Microfinance is the provision of financial services to individuals and small businesses, particularly those with low incomes and limited access to conventional banking and related financial services. It encompasses services such as microcredit, savings, checking accounts, microinsurance, and payment systems.
Modern microfinance developed in the 1970s, particularly through the work of Muhammad Yunus and the Grameen Bank in Bangladesh, although its historical roots extend to earlier cooperative lending and savings initiatives in Europe. Originally associated with small loans to entrepreneurs lacking access to credit, microfinance later expanded to encompass a broader range of financial services and evolved into a wider approach to financial inclusion aimed at expanding access to financial services for underserved populations.
Microfinance has been promoted as a means of reducing poverty, supporting economic development, fostering entrepreneurship, and improving households' ability to manage financial risks. Its effectiveness and social impact remain subjects of debate, particularly regarding poverty reduction, borrower over-indebtedness, interest rates, financial sustainability, and its impact on women and low-income communities.
Some recent developments have been the expansion of digital financial services and greater emphasis on understanding the wider ecosystem in which microfinance institutions operate to improve the sustainability and effectiveness of financial inclusion initiatives.
History Over the past centuries, practical visionaries, from the Franciscan friars who founded the community-oriented pawnshops of the 15th century to the founders of the European credit union movement in the 19th century (such as Friedrich Wilhelm Raiffeisen) and the founders of the microcredit movement in the 1970s (such as Muhammad Yunus and Al Whittaker), have tested practices and built institutions designed to bring the kinds of opportunities and risk-management tools that financial services can provide to the doorsteps of poor people.
The origins of microfinancing can be traced back as far as the 1720s in Ireland with the establishment of the Irish Loan Funds under the writer, philosopher, and satirist Jonathan Swift (1667–1745). Swift, who wrote much on the poverty of Ireland which was then a British colony, may be credited with starting the loan fund system when he created a small fund with £500 of capital for use by poor but creditworthy people who had projects that promised high return on investment but who lacked collateral. The small loans were made to "poor industrious tradesmen" for reproductive purposes: the seed money would multiply.
The practice later appeared elsewhere in Europe from the middle of the 1800s, when the theorist Lysander Spooner was writing about the benefits of small credits to entrepreneurs and farmers as a way of getting the people out of poverty. Independently of Spooner, Friedrich Wilhelm Raiffeisen founded the first cooperative lending banks to support farmers in rural Germany.
The modern use of the expression "microfinancing" has roots in the 1970s when Grameen Bank of Bangladesh, founded by microfinance pioneer Muhammad Yunus, was starting and shaping the modern industry of microfinancing. The approach of microfinance was institutionalized by Yunus in 1976, with the foundation of Grameen Bank in Bangladesh. Another pioneer in this sector is Pakistani social scientist Akhtar Hameed Khan.
Since people in the developing world still largely depend on subsistence farming or basic food trade for their livelihood, significant resources have gone into supporting smallholder agriculture in developing countries.
Poverty
In developing economies, and particularly in rural areas, many activities that would be classified in the developed world as financial are not monetized: that is, money is not used to carry them out. This is often the case when people need the services money can provide but do not have dispensable funds required for those services. This forces them to revert to other means of acquiring the funds. In their book, The Poor and Their Money, Stuart Rutherford and Sukhwinder Arora cite several types of needs: Lifecycle Needs: such as weddings, funerals, childbirth, education, home building, holidays, festivals, widowhood and old age Personal Emergencies: such as sickness, injury, unemployment, theft, harassment or death Disasters: such as wildfires, floods, cyclones and man-made events like war or bulldozing of dwellings Investment Opportunities: expanding a business, buying land or equipment, improving housing, securing a job, etc. People find creative and often collaborative ways to meet these needs, primarily through creating and exchanging different forms of non-cash value. Common substitutes for cash vary from country to country, but typically include livestock, grains, jewelry and precious metals. As Marguerite S. Robinson describes in his book, The Micro Finance Revolution: Sustainable Finance for the Poor, the 1980s demonstrated that "micro finance could provide large-scale outreach profitably", and in the 1990s, "micro finance began to develop as an industry". In the 2000s, the microfinance industry's objective was to satisfy the unmet demand on a much larger scale, and to play a role in reducing poverty. While much progress has been made in developing a viable, commercial microfinance sector in the last few decades, several issues remain that need to be addressed before the industry will be able to satisfy massive worldwide demand. The obstacles or challenges in building a sound commercial microfinance industry include: Inappropriate donor subsidies Poor regulation and supervision of deposit-taking microfinance institutions (MFIs) Few MFIs that meet the needs for savings, remittances or insurance Limited management capacity in MFIs Institutional inefficiencies Need for more dissemination and adoption of rural, agricultural microfinance methodologies Members' lack of collateral to secure a loan
Microfinance is the proper tool to reduce income inequality, allowing citizens from lower socio-economical classes to participate in the economy. Moreover, its involvement has shown to lead to a downward trend in income inequality.
Ways in which poor people manage their money
Rutherford argues that the basic problem that poor people face as money managers is to gather a "usefully large" amount of money. Building a new home may involve saving and protecting diverse building materials for years until enough are available to proceed with construction. Children's schooling may be funded by buying chickens and raising them for sale as needed for expenses, uniforms, bribes, etc. Because all the value is accumulated before it is needed, this money management strategy is referred to as "saving up".
Often, people do not have enough money when they face a need, so they borrow. A poor family might borrow from relatives to buy land, from a moneylender to buy rice, or from a microfinance institution to buy a sewing machine. Since these loans must be repaid by saving after the cost is incurred, Rutherford calls this 'saving down'. Rutherford's point is that microcredit is addressing only half the problem, and arguably the less important half: poor people borrow to help them save and accumulate assets. However, microfinance is not the magical solution to take people out of poverty; it is merely a tool that the poor can use to raise their prospects for an escape from poverty.
Most needs are met through a mix of saving and credit. A benchmark impact assessment of Grameen Bank and two other large microfinance institutions in Bangladesh found that for every $1 they were lending to clients to finance rural non-farm micro-enterprise, about $2.50 came from other sources, mostly their clients' savings. This parallels the experience in the West, in which family businesses are funded mostly from savings, especially during start-up.
Recent studies have also shown that informal methods of saving are unsafe. For example, a study by Wright and Mutesasira in Uganda concluded that "those with no option but to save in the informal sector are almost bound to lose some money—probably around one quarter of what they save there".
The work of Rutherford, Wright and others has caused practitioners to reconsider a key aspect of the microcredit paradigm: that poor people get out of poverty by borrowing, building microenterprises and increasing their income. The new paradigm places more attention on the efforts of poor people to reduce their many vulnerabilities by keeping more of what they earn and building up their assets.
Examples The microfinance project of "saving up" is exemplified in the slums of the south-eastern city of Vijayawada, India. This microfinance project functions as an unofficial banking system where Jyothi, a "deposit collector", collects money from slum dwellers, mostly women, in order for them to accumulate savings. Jyothi does her rounds throughout the city, collecting Rs5 a day from people in the slums for 220 days, however not always 220 days in a row since these women do not always have the funds available to put them into savings. They ultimately end up with Rs1000 at the end of the process. However, there are some issues with this microfinance saving program. One of the issues is that while saving, clients are actually losing part of their savings. Jyothi takes interest from each client—about 20 out of every 220 payments, or Rs100 out of 1,100 or 9%. When these slum dwellers find someone they trust, they are willing to pay up to 30% to someone to safely collect and keep their savings. There is also the risk of entrusting their savings to unlicensed, informal, peripatetic collectors. However, the slum dwellers are willing to accept this risk because they are unable to save at home, and unable to use the banks in the country because of illiteracy. This microfinance project also has many benefits, such as empowering women and giving parents the ability to save money for their children's education. This specific microfinance project is an example of the benefits and limitations of the "saving up" project.
The microfinance project of "saving through" is shown in Nairobi, Kenya which includes a Rotating Savings and Credit Associations or ROSCAs initiative. This is a small scale example, however Rutherford (2009) describes a woman he met in Nairobi and studied her ROSCA. Every day 15 women would save 100 shillings so there would be a lump sum of 1,500 shillings and every day 1 of the 15 women would receive that lump sum. This would continue for 15 days and another woman within this group would receive the lump sum. At the end of the 15 days a new cycle would start. This ROSCA initiative is different from the "saving up" example above because there are no interest rates affiliated with the ROSCA, additionally everyone receives back what they put forth. This initiative requires trust and social capital networks in order to work, so often these ROSCAs include people who know each other and have reciprocity. The ROSCA allows for marginalized groups to receive a lump sum at one time in order to pay or save for specific needs they have.
Debates and challenges
There are several key debates at the boundaries of microfinance.
Loan pricing