Microfinance: What It Is and Why It Matters

Unemployed or low-income individuals don’t have to remain in the same financial state forever; they deserve a chance to thrive. Sometimes, all that’s needed is a little help to get started. However, these individuals likely don’t qualify for a standard bank loan.

Microfinancing is an option for impoverished dreamers looking to start a business and get ahead. Here’s everything you need to know about the lending service.

What is microfinance?

Microfinance, also known as microcredit, is a financial service that offers loans, savings and insurance to entrepreneurs and small business owners who don’t have access to traditional sources of capital, like banks or investors. The goal of microfinancing is to provide individuals with money to invest in themselves or their business.

Microloans are typically lower than the average business loan (ValuePenguin reported this figure to be $713,000 in the fourth quarter of 2016). According to the SBA, the average microloan is about $13,000, but some reach up to $50,000.

History of microfinance

While the concept has been used globally for centuries, Bangladesh’s Muhammad Yunus is the pioneer of the modern version of microfinance, according to Kiva, a crowdfunding-based microlending organization inspired by Yunus’ work. While working at Chittagong University in the 1970s, Yunus began offering small loans to destitute basket weavers. Yunus carried on this mission for nearly a decade before forming the Grameen Bank in 1983 to reach a much wider audience.

Joseph Blatchford, former head of the Peace Corps and a UC Berkeley law student, is also credited with building up the modern-day microfinancing efforts. Blatchford founded nonprofit Accion as a volunteer project in 1961, and in 1973, the organization began offering small loans to entrepreneurs in Brazil to see if a one-time influx of money could help lift them out of poverty. The operation was a success: 885 loans helped create or stabilize 1,386 new jobs. Accion expanded the model to 14 other Latin American countries over the next decade.

Microfinancing institutions

Microfinance is available through microfinance institutions, which range from small nonprofit organizations to larger banks. These institutions include for-profit companies, like General Electric Consumer Finance and Citi Microfinance, as well as nonprofit organizations, such as Kiva, Accion and BRAC.

They offer small loans and help set up and maintain a savings account. They also assist borrowers in obtaining insurance for a variety of needs, such as death, illness or loss of property.

The downsides of microfinance

According to the most recent data from the World Bank, “the microfinance industry is estimated at $60 to 100 billion, with 200 million clients.” However, there is much criticism on the concept.

Microloans are smaller than traditional bank loans, but they have much higher interest rates. Many believe the loans are not enough to start a successful business and only provide basic needs, like food and shelter, which eventually lead to more debt.

However, there are many ways to ensure timely repayment on the loans. According to Investopedia, many microlenders allow borrowers to work together to repay their loans, helping each other when needed. This holds borrowers more accountable for their repayments, which in turn leads to better credit and sets them off on the right foot.