Microfinance 101

What is Microfinance?

You may have heard about microfinance, but do you really know what it means or how it can potentially benefit you? Microfinance is not a new concept, but it is a relatively novel idea for many people living in the United States. In a nutshell, microfinance is a type of banking service provided to unemployed or low-income individuals or groups who would otherwise have no other means of gaining financial services. The ultimate goal of microfinance is to to provide low income people with an opportunity to become self-sufficient. Self-sufficiency is achieved by providing a means of saving money, borrowing money, and insurance. Microfinance gives those who are often overlooked by the traditional banking system a way to get the money they need to get their business off the ground or to keep their life moving forward in a positive direction.

As mentioned before, many people in the U.S. may be unfamiliar with microfinance, because most present-day microfinance institutions operate in developing countries. You may assume the rate of payment default for loans would be high if most of the borrowers come from developing countries, but the default rate is surprisingly low — more than 90% of loans are repaid on time. For those who need to borrow money and do not have access to other viable options, microfinance loans are one of the best ways to get money in an efficient and secure manner.

Microfinance Institution Basics

Microfinance instituions operate much like conventional banking operations. Meaning, they must charge their lenders interest on loans. Interests rates are generally lower than those offered by more mainstream banks. Opponents of the microfinance concept argue these institutions are making money off of the poor. However, according to information found on the website Investopedia, the World Bank estimates there are more than 500 million people who have directly or indirectly benefited from microfinance-related operations.

Microfinance is based on the notion that low-income individuals are capable of lifting themselves out of poverty if given access to high-quality financial services. However, microfinance should not be seen as the only tool for combating or even ending poverty. It is important to note there are many factors contributing to one’s socioeconomic status. Microfinance can play a role in the battle against poverty, but it may not always be the most appropriate method. That being said, microfinance certainly represents a step in the right direction.

Micro vs. Macro Finance

You may be wondering why the term microfinance is used to describe the supply of loans, savings, and other basic financial services to the poor. Micro means small and these financial services usually involve a small sum of money. Microfinance is a term used to differentiate these services from those which formal banks provide. If you are interested in a small loan or small savings, then you are interested in microfinance. Think about it — someone who doesn’t have a lot of money is most likely not going to want to take out a $60,000 loan or have the means to do so. Likewise, someone living at or below the poverty level will not be able to open a savings account with an opening balance of $2,000 or even $1,000.

You may think poor people do not need access to financial services, but they frequently rely on these types of services — just in a different way. Low-income people are saving money all the time, but in informal ways. For instance, they may set aside corn from their harvest to sell at a later date or stash money under their mattress. They may also invest in assets such as gold or jewelry. Microfinance services provides these individuals with a way to do what they’re already doing in a more formal, structured manner. By giving the low-income segment of a developing or previously developed population a way to take advantage of all types of financial services, the potential benefits for borrowers and the country as a whole are truly limitless.