FAQs on Microfinance
- What is microfinance?
- What is a microfinance institution?
- Why don’t poor people just use traditional banks?
- Why are microcredit interest rates so high?
- What are some of the ways that people use their microfinance loans?
- Are poor people able to repay their loans?
- Aren’t the poor too poor to save?
- Does microfinance really help solve poverty?
Microfinance is the supply of loans, savings and other financial services to the poor. The term “micro” is in reference to the small amounts typically involved in the practice. These services are small – “micro” – because a person who does not have a lot of money most likely will not need a loan of several thousand dollars. However, a loan of a few hundred dollars may make a huge difference in their lives, giving them the ability to purchase livestock for a small farm, a sewing machine to help make accessories and clothes, or supplies for a small store, for example.
The poor throughout the developing world frequently are not part of the formal employment sector. They may operate small businesses, work on small farms or work for themselves or others in a variety of businesses. Many start their own “micro” businesses, or small businesses, out of necessity, because of the lack of jobs available.
A microfinance institution (MFI) is an organization that provides microfinance services – loans, savings, maybe even insurance – to the world’s poor. An MFI can operate as a nonprofit such as a non government organization (NGO), credit cooperative, non bank financial institution (NBFI), or even a formal, regulated for profit bank.
MFIs differ in size and reach; some serve a few thousand clients in their immediate geographical area, while others serve hundreds of thousands, even millions, in a large geographical region, through numerous branches. Many MFIs offer services beyond loans and savings, including education on business and financial issues and social services focused on health and children.
Poor people in developing countries usually do not qualify for any type of services from the formal banking sector: they typically have no credit history, and most are not employed in the formal sector, so there is no record of employment. Moreover, they are unable to provide collateral. And in many parts of the world, opening a savings account at a traditional bank requires a certain amount of money be deposited, and poor people, although statistically excellent savers, do not have the large sum of money required to open a savings account.
Yet, people living in poverty, like everyone else, need access to a diverse range of financial services to help run a small business, manage risks, and plan for a more stable future.
Like other financial institutions, MFIs charge an interest rate for the loans they give their clients. This is a way for the MFI to be self-sustaining so that it can be a stable, long term provider of finances in its area of operations. A self-sustaining MFI is critical to the health of the sector and for it to continue to provide microfinance services to its clients. However, because managing many small loans costs more money for any institution than managing one large loan, an MFI typically needs to charge higher interest rates to cover their costs.
The ways in which people use their loans vary as much as the ways people earn a living. Some buy livestock; a sewing machine and fabric to make cloths and accessories; stock for a local store; a tractor or seed and other farming equipment and supplies. The possibilities are endless as to what a micro-entrepreneur can do with his or her loan.
Microfinance clients have excellent track records for repayment. Repayment rates for microfinance loans on a global level average about 97 percent.
The poor already save in ways that we may not consider as “normal” savings - investing in assets, for example, that can be easily exchanged for cash in the future (domestic animals for instance). After all, they face the same series of sudden demands that we all face: illness, housing repairs, school fees, burial fees.
Poverty is a very complicated issue, and many different approaches and tools are required to address it. Microfinance is one tool that is appropriate for millions of the working poor to lift themselves out of poverty. However, microfinance is not the only answer, and in fact is not always appropriate. For instance for the extreme poor, or those who are sick and/or unable to work, microfinance may not be an appropriate tool.
View the Glossary of Terms