Intro to Microfinance 101

by Staff Writers, Online Business Degree

By some estimates, more than half the world’s population does not have access to basic financial services. In many developing countries, the opportunity to take out and repay a loan does not exist, and this lack of access to credit perpetuates the cycle of poverty and stagnates a country’s economic growth. Microfinancing, a type of financial service designed for people with little in the way of capital or collateral, is offering a way for poor people to finance their business and lift themselves out of poverty.  But some critics believe microfinancing takes advantage of the very people it purports to assist. So what is microfinancing, and does it have the potential to better the world? Here’s a quick guide.

• What is microfinancing?

Microfinancing refers to a broad range of financial services for people who lack the capital or collateral to do business with a traditional bank. Such services include providing small loans (sometimes called microloans or microcredits) with low, affordable interest rates to individuals, small businesses, or a group of people who wish to be collectively responsible for a loan. Grameen Bank, the first large microfinance bank, was founded and continues to operate as a global nonprofit. However, there is debate in the microfinance community as to whether their services should be for-profit or not-for-profit.

• Who invented microfinancing?

The concept and first implementation of modern microfinancing is generally credited to Dr. Mohammad Yunus who, back in the 1970s, began lending to impoverished women in Jobra, Bangladesh, while teaching economics at Chittagong University. He went on to found the aforementioned Grameen Bank (“Grameen” means “village” in Bengali). Dr. Yunus believes credit is a human right, just like food and shelter, and that credit can provide such basic human needs more easily than any government or charity.

• Why is credit so important?

Arguably the most beneficial service microfinance institutions provide to customers with little in the way of capital, collateral, or financial history is credit. Dr. Yunus believes that credit in the form of taking out and repaying small loans creates self-employment, generates income, and allows the borrower to take care of their basic needs, including food, water, shelter, and health care. If members of a poor community are making money and building good credit, their local and national economy will grow and improve as a result.

• Does microfinancing actually work?

The Consultative Group to Assist the Poor reports that microfinancing helps poor people stabilize their households and businesses by eliminating the need to sell assets just to stay afloat. Sudden expenses are easier to cope with, and enterprises can grow into thriving businesses. Across the globe, women make up the majority of microfinance customers. As a result, gender equity is becoming more accepted as women are empowered by their financial knowledge and well-being.

• When is microfinancing not appropriate?

It may be difficult or impossible to implement microfinance services for nomadic or geographically dispersed populations. Communities that are used to bartering as opposed to paying cash for goods and services, or rely on one activity or crop for their livelihood, may not be suitable for services offered by microfinance institutions. Government corruption and civil unrest can hinder and block entrepreneurship and prevent microfinance from operating to the benefit of the populace.

• What are some criticisms of microfinancing?

For a relatively new and still evolving institution, microfinance has received a fair amount of criticism. Some microfinance institutions operate as for-profit businesses, which some say put the need for a profit over the needs of their customers. Predatory behavior on the part of some such institutions, and the widely reported incidents of suicide by several borrowers who were unable to pay back microloans, have led to calls for more regulation of microfinancing. The Smart Campaign is a global initiative that seeks to bring a set of ethical standards to the microfinance industry.

• Can I become a lender?

You can make a microloan to an entrepreneur by visiting kiva.org, a nonprofit organization that facilities the funding of loans provided by a network of lending partners. The site provides a detailed profile of each person seeking a loan, as well as information about each lending partner, many of whom provide financial literacy training to borrowers in addition to simply lending them money. Check out Kiva’s video, which briefly describes microfinancing; you may decide that a loan of 10 or 20 bucks can go a long way in helping entrepreneurs across the world.

Related Articles

Women SHGs and Micro-Finance:  Robust Financial Lifeline Between Rich and Poor by Sanjeev Kulkarni

News articles about Grameen Bank microfinance