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Microfinance is a growing sector. According to the 2023 Microfinance Social Performance Report by BNP Paribas, 156.1 million borrowers worldwide benefited from these services in 2022. Learn how microfinance helps people access financial services and potentially climb out of poverty and how you can get involved as an individual, investor, or finance professional.
Key Takeaways
- Microfinance is a range of banking products and services (microloans, microsavings accounts, micro-insurance) provided to low-income individuals or groups who don’t otherwise have access to financial services.
- Like regular lenders, microfinance lenders set specific repayment plans and charge interest on their loans.
- Microfinance lenders comply with ethical lending practices, allowing borrowers to take on small business loans in a safe manner.
- Microfinance practices try to demonstrate that low-income people can pull themselves out of poverty.
- Investors and finance professionals can benefit from the rapid growth of the microfinance market.
What Is Microfinance?
The term microfinance describes the range of financial products (such as microloans, microsavings, and micro-insurance products) that microfinance institutions (MFIs) offer to their clients.
Microfinance began in the 1970s when social entrepreneurs began lending money on a large scale to people with low incomes and no access to credit. One individual who gained worldwide recognition for his work in microfinance is Professor Muhammad Yunus who, with Grameen Bank, won the 2006 Nobel Peace Prize.
Yunas demonstrated that people with low incomes have the ability to pull themselves out of poverty. He also demonstrated that loans made to this demographic, if properly structured, had very high repayment rates. His work caught the attention of both social engineers and profit-seeking investors.
The global microfinance market is expected to triple in value by 2033.
Microfinance Products and Services
The following products and services are currently being offered by microfinance institutions :
Microloans
Microloans (also known as microcredit) are loans that have a small value. These loans are generally issued to finance entrepreneurs who run micro-enterprises in developing countries. Examples of micro-enterprises include basket-making, sewing, street vending, and raising poultry.
Interest rates are typically high, due in part to higher default risks and the higher costs associated with processing the labor-intensive micro-loan transactions, and can vary considerably, depending on the borrower and country as well as the size and length of the loan. Interest rates, worldwide, are said to average about 36.6%.
In some cases, interest rates have been reported to even be as high as 100%, although many countries have caps in place to prevent such extortionate borrowing costs. Microloans funded by the U.S. Small Business Administration are available in amounts up to $50,000, with repayment terms up to seven years and interest rates that range from 8% to 13%.
Microsavings
Microsavings accounts allow individuals to store small amounts of money for future use without minimum balance requirements. Like traditional savings accounts in developed nations, micro-savings accounts are tapped by the saver for life needs such as weddings, funerals and old-age supplementary income.
Micro-Insurance
Individuals living in developing nations face more risks and uncertainties in their lives. For example, there is more direct exposure to natural disasters, such as mudslides, and more health-related risks, such as communicable diseases.
Micro-insurance, like its non-micro counterpart, pools risks and helps provide risk management. But unlike its traditional counterpart, micro-insurance allows for insurance policies that have very small premiums and policy amounts. Examples of micro-insurance policies include crop insurance and policies that cover outstanding balances of micro-loans in the event a borrower dies.
Due to the high administrative expense ratios, micro-insurance is most efficient for MFIs when premiums are collected together with microloan repayments.
Microfinance has been credited with helping to eradicate poverty and making it worse through expensive borrowing costs and generally unfavorable terms.
Investing in Microfinance
It’s possible to get involved in microfinancing and potentially make money from it.
Ways include:
- Investing directly in a MFI
- Investing in a fund that invests in microenterprises and MFIs
- Microfinance bonds
- Peer-to-peer lending services
Microfinance has been pitched as a way to make decent money while doing good. Default rates are said to be lower than maybe expected and as borrowing costs can be high this can result in attractive returns.
However, it’s important to remember that microfinance investments have different risk profiles. Some may be less volatile and offer low prospective returns and vice versa.
It’s also possible to lend micro-entrepreneurs money without demanding a return through non-profit online services such as Kiva.
Institutions generally make high returns on their microfinance investments.
Microfinance Career Opportunities
Microfinance requires highly specialized financial knowledge as well as a unique combination of skills, such as knowledge of social science, local languages, and customs. Finance professionals with these skills shouldn’t have trouble finding work.
Moreover, traditional career roles are blurring as microfinance brings together professionals with varied backgrounds to work in collaborative teams. For example, development professionals (such as people who have worked for the Asian Development Bank or other development agencies) can now be found working side by side with venture capitalists.
A wide range of microfinance career opportunities can be found online, including at FinDev Gateway.
In What Countries Is Microfinance Most Popular?
The majority of microfinance services take place in developing countries like Bangladesh, Cambodia, India, Afghanistan, the Democratic Republic of Congo, Indonesia, and Ecuador.
What Is the Main Criticism of Microfinance?
The greatest criticism of microfinance is the idea that the financial world is making money instead of providing a service and essentially offering unfavorable financial terms to people in financial difficulty. In other words, microfinance lenders can become a profitable business at the cost of borrowers. Contributing factors that shed a negative light on microfinance are the alleged lack of policies to protect borrowers’ rights, the high interest rates on microfinance loans, and the high pressure to repay loans.
Who Provides Microfinance Services?
Microfinance products and services are provided by a variety of institutions such as non-profit organizations, some traditional banks, credit and savings cooperatives, and other non-bank financial institutions.
The Bottom Line
Capital and expertise are increasingly flowing into microfinance, a type of banking service provided to low-income individuals or groups who otherwise wouldn’t have access to financial services. Microfinance is potentially helping to eradicate poverty and provide equal opportunities. It’s also emerging as a new type of asset class for investors.