Microfinance encompasses the provision of financial services and the management of small amounts of money through a range of products and a system of intermediary functions that are targeted at low income clients. Access to financial services, especially capital, has proved vital to empowering communities. Many development experts agree that microfinance, when properly harnessed and supported, can economically empower individuals and small enterprises and enable them to contribute to and benefit from economic development. Having access to financial services helps people improve their lives and work their way out of poverty.
Microfinance encompasses the provision of financial services and the management of small amounts of money through a range of products and a system of intermediary functions that are targeted at low income clients.
The most common product that microfinance institutions (MFI’s) offer are loans. Except from being small in size, microloans generally have short loan terms and do not require conventional collateral. Often, loans are given out to groups of for example farmers and the members are together responsible for repayment. Most micro finance institutions also offer savings accounts and many have also expanded into the insurance industry.
Microfinance services are in general targeted to small scale businesses in rural or poor urban areas. Standard banks do usually not serve these areas since both operational costs and default risks are high and expected profitability is low. Although local moneylenders have been willing to fill the gap, rates charged in the informal sector are extremely high, sometimes monopolistically so, and the service unreliable. Consequently, poor urban and rural communities have typically been left either without credit at all, or with credit available only at exorbitant interest rates. With the increasing outreach of microfinance, this is now changing.
Poor urban and rural communities have typically been left either without credit at all, or with credit available only at exorbitant interest rates. With the increasing outreach of microfinance, this is now changing.
The first officially known microloan was disbursed in 1976 when a gentleman named Muhammad Yunus returned to his home country Bangladesh after having spent some time in US becoming and working as a professor in economics. Yunus discovered that what he had learned about economics did not reflect the reality in rural Bangladesh. He realized how lack of capital was a major issue and many small scale businesses had to rely on informal money lenders whose high interest rates left them more or less without profit. Yunus decided to help a group of women that produced bamboo stools and lent them $ 27 of his own money. This experience encouraged him to continue lending money in this manner and he eventually founded the first micro finance institution; Grameen bank, in 1983. Since then, micro finance as a tool for reducing poverty has increased tremendously. Especially after Muhammad Yunus got awarded with the Nobel peace prize in 2006 for his work with reducing poverty in Bangladesh, it has become a well-known concept. Today, it is estimated that there are around 130 million users of the MFIs services. The demand for this kind of service is however far from being met and it is reckoned that only about 20 percent of the potential market is served today.
Microfinance appears to have defied the conventional wisdom about credit markets for the poor in developing countries. Although most MFIs are financed, at least initially, through grants or low-interest loans from aid organizations or donor governments, very many have achieved operational and financial self-sufficiency. In the recent year, more and more profit driven companies have also entered the industry.
Learn more about the history and development of the microfinance industry in this article:
Sengupta, R., & Aubuchon, C. P. (2008). The microfinance revolution: An overview. Federal Reserve Bank of St. Louis Review. https://research.stlouisfed.org/publications/review/08/01/Sengupta.pdf
According to International Finance Corporation, http://www.ifc.org/wps/wcm/connect/Industry_EXT_Content/IFC_External_Corporate_Site/Industries/Financial+Markets/MSME+Finance/Microfinance/ acc. 2016-01-12