What is Microfinance?
Microfinance is financial services for the poor and the unbanked, primarily in developing countries. Originally consisting of just loans (microcredit), the industry has expanded over the years to include savings and insurance products. Begun in the 1970s by Bangladeshi economist Muhammad Yunus, the idea is to give poor people very small loans (Dr. Yunus started the movement with a $27 loan to a group of female basket weavers) to help them start a small business. With the profits from the business, they can put more food on the table, put more clothes on their children's backs, give their family better healthcare and send their kids to school. Giving a poor person in a developing country even $25 can go a long way to helping them start a business and help to pull the family out of poverty.
How Does Microfinance Work?
How can banks give money to poor people who have no collateral? The truth is, they do have collateral, it's just that it is not material or financial collateral. Instead, they have trust collateral. Most microloans are given to a group of borrowers who form what is called a trust group. Everyone in the group gets a share of the group loan, which may or may not be equal. They then monitor each other to make sure they each pay back their loans on time. If they don't pay back on time, the entire group may be prohibited from getting any more loans. Therefore, it is imperative that each borrower pay their loan back on time, because everyone in the group is impacted if they don't. If a borrower can't make her payment on time, the group will generally cover for her once or twice. But if it becomes a frequent issue, that borrower may be removed from the group for subsequent rounds of loans. In many developing countries, a good reputation in the village or town or city is important. If your reputation is damaged, you could be ostracized and shunned by society. Therefore, borrowers take their loan payment responsibilities very seriously. With this model in place, the payback rate has been extremely high, upwards of 95% or better, which is much better than payback rates seen in many developed countries.
Who Are the Borrowers?
Most microfinance institutions (MFIs) lend primarily to women. Research has shown that women are much more responsible with money. With the profits from their businesses, they are more likely to put more food on the table, put their kids through school or improve the family's healthcare. In contrast, men tend to squander their money on gambling, women, tobacco and alcohol. Borrowers use the money for all kinds of businesses like food carts, retail shacks, restaurants, clothing stores, taxi services, hair salons and so much more. The loans help them to start these businesses without having to go to loan sharks and moneylenders. While interest rates can be relatively high for microloans, they are generally much lower than the rates charged by moneylenders, which can sometimes reach 100% per year or more.
Why Are Interest Rates on Loans to Poor People So High?
There are many reasons why interest rates on loans to the poor are high. The main reason is that it is much more expensive to administer many small loans compared to one big loan. Many small loans means going from village to village collecting payments, making disbursements and giving business training. In addition, many villages are far away from business centers and have poor roads on the way, making many of these trips laborious and time consuming for loan officers. Second, many developing countries have both high inflation and high interest rates, thus driving lending rates higher as well. Third, many small businesses have high return on capital when they start out, so they can absorb high costs of capital. For all these reasons, while a 30% lending rate may seem high to Americans, it is a fairly reasonable interest rate given the circumstances of lending to small businesses in developing countries.
Is Microfinance Risky?
Although the repayment rate has generally been very high, recently the industry has come under fire. A major issue has been over-indebtedness in some countries, particularly in India. It has come to light that many borrowers have borrowed from multiple MFIs, in some cases 20 or more! Some borrowers are also borrowing from one MFI to payoff loans from another MFI. The problem in India came to a head as runaway growth in the industry led to reckless lending, and many heavily indebted borrowers began to default on their loans, thereby increasing the pressure on them to pay the loans back. When they couldn't, some borrowers began to commit suicide. As a result, the government basically shut down the industry in the state of Andhra Pradesh, while protest groups rallied to encourage borrowers to purposely default on their loans. It must be noted that the problem of over-indebtedness was only specific to a few countries, it was not industry wide. Still, because of this and other issues, MFIs have come together to try and fix the problems in the industry.
How Can I Get Involved?
Despite the problems in the industry, microfinance is still a good way to help the poor improve their lives. However, it is certainly not a panacea to eliminate poverty. If you would like to get involved, I would suggest Opportunity International or Kiva for starters. On these websites, you can pick a borrower to lend to from a country and industry of your choice. Once enough small donations from multiple donors are made to the borrower, the loan is fully funded. You will then get updates about the borrower's business and repayment status over time. I would suggest giving small amounts to each borrower ($25 is usually the smallest amount you can lend) and spreading them out among different countries and different industries to minimize your risk. Out of 30 or so loans I have funded, I have only had one default, and I only lost $25. The other thing to keep in mind is that on these websites you do not get a return on your investment. It is simply a donation. However, on Kiva you can take your money back out once it is paid back if you want, whereas on Opportunity International it is a straight donation that you do not get back.
If you would like to know more about microfinance, please contact me. I will add more to this page as time permits.
If you would like to know more about microfinance, please contact me. I will add more to this page as time permits.
Microfinance Project
Here are some reports I put together following a roundtable on poverty I hosted in December 2008. We just went around the room and let people tell their stories about their experiences with poverty. It was a very fruitful and eye-opening experience for me, and I had the opportunity to meet a lot of really great people as well.
| microfinance_roundtable_-_report.pdf |
| microfinance_roundtable_-_bullet_point_summary.pdf |
| microfinance_roundtable_-_quotes.pdf |
Causes and Solutions to Poverty
This is a working document on the causes of poverty and what can be done to solve these problems. It will be updated as time permits. It is clear that lack of credit is only one of myriad factors that cause poverty. Hence, it can only be a small part of the solution to eradicating global poverty. But it certainly can bring hope, which is vital in the fight.
| causes_of_poverty.docx |
Microfinance / Development Papers
Here are a few papers I have read on microfinance and development if you are interested in learning more.
| microfinance2011duvendackreport.pdf |
| africas_infrastructure.pdf |
| microcredit_summit_2012.pdf |
| microfinance_banana_skins_2012.pdf |
| localizing_development.pdf |