Skip to main content.

Small Business» Money & Debt» Business Credit Resources»

Role of Microfinance Institutions

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

Role of Microfinance Institutions

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 short, the purpose of microfinance is to finance the livelihood, health care,
housing improvements, small business creation, and other needs in under served populations,
specifically poverty and near-poverty level individuals in the U.S. and worldwide.

What Is a Microfinance Institution?

An estimated 1.7 billion people around the world don't have access to financial services, according to
The World Bank. The organization is an international banking group with189 member 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 Bethesda, Maryland nonprofit investment firm that works with investors to move
capital into communities around the world, 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' depends on the geographic context. India defines microfinance as
loans less than 1 lakh which is about $1,500 today (as of March 2017) while the U.S. SBA defines
microloans as loans less than $50,000."
Put simply, the importance of microfinance, and thereby of microfinance institutions, is that
microfinance is increasingly being considered as one of the most effective tools for reducing poverty,
according to MicrofinanceInfo.com, a website that 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:

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.

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."

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.

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.

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.

It can create jobs. Microfinance is also able to let entrepreneurs in impoverished communities and
developing countries create new employment opportunities for others.

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.
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.

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.

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.

Online Degrees In Uganda - The Cost May Surprise You

Online Degrees | Sponsored Listings

Sponsored

Work From Home Jobs in the USA May Pay More Than You Think

Online Jobs in USA | Search Ads

Sponsored

Getting a Job in Australia May be Easier Than You Think

Jobs in Australia | Search Ads

Sponsored

25 Celebs You Didn't Realize Are Gay - No. 8 Will Shock Women
Car Novels

Sponsored

[Pics] After Rescuing Them, Firemen Realized They Weren't Puppies

Rich Houses

Sponsored

Dutch museum says van Gogh painting stolen in overnight raid

THE HAGUE, Netherlands (AP) - A painting by Dutch master Vincent van Gogh was stolen in an overnight
smash-and-grab raid on a museum that was closed to prevent the spread of the coronavirus, police and
the museum said Monday. The Singer Laren museum east of Amsterdam said that "The Parsonage
Garde

Chron

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.

Cite this Article

More Articles

Funding Programs for Micro Entrepreneurs

Funding Programs for Micro Entrepreneurs

What Are Private Sources for Money for Starting a Nursing Business?

What Are Private Sources for Money for Starting a Nursing Business?

Special Business Loans for Women

Special Business Loans for Women

Grants for Students Interested in Nonprofits

Grants for Students Interested in Nonprofits

Also Viewed

Grants for Women Over 40

Why Do Banks Loan Money to Companies?

Community Bank vs. Commercial Bank

How Does the Key Interest Rate Compare to a Prime Rate?

Economic System of Mercantilists

What Does Capitalism Mean in Business?

Federal Funds for Daycares

LogoReturn to Top

About

Privacy Notice Your California Privacy Rights Interest Based Ads Terms of Use Our Company Careers
Advertise with Us Ad Choices

Contact

Customer Service Newsroom Contacts

Connect

Email Newsletter Facebook Twitter Pinterest Google Instagram

Subscribe

iPad app HoustonChronicle.com Houston Chronicle Archives eEdition Demo Today's eNewspaper

Hearst Newspapers© Copyright 2020 Hearst Newspapers, LLC