What is microfinance?
Microfinance refers to financial services for poor and low-income clients. Although most attention has been on the provision of small loans, microfinance in fact also includes the provision of other basic financial services such as savings, money transfer and insurance for poor people. Improving access to such services allows poor and low-income people to finance income-generating activities, build assets, stabilise consumption and protect against risks. Microfinance can play an important role in improving the lives of poor people.
Who is microfinance aimed at?
Microfinance is usually aimed at economically active poor and low-income people who have limited or no access to the services provided by formal financial intermediaries such as banks. Since there are so few salaried work opportunities, they are usually self-employed microentrepreneurs often working from home. Typically, they operate small businesses such as grocery shops, market stalls, car repair, carpentry or other workshops, and in rural areas they tend to focus on food processing, agriculture and raising livestock and poultry. Around two-thirds of microfinance clients worldwide are women.
Why has microfinance become so popular?
There are many reasons for the popularity of microfinance but primarily because it is seen as a long-term and more sustainable approach to helping poor people. When poor people have access to a range of financial services – loans, savings, insurance and money transfer facilities – often accompanied by training in financial literacy and business management, they can improve their lives. Microfinance is not charity and builds on the principal that teaching someone to fish is infinitely better than simply giving them fish. It focuses directly on helping poor people to work and become more self-sufficient. Microfinance became very popular very quickly because it was believed that it could create a virtuous cycle of investment and increased income and thereby break the cycle of poverty in which many poor people are trapped. Much of the focus was on microcredit, and it was believed that with access to successive loans over a longer period of time and through the cycle of further investment and increased income, poor people could through their own efforts gradually climb out of poverty. However, the reality is much more complicated and the relationship between access to microfinance and poverty is not so straightforward, particulalry since microfinance is provided by a range of organisations with differing motives, objectives and methodologies in vastly different environments to people with different skills sets and capacities.
What kinds of institutions provide microfinance services?
Most microfinance initiatives were started by non-governmental organisations (NGOs), like CARE. These often developed into formal microfinance institutions or MFIs whose activities are regulated by the relevant national banking or microfinance authorities. MFIs are now generally organised as for-profit entities, be they non-bank financial institutions, specialist commercial microfinance banks, or microfinance departments of larger commercial banks. In addition to insurance and money transfer facilities in recent years some MFIs have also begun providing social services, such as basic healthcare and education for their clients and their families.
When is microfinance NOT an appropriate tool?
Microfinance can help poor people; however it may not always be appropriate. For example, when small loans are to be used for business purposes, microcredit is most useful for those entrepreneurs who have already identified a productive and profitable economic opportunity, possess the necessary entrepreneurial skills, can capitalise on it if they have access to credit and are capable of making the regular repayments in order to have continued access. The very poorest people may be unable to repay even a small loan and providing them with a grant to help them build assets or start an enterprise may be more appropriate. In fact, they are generally more in need of help in meeting their basic needs such as food and shelter. Providing credit to those who cannot use it productively could push already vulnerable poor people into debt and in fact worsen their situation.
What is the difference between microfinance and microcredit?
Although often used interchangeably, microfinance and microcredit are in fact quite distinct. Microfinance is a much broader concept than microcredit and refers to loans, savings, insurance, money transfers, and other financial products targeted at poor and low-income people. Microcredit refers more specifically to making small loans available to poor people, especially those traditionally excluded from financial services, through programmes designed specifically to meet their particular needs and circumstances. Typically, the characteristic features of microcredit are that:
- Loans are usually relatively short term, less than twelve months in most instances and often even six months or less, and generally for working capital with immediate regular weekly or monthly repayments – they are also disbursed quickly after approval. Loans are usually quite small to begin with; typically they are in the range of $100-500. As borrowers regularly repay their loans and demonstrate their creditworthiness, they become eligible for larger loans.
- The traditional lender’s requirements for physical collateral such as property are usually replaced by a system of collective guarantee (or solidarity) groups whose members are mutually responsible for ensuring that their individual loans are repaid. Alternatively, borrowers may be requested to find one or two personal guarantors – often these are respected local community leaders.
Loan application and disbursement procedures are designed to be helpful to low income borrowers – they are simple to understand, locally provided and quickly accessible with minimal paperwork.