Microfinance, sometimes referred to as microcredit, is a revolutionary type of financial service offered to low-income individuals or groups who lack access to conventional banking services.
While these institutions primarily provide small loans, which can be as modest as $50 up to $50,000, they also offer other essential services like checking and savings accounts and micro-insurance products. Some even provide financial and business education with the ultimate goal of enabling impoverished individuals to achieve self-sufficiency.
Key Takeaways
- Microfinance: A banking service aimed at low-income individuals or groups who otherwise wouldn’t access financial services.
- Diverse Offerings: Includes small business loans, sometimes complemented by checking and savings accounts, and financial education.
- Ethical Lending Practices: Allows for safe, reasonable small business loans consistent with ethical standards.
- Global Reach: Predominantly active in developing countries like Bangladesh, Cambodia, India, Afghanistan, DR Congo, Indonesia, and Ecuador.
- Market Growth: Valued at approximately $187 billion in 2022, with projections surpassing $488 billion by 2030.
Understanding Microfinance
Microfinance services are crafted for unemployed or low-income individuals who often lack the financial resources to qualify for traditional banking services. Despite their financial challenges, those surviving on as little as $2 a day still strive to save, borrow, and make credit or insurance payments. Prior to having access to microfinance, many of them rely on family and friends or resort to loan sharks with exorbitant interest rates.
Microfinancing offers a secure and ethical alternative for taking reasonable micro-loans. Although these organizations exist globally, most are concentrated in developing nations. Microfinance institutions (MFIs), often focusing on women, play a vital role in supporting diverse activities from basic banking to educational programs in business and professional skills.
Many microfinance organizations assist entrepreneurs by offering essential education on money management before enabling access to loans. Applicants often undergo basic financial literacy courses to grasp concepts like interest rates, cash flow management, financing agreements, budgeting, and debt management. Post-training, borrowers proceed with loan applications through processes similar to those at traditional banks.
Microfinance Loan Terms
Microfinanciers charge interest on loans and have structured repayment plans with regular installments. In some cases, borrowers must save a portion of their income in accounts serving as a financial safety net. Successful repayment not only ensures savings but also helps build their credit history, paving the way for larger loans in the future.
Pooling borrowers is common practice—creating collective responsibility and peer support within borrower groups ensures higher repayment rates.
Empowering Through History
The concept of microfinance dates back to the 18th century, with one of the earliest projects being Jonathan Swift’s Irish Loan Fund system. Modern-day microfinancing gained global traction in the 1970s, most notably through the Grameen Bank established by Muhammad Yunus in 1983.
Benefits of Microfinance
A Washington-based global nonprofit, the Consultative Group to Assist the Poor, reported that over 120 million people benefited from microfinance as of 2021. Microfinance not only provides access to capital but also nurtures entrepreneurial ventures that generate jobs and enhance economic conditions within communities.
The For-Profit Controversy
Despite the success stories, microfinance faces criticism, especially when nonprofit operations shift to for-profit models. Companies like Mexico’s Banco Compartamos, initially nonprofit, now serve public shareholders. Critics argue this shift prioritizes profit over poverty alleviation and could lead to higher interest rates and debtor spirals.
Other Criticisms of Microfinance
Various critiques target the limitations of individual microloans, suggesting that they may not suffice for genuine independence. Critics promote industrialization and larger-scale employment models, citing the economic progress seen in China and India. The interest on microloans is another debated point. Failed ventures and unforeseen circumstances can lead to deeper debt for some borrowers.
General Terms of a Microfinance Loan
Typically involving interest and regular repayments, microfinance loans sometimes require a percentage of income to be saved regularly, accumulating funds that serve as safety nets. Successful repayment translates to increased savings and enhanced creditworthiness for larger future loans.
The Bottom Line
Microfinance serves as a crucial financial underpinning for the low-income population lacking access to conventional services. However, as the sector evolves, it faces criticisms related to high-interest rates, profit-centric models, and insufficient individual loan amounts. Nevertheless, the overarching aim remains the empowerment and self-sufficiency of impoverished individuals through ethical lending and financial education.
Related Terms: Microcredit, Microfinance institutions, Grameen Bank, Small business loans.
References
- U.S. Chamber of Commerce. “Everything Your Small Business Needs To Know About Microlending”.
- FINCA. “Examples of Microfinance Services”.
- World Bank. “MIX Market Data - MFI Company Metadata”. (Download Excel spreadsheet, sort by home country of microfinance institutions.)
- StrategyR. “Microfinance World Market Report”.
- The Nobel Prize. “Grameen Bank - Facts”.
- Opportunity International. “Micro Banking”.
- Opportunity International. ‘“Spring 2022 Global Report”, Pages 3-4.
- University of Michigan. “The Grameen Bank”.
- Department of Economics - University of Toronto. “The Evolution of a Microcredit Institution: The Irish Loan Funds, 1720 - 1920”, Page 5.
- Glasgow Caledonian University. “Chancellor Emeritus”.
- Village Volunteers. “Grameen Bank’s Sixteen Decisions”.
- Kiva. “Microfinance 101: What It Is and How To Get Involved”.
- Consultative Group to Assist the Poor. “Small but Mighty: CGAP and the Future of Financial Inclusion”.
- International Finance Corp. “Microfinance”.
- Asian Development Bank. “Impact of Restrictions on Interest Rates in Microfinance”, Page 1.
- Stanford Graduate School of Business. “Social Entrepreneurship Banco Compartamos”.
- Consultative Group to Assist the Poor. “CGAP Reflections on the Compartamos Initial Public Offering”.
- Banco Compartamos. “Woman Credit”.
- Banco Compartamos. “Financial Information”.
- Bloomberg. “Big Money Backs Tiny Loans That Lead to Debt, Despair, and Even Suicide”.
- Citigroup. “Social Finance”.
- Barclays. “Banking for Billions”.
