Microfinancial Institutions (MFIs)

Microfinance institutions are organizations that provide debts to low-income clients, that
include micro-firms and self-employed individuals, who normally lack access to financial
sources from Banking Institutions. Loans tend to be for small amounts in developing
countries and short-term. Due to the small amounts and duration of the loans, unlike
Banking Institutions, these loans are not secured by collateral assets and usually require
weekly repayment installments rather than monthly.
MFIs are concerned with the environmental and social risks of their transactions and are
taking steps to manage any potential risks in order to minimize negative impacts in the
communities.
History of MicroFinancial Institutions
MFIs concept goes back to 1864 Germany, where Friedrich Wilhelm Raiffeisen’ village bank
was giving out loans to poor people, in order for them to support their farms.
Even though the concept was used a while ago, today’s use of the expression micro-
financing has roots in 1970s Bangladesh. At the time, Grameen Bank of Bangladesh started
shaping the modern microfinancing industry. Many enterprises began experimenting with
giving out loans to poor people, with the main idea to show that underserved people are
reliable and will be repaying loans. In addition, the idea was to show that poor people can
be provided with financial services through enterprises without subsidy. (Roodman, D.,
2012)
Advantages of Microfinancial Institutions
When looking at advantages of MFIs, both issuer’s and receivers’ sides can be discussed.
Loans are collateral-free. With MFIs, there is minimum paperwork involved as well as with
no hassle, therefore loans are a quick fundraising option.
Helps individuals meet financial needs. This can be considered as one of the biggest
advantages, since financial support is available to low-income groups. MFIs are designed to
serve poor and unemployed individuals in order to provide easy financial credit.
MFIs provide an extensive portfolio of loans, therefore they not only provide emergency
financial support, but also aid with housing, business and working capital loans.
MFIs can be promoting self-sufficiency and entrepreneurship, since financial support could
be used to set-up a healthy business with minimum investment, but sustainable profits in
the long-term. This promotes entrepreneurship and self-sufficiency in lower-income groups.
Disburse quick loan under urgency. Financial crisis is unpredictable, however microfinance

companies provide secure and collateral-free funds to all individuals in demand of financial

support.

Disadvantages of Microfinancial Institutions

Even though there may seem that MFIs only have the positives, there are some
disadvantages as well.
Repayment criteria is harsh. The installments in order to repay the loan tend to be weekly,
however in case the payments are missed or absence of legit working protocol and
compliances, MFI could adopt a harsh repayment approach. MFIs work under strict
compliances, which could lead to them manipulating customers to repay loans unethically.
Small Loan amount. MFIs tend to only offer small loan amounts, since they do not ask for
collateral against the credit and thus large amounts are very unlikely.
HIgh-interest rates. Unlike Financial Institutions, MFIs are unable to render low-interest
loans, since fund accumulation is difficult. In addition, MFIs sometimes themselves need to
borrow money from financial institutions in order to execute appropriately. OPerating costs
of MFI then become high and lead to higher interest rates. In addition, MFI accumulates
funds through private equity and therefore indicates that firms are working for higher
profits for their investors, which lead to higher interest rates (Finezza, 2020.
MFIs regulations
As for regulations in the banking sector, those are usually more referred to as binding rules.
Mainly, there are self-regulation and prudential regulations (Uprety, 2008). The first refers
to an internal system where each: shareholders, management and investors should
communicate towards a common goal and so risk management is a joint process (Gallardo,
Greuning & Randhawa, 1998). The second, external regulations' main goal is to protect the
entire financial system (Gallardo, Greuning & Randhawa, 1998).
In general, MFIs are under binding rules depending on their status. They must follow the
general banking regulations which are set by authorities as the same for the other banks.
How do MFIs operate?
MFIs operating method can be named as unique, different from traditional banks. When
granting a loan, MFIs base their decision on individual relationship with community, perform
interviews and evaluate personal traits such as motivation, competence or experience (BNP
Paribas, 2016). It is often the case that members from the community act as a guarantee for
the borrower. MFIs get their funding through close relationships with public and private
investors, through members deposits or from their own capital. The repayments are usually
set accordingly to a particular audience, but they are as for example - weekly payment
dates. In such a case, MFIs develop a close relationship with the borrowers where they help
the borrowers' families to manage budgets or even train them for educational purposes.
MFIs offered services include (Investopedia, 2020):
● microsavings - ability for people to save their money for the future spendings such as
funerals or weddings
● microloans - small amounts of loans which are granted for small businesses in
developing countries
● micro insurance - people in developing countries are more exposed to risks such as
floods, hurricanes or landslides, thus risk management in their lives is an important
component
MFIs and COVID-19 pandemic
The recent worldwide pandemic has touched all the countries, some of them were less
affected while other countries had severe impacts. As most countries implemented a
lockdown during the pandemic, it has some influence on MFIs also. In general, MFIs seem to
have experienced pandemic impact quite well, even though they had some difficulties and
were forced to implement some changes in their operations. The main difficulties were in
disbursements, organizing meetings with clients as well as in the need to reorganize the
internal workflow while changes included lower wages for employees, reduced lending
activities when actually borrowers desired for liquidity (Dąbrowska, Koryńskiand &
Pytkowsk, 2020). In order to deal with these challenges, MFIs have adjusted their continuity
strategies, risk and crisis management procedures. The impacts of COVID-19 on MFIs
include:
● Should operate in narrow market
● Weaker liquidity position
● Limited government support
 ● No additional funding
When it comes to MFIs clients, most of the micro businesses which operate in
accommodation, transportation or retail had to shut down their operations due to
decreased profits (Dąbrowska, Koryńskiand & Pytkowsk, 2020). The impacts of COVID-19 on
MFIs clients include:
● Reduced salaries and employees firing
● Businesses shut down
● Decrease in sales and turnover
● Suffering from inability to digitized operations
To conclude, it can be said that although MFIs were able to survive this period quite well,
their clients had experienced tough times. This pandemic showed that MFIs are not able to
fully help their clients in such difficult situations and thus, MFIs are not in line with their
mission - to offer help for small businesses.
MFIs empirical evidence regarding efficiency
According to the World Bank (2021) 689 million people live in extreme poverty on less than
$1.90 a day. Since Microfinance tends to focus on serving low-income populations, it has
been promoted as a powerful solution in the fight against global poverty (Efendic &
Hadziahmetovic, 2017). Despite that, MFIs were not efficient when using their resources to
achieve both social and financial efficiency (Anwar, et al. 2020). Meaning that there are
debates over whether MFIs adhere to their initial socio-economic mission or are shifting
towards prioritizing the achievement of their financial goals (Widiarto & Emrouznejad 2015).
MFIs by numbers 2020
According to Fassin & Larose (2021) in 2020, microfinance institutions ended the year with a
total gross loan portfolio amounting to $159.9 billion. This reflects a 2.0% growth rate by an
institution from 2019, which is approximately in line with worldwide inflation (1.9%) but
significantly lower than the previous median year-on-year growth rates observed from
2017-19 (12.4-16.3%). The top 100 MFIs dominated the sector and in 2020 hold 74.4% of
the total gross loan portfolio.
The total number of borrowers reached 140.3 million. In the previous three years, active
borrowers annual growth ranged between 6-10%, while in 2020 the growth was 0.3%. What
is more, female clients continue to be primary borrowers, accounting for 80.9% while men
account for 19.1%.
Regarding the portfolio quality, credit risk has increased to 7.1% in 2020, while in 2019 it
reached only 4.3%. The growth of credit risk influenced portfolio yield – it decreases from
24.6% in 2019 to 22.3% in 2020. Despite this, solvency has remained stable until the end of
2020. For example, the median equity to assets ratio was at 22.4% which is between the
range observed in 2017-2019 (21.6% to 22.8%).
What is more, South and Southeast Asia continues to be the dominant region based on total
gross loan portfolio and number of borrowers which make up 43.1% and 70.3% of market
share respectively (Perez, et al. 2020).
Recommendations for further studies
The following topics of the field are suggested for further research:
● Since market conditions are changing rapidly, variability of risk across MFIs increases,
therefore, it is important to continue to monitor trends of this sector during the
upcoming years;
● MFIs should focus more on managerial operations to improve the level of efficiency.