
and economic context of the country in which the model has been implemented.

Islamic finance is application of Islamic Law or Sharia. Quran and Sunnah form the Islamic Law.

Quran is a Words of Allah while Sunna, in Arabic word means tradition or teaching. Sunnah is a collection of
Muhammad's life. It a second important book of Islam because it tells Muslims what and why to do it.

In the Gulf Cooperating Countries (GCC) there is a direct relationship between adopting Islamic finance and the
Economic growth of its member countries. The performance of their banking institutions has contributed to the economic
growth through induced financing activities.

Managers of the Islamic banks have an understanding of how their institutions could improve economic performance as
it reduces the severity of the financial crisis by avoiding major weaknesses of the conventional banking system.

Islamic Banks Vs. Conventional Banks

Islamic Banking system which completely prohibits "Interest", and its practices are based on "Shariah Laws".
 Asset Based Financing
 Disallow Prohibited Trade Elements (Such Pork, Bee, Alcohol, Drugs, Gambling or anything else that the
Shariah consider UNLAWFUL or UNDESIRABLE (HARAM))
Conventional Banks is a type of banking allows individuals to put their money into a conventional bank, where it can sit
and earn interest while they are not using it.
 Profit oriented system

The Philippines as a predominantly Catholic country, would contribute mainly to its Halal industry to address the
international system of Islamic finance. In the study made by Martin 2020 it showed that the knowledge of Halal concept
makes the respondents of the said study agree more with the active role of Islamic finance.

Halal means literally, that which permitted or prescribed, primarily refers to dietary restriction that Muslims are expected
to follow. Halal products are in great demand by consumers all over the world.

References:
https://www.stlouisfed.org/publications/bridges/summer-2012/microsavings-opening-the-door-for-individuals-to-invest-in-
themselves#:~:text=Microsavings%20is%20a%20form%20of,are%20designed%20for%20small%20deposits.
https://www.investopedia.com/terms/r/rotating-credit-and-savings-association.asp
https://www.adb.org/publications/role-financial-intermediaries-poverty-reduction#:~:text=Providing%20efficient%20micro
%2Dfinance%20to,income%20earning%20capacity%2C%20and%20generally
https://corporatefinanceinstitute.com/resources/commercial-lending/microfinance/
https://www.adb.org/sites/default/files/institutional-document/691951/ado2021bn-microfinance-social-development.pdf
https://www.investopedia.com/terms/r/rotating-credit-and-savings-association.asp
https://aims.education/study-online/difference-between-islamic-banking-and-conventional-banking-
system/