Microfinancing, also referred to as microcredit, is a financial arrangement in which primarily low-income individuals (or sometimes groups) are given “microloans” or loans that typically range from between the equivalent of US$50 to a few thousand dollars. In rare instances, microinsurance products are included under the macro term microfinance. Microfinancing is particularly prevalent in developing nations where few people have the ability to borrow from conventional lenders such as commercial banks.
Despite the relatively small amounts being borrowed on an individual basis, collectively, the global microfinance market was valued at $187 billion in 2022, with predictions that this will more than double in value by 2030. Furthermore, due to high repayment rates and an ever-expanding customer base, microfinance lending is a profitable business model.
The theory behind using microfinance programs to reduce poverty and stimulate economic development is that many households in poorer countries assess their wealth primarily in terms of tangible assets such as a house or land, making it difficult to accumulate sufficient capital to effect significant changes such as investing in better transport to take their goods to market or to enroll their children in school as well as to stabilize incomes for subsistence farmers whose income varies significantly depending on the season and crop yields.
The positive effects of microfinance programs on poverty alleviation include
- Access to flexible and tailored financial instruments. Microfinance institutions can offer tailored approaches to the needs of various groups such as the specific requirements of farmers cultivating various crops.
- Micro-loans for business or entrepreneurship initiatives, i.e., other than consumption needs, facilitate a chain of beneficial economic effects such as job creation, and trade facilitation.
- Increased financial literacy of marginalized groups. Future borrowers are often required to complete a basic money-management course prior to being offered a loan.
- Positive credit records for low-income groups which contribute to a better overall financial situation in a given economy.
- Women empowerment. As women are often marginalized in developing and poor nations, microfinancing programs offer an opportunity so that they can improve their potential and become independent.
Unfortunately, while providing access to credit for people who are otherwise unable to borrow money from the formal financial sector has its benefits, it is also accompanied with some drawbacks.
The drawbacks and disadvantages of micro-financing initiatives
- For-profit controversy. Many micro-financing institutions argue that by operating as for-profit business entities, they can expand their capital by attracting investors and thus be able to provide more funds to borrowers. However, this often results in higher interest rates which result in higher impoverishment rates.
- Higher interest rates. Compared to traditional financial institutions, microfinance organizations ask for higher interest in exchange for their readiness to provide loans without collateral or other guarantees.
- Limited loans that do not allow borrowers to become self-sufficient.
An overview of microfinance programs
Unlike traditional forms of Official Development Assistance (ODA) where large-scale financing is provided to sovereign governments and/or consortia of well-established organizations, microfinancing programs are largely provided by private sector lenders.
Perhaps the oldest and most successful microfinance program is that offered by the Grameen Bank which began as a pilot project in 1976 in Bangladesh and has since expanded to nearly 11 million customers borrowing more than US$37 billion across 81,000 villages in the country. The winner of the Nobel Peace Prize in 2006, Grameen was lauded for being the “Banker to the Poorest of the Poor” and heralded as the inspiration for microfinance programs all over the world.
According to the Grameen Bank corporate website, the average recovery rate of the institution is close to 97%, with over 97% of borrowers being women.
According to a World Bank study, Grameen Bank had a positive effect on rural wages and a net positive effect on local economic growth, leading to sustainable poverty reduction. Other studies have shown that per capita daily caloric intake also increased for Grameen Bank borrowers.
Attempts to replicate the long-term sustainable success and social inclusion of Grameen Bank’s program in other countries have not always led to similar positive results. Due to poor regulations, a lack of transparency, and coercive recovery practices, many borrowers in Asian countries such as Cambodia, Sri Lanka, and India have been at the center of dramatic news reports after not being able to repay their debts.
Microfinance programs across the developing world
1️⃣ Grameen Bank (Bangladesh), one of the most well-known and successful microfinance programs in the world.
2️⃣ BancoSol (Bolivia) is a microfinance institution, founded in Bolivia in 1992. The company developed to become one of the largest microfinance institutions in Latin America with more than 180 branches across the country, and more than 320,000 customers.
3️⃣ Bharat Financial Inclusion (formerly SKS Microfinance, India), was founded in 1997 by Vikram Akula. Originally a non-profit organization, it provided microloans and other financial services to poor women in India. Today, the company has evolved to become a non-banking financial, for-profit institution.
4️⃣ FINCA International (Global) is a non-profit microfinance institution founded by John Hatch in 1984. Considered to be an innovator and the author of the village banking methodology in microcredit, he is often regarded as one of the pioneers of modern-day microfinance.
5️⃣ Kiva (Global) is an international nonprofit organization founded in 2005 in San Francisco. The institution’s mission is “to expand financial access to help underserved communities thrive”. So far, Kiva has facilitated over US$1.5 billion in loans and has a repayment rate of over 96%.
Micro-financing programs are a powerful tool with which to alleviate poverty and facilitate economic development if used in conjunction with an adequate financial regulatory framework, systematic financial literacy programs for the poor, and strict supervision by governments. Over time, millions of impoverished people across the globe have managed to improve their financial situations after being granted micro-loans by microfinancing programs. Nevertheless, the micro-financing model is often criticized for its lack of transparent regulations and high interest rates.
