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Role of Microfinance Institutions

by Leon Teeboom; Reviewed by Michelle Seidel, B.Sc., LL.B., MBA; Updated February 04, 2019

As the name implies, microfinance institutions are bankers and

lenders who provide microfinance services, such as deposits,
loans, payment services, money transfers, and insurance. The
importance of microfinance is that it provides much-needed
financial services to poor and low-income households,
entrepreneurs, and nascent businesses, who would otherwise
not have access to such services.

The role of microfinance in economic development is that it

serves the needs of economically marginalized populations. In More Articles
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countries that work to reduce poverty and "build shared prosperity" in developing countries. Microfinance institutions (MFI)
work to serve those individuals. According to Songbae Lee, an investments senior officer at Calvert Impact Capital, Inc., a
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“
microfinance institutions are:

"...financial institution(s) that provides small loans to people who

otherwise wouldn’t have access to credit. The definition of 'small loans' Also Viewed
depends on the geographic context. India defines microfinance as loans

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Put simply, the importance of microfinance, and thereby of microfinance institutions, is that microfinance is increasingly How Does a Bank Work?
being considered as one of the most effective tools for reducing poverty, according to MicrofinanceInfo.com, a website that Grants for Students Interested in Nonprofits

“
provides information and resources related to microfinance. MicrofinanceInfo.com adds that:

"(Microfinance institutions) are the pivotal overseas organizations in

each country that make individual microcredit loans directly to villagers,
microentrepreneurs, impoverished women and poor families. An
overseas MFI is like a small bank with the same challenges and capital
needs confronting any expanding small venture but with the added
responsibility of serving economically-marginalized populations. Many

”
MFIs are creditworthy and well-run with proven records of success,
many are operationally self-sufficient."

Various institutions offer microfinance, and would thus be considered microfinance institutions, including credit unions,
commercial banks, nongovernmental organizations, and even government banks, says MicrofinanceInfo.com. Additionally,
according to MicrofinanceInfo.com, the goals for microfinance institutions, and hence the function of microfinance is to:

Be a viable financial institution developing sustainable communities.

Mobilize resources to provide financial and support services to the poor, particularly women, for viable productive income
generation enterprises enabling them to reduce their poverty.
Learn and evaluate what helps people to move out of poverty faster.
Create opportunities for self-employment for the underprivileged.
Train rural poor in simple skills and enable them to utilize the available resources and contribute to employment and income
generation in rural areas.
What Is a Microfinance Company?

What a microfinance company is has changed in recent years. Historically, the importance of microfinance was that it
served a great role in alleviating poverty. According to Investopedia, "For many years, microfinance had this primary social
objective and so traditional MFIs consisted only of non-governmental organizations (NGO), specialized microfinance banks
and public sector banks."

The role of microfinance in economic development was that it helped struggling individuals, and even communities, gain
access to financial services, and hopefully, rise from poverty. Microfinance companies, then, were generally nonprofit or
governmental institutions that sought to help the poor. Profit was never the goal for microfinance companies.

“
That has changed in recent years. According to Investopedia:

"Some non-profit MFIs (microfinance companies) are transforming

themselves into profit-seeking institutions to achieve greater strength,
sustainability and market reach. They are being joined in the
microfinance marketplace by consumer finance companies, like GE
Finance and Citi Finance. 'Big-box' consumer retailers, like Wal-Mart,
Elektra and Tesco are beginning to emerge as consumer lenders and a
few are venturing into microfinance. Although most MFIs still consider

”
poverty alleviation the primary goal, selling more products to more
consumers is the primary motivation of many new entrants."

Today, microfinance companies are a mix of governmental banks, nongovernmental nonprofit organizations, and large
businesses and lenders seeking to serve the financial needs of the millions of consumers worldwide who live at or near the
poverty level.

What Is the Purpose of Microfinance?

The purpose of microfinance is to provide financial services to people "generally excluded from traditional banking
channels because of their low, irregular and unpredictable income," according to ING, a global financial institution with a
strong European base. In other words, the purpose of microfinance is to help disadvantaged households and
entrepreneurs gain access to affordable financial services to help them finance income-generating activities, accumulate
assets through savings, provide for family needs, and protect themselves against the risks of daily life, such as illness,
death, theft, natural disasters, says ING.

Whether for-profit or nonprofit, microfinance seeks to assist the poor, and indeed, microfinance institutions seek to be the
bankers of the poor. For-profit microfinance companies see this sector as underserved and a great way to make a profit.
By contrast, nonprofit microfinance companies seek to help the poor for altruistic reasons.

Microfinance was developed by a Bangladeshi economist Muhammad Yunus, says ING, adding that he came to be known
as "the banker of the poor." In 1976, Yunus established Grameen Bank in Bangladesh, which provided "microcredit,"
literally the extension of loans to impoverished borrowers. Before that, banks had generally concentrated only on lending
to middle- and upper-income clients, as well as the very rich, of course. Yunis' idea of microcredit caught on quickly. It was
so popular that it led to similar microfinance institutions springing up all over the world, eventually evolving into what is
today known as microfinance.

For his efforts, Yunus won the 2006 Nobel Peace Prize. In awarding Yunus the peace prize, which was actually awarded
jointly to Yunus and his bank, the Nobel committee noted that it was honoring Yunus and his bank "for their efforts to
create economic and social development from below." In other words, the committee paid homage to Yunus' concept of
creating economic opportunity from the ground up.

What Is the Meaning of Microfinance?

“
According to the Eurasian Union of Scientists:

"Microfinance is the provision of a broad range of financial services such

”
as deposits, loans, payment services, money transfers, and insurance to
poor and low-income households and, their microenterprises."

ING, which as an organization is actually one of the world's top experts on microfinance, explains the importance of
microfinance and the purpose of microfinance in terms of its historical development. "Over recent decades," says ING,
"microfinance has developed to now cover a range of financial products such as savings, insurance, payment methods
and money transfers." The core meaning of microfinance still refers to offering and serving small loans to the poor. But
microfinance now encompasses a far greater range of financial services than it did when Yunus established the concept.

Microfinance now means, or refers to, products designed to service the highly diverse needs of low-income populations,

“
such as group loans and group guarantees, says ING. Further, ING notes:

"Microfinance is primarily aimed at households living just below or just

above the poverty threshold ($1.25 per day), and the majority of
borrowers are women. It is mainly developing in southern hemisphere
countries where it enables small tradesmen, traders or farmers to carry

”
out micro-projects, but the idea is also gaining ground in Europe and the
United States."

Put simply, microfinance, or microcredit, is a type of banking service that is provided to unemployed or low-income
borrowers or groups who otherwise would have no other access to financial services, says Investopedia.

What Are the Benefits of Microfinance?

There are literally dozens of benefits for microfinance, but the key pluses involve the role of microfinance in economic
development. Vitanna.org and Plan International provide possibly the top benefits of microfinance:

1. It allows people to provide for their families. Through microfinance, more households are able to expand their
current opportunities so that more income accumulation may occur, says Vitanna.org, a financial services website.
2. It gives people access to credit. "By extending microfinance opportunities, people have access to small amounts of
credit, which can then stop poverty at a rapid pace," says Vitanna.org. Plan International, a global organization
dedicated to advancing children’s rights and equality for women, agrees, stating: "Banks simply won’t extend loans to
those with little or no assets, and generally don’t engage in the small size of loans typically associated with
microfinancing. Microfinancing is based on the philosophy that even small amounts of credit can help end the cycle of
poverty."
3. It serves those who are often overlooked in society. About 95 percent of some loan products extended by
microfinance institutions are given to women, as well as those with disabilities, those who are unemployed, and even
those who simply beg to meet their basic needs, Vitanna notes. Microfinance services can help recipients take control
of their own lives.
4. It creates the possibility of future investments. Microfinance disrupts the cycle of poverty by making more money
available. When basic needs are met, families can then invest in better housing, health care, and even, eventually,
small business opportunities.
5. It is sustainable. There's little risk with a $100 or loan, says Vitanna, adding: "Yet $100 could be enough for an
entrepreneur in a developing country to pull themselves out of poverty." Plan International agrees, stating that a $100
loan can be enough to launch a small business in a developing country that could help the benefactor pull herself and
her family out of poverty.
6. It can create jobs. Microfinance is also able to let entrepreneurs in impoverished communities and developing
countries create new employment opportunities for others.
7. It encourages people to save. "When people have their basic needs met, the natural inclination is for them to save
the leftover earnings for a future emergency," says Vitanna.
8. It offers significant economic gains even if income levels remain the same. The gains from participation in a
microfinance program including access to better nutrition, higher levels of consumption, and eventually, growing
economies, even in small and impoverished communities.
9. It leads to better loan repayment rates. "Microfinance tends to target women borrowers, who are statistically less
likely to default on their loans than men. So these loans help empower women, and they are often safer investments
for those loaning the funds," says Plan International.
10. It extends education. Families receiving microfinance services are less likely to pull their children out of school for
economic reasons, says Plan International.

Microfinance, then, may involve very small loans and financial services, but it has a worldwide impact over the last four-
plus decades. For a small business that needs just a bit of extra cash or credit to secure a new opportunity, microfinance
may be just the ticket. And for a small lending or banking business looking for new opportunities, microfinance literally
offers a world of opportunities – one small loan or financial service at a time.

References (7)
Eurasian Union of Scientists: Importance of the Microfinance Institutions in Economy
ING: What Is the Purpose of Microfinance?
Microfinanceinfo.com: Microfinance and Microcredit – Micro Financial Institutions
Medium Calvert Impact Capital, Inc.: Songbae Lee, Introduction to Microfinance Institutions (MFIs) Part I
World Bank: UFA2020 Overview: Universal Financial Access by 2020
Investopedia: Microfinance
Vittana.org: 12 Benefits of Microfinance in Developing Countries
Resources (1)
ProQuest CSA Discovery Guides: The Promise of Microfinance; May 2007
About the Author

Leon Teeboom has written for such newspapers as "The Los Angeles Times" and "The Orange County Register." He has
also written for/and worked as an editor at "The Press-Enterprise" as well as two business publications and several online
media companies.

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