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Introduction to Microfinance

Learning Outcome

• Define Microfinance

• Describe history of Microfinance

• Differentiate Microfinance and Microcredit

• Identify key principles of Microfinance

• Explain the characteristics of Microfinance

• Analyze the advantages of Microfinance


Microfinance Definition - 1
• A relatively new branch of financial services

• Microfinance aims to promote self-sufficiency and


economic development among people who don't have
access to the traditional financial sector.

• They do this primarily by extending small loans without


the strict requirements

• Recipients are usually the poor and unbanked, but it


includes people who are not poor but who lack the credit
standing to borrow money to start or grow a business.
Microfinance Definition - 2
• Microfinance has evolved as an economic
development approach intended to benefit low-income
women and men.

• Financial services generally include savings and


credit; however, some microfinance organizations also
provide insurance and payment services
• In addition to financial intermediation, many MFIs
provide social intermediation services such as group
formation, development of self-confidence, and training
in financial literacy and management capabilities
among members of a group.

• Thus the definition of microfinance often includes both


financial intermediation and social intermediation.

• Microfinance is not simply banking, it is a


development tool.
Microfinance Definition
Microfinance activities usually involve:
– Small loans, typically for working capital
– Informal appraisal of borrowers and investments
– Collateral substitutes, such as group guarantees or
compulsory savings
– Access to repeat and larger loans, based on repayment
performance
– Streamlined loan disbursement and monitoring
– Secure savings products.
Some MFIs provide enterprise development services,
such as
– skills training and marketing, and
– social services, such as literacy training and health
care
these are not generally included in the definition of
microfinance.
Microfinance Definition - 3
• Microfinance is defined as any activity that includes
the provision of financial services such as credit,
savings, and insurance to low income individuals
which fall just above the nationally defined poverty
line, and poor individuals which fall below that
poverty line, with the goal of Creating Social Value.

• The creation of social value includes poverty


alleviation and the broader impact of improving
livelihood opportunities through the provision of
capital for micro enterprise, and insurance and
savings for risk mitigation and consumption
smoothing.
Microfinance Definition - 4

• The means by which poor people convert small sums of


money into large lump sums (Rutherford 1999)

• The goals are


– Eradicate Extreme Poverty & Hunger.
– Achieve Universal Education.
– Promote Gender Equality & Women’s Empowerment.
– Reduce Child Mortality
– Combat Diseases
– Developing Entrepreneurial Spirit
Microfinance Definition – 5

• Microfinance, according to Otero (1999, p.8) is “the


provision of financial services to low-income poor
and very poor self-employed people”.

• These financial services according to Ledgerwood


(1999) generally include savings and credit but can
also include other financial services such as insurance
and payment services.
Microfinance Definition - 6

• Schreiner and Colombet (2001, p.339) define


microfinance as “the attempt to improve access to
small deposits and small loans for poor households
neglected by banks.”

• Therefore, microfinance involves the provision of


financial services such as savings, loans and insurance
to poor people living in both urban and rural settings
who are unable to obtain such services from the
formal financial sector.
• Traditionally banks and Lending Institutions do not lend money to
low-income Individuals

• The reasons being


– Lack of Information about Individuals.
– Collateral.
– High Transaction cost of processing

Microfinance provides a solution for the above problem.

• In 2010 alone an estimated 105 million people received


a microloan in developing countries. 80% of those
borrowers were women and 70% of borrowers came
from rural areas.
HISTORY OF MICROFINANCE

The history of microfinancing can be traced back as


long to the middle of the 1800s when the theorist
Lysander Spooner was writing over the benefits from
small credits to entrepreneurs and farmers as a way
getting the people out of poverty.
HISTORY OF MICROFINANCE
• An economical historian at Yale named Timothy Guinnane
has been doing some research on Friedrich Wilhelm
Raiffeisen´s village bank movement in Germany which
started in 1864 an by the year 1901 the bank had reached
2million rural farmers.

• Timothy Guinnane means that already it was proved that


microcredit could pass the two tests concerning peoples’
payback moral and the possibility to provide the financial
service to poor people.
HISTORY OF MICROFINANCE

• Another organization, The caisse populaire movement


grounded by Alphone and Dorimène Desjardins in
Quebec , was also concerned about the poverty, and
passed those two tests.

• Between 1900 to 1906 when they founded the first


caisse, they passed a law governing them in the
Quebec assembly , they risked their private assets
and must have been very sure about the idea about
microcredit.
HISTORY OF MICROFINANCE

• The today use of the expression microfinancing has it


roots in the 1970s when organizations, such as
Grameen Bank of Bangladesh with the microfinance
pioneer Mohammad Yunus, where starting and
shaping the modern industry of microfinancing.

• The main reason why microfinance is dated to the


1970s is that the programs could show that people
can be relied on to repay their loans and that it´s
possible to provide financial services to poor people
through market based enterprises without subsidy.
Today the World Bank estimates that more than 16
million people are served by some 7000 microfinance
institutions all over the world.

CGAP [ Consultative Group to Assist the Poorest]


experts means that about 500 million families benefits
from these small loans making new business possible.
Characteristics and Features of Microfinance
Microfinance and microcredit
Microfinance is the process of extending financial aid
and services to people who have low incomes such as
consumers and the self-employed who find it hard to
avail themselves of these services from banks and other
financial institutions.

These financial institutions only offer loans or credit to


those who have properties that they can use as
collateral and those who have a steady income which
the poor do not have.
• Microcredit is one aspect of microfinance, and it is
designed to provide credit to poor clients, the
proceeds of which are meant to be used as capital
for a small business so that they may become self-
sufficient and finally get out of their poverty.

• Through microcredit, poor people can have a chance


at acquiring a loan without collateral or a steady
income provided that they use it to start a business
enterprise that will earn them an income.
• Microcredit and microfinance are both seen as important
factors in a country’s development since a huge percentage
of the population is usually poor and needs all the help it
can get to make its life better and, in effect, improve the
economic status of the country.

• Microfinance is the process of providing financial assistance


as well as other services such as insurance and savings to
underprivileged people while microcredit is one aspect of
microfinance and is the process of extending credit to the
poor.

• Microfinance was developed for people who find it hard to


get financial assistance from mainstream institutions while
microcredit was developed to provide credit and loans to
the same people.
Key Principles of Microfinance
These principles were developed and endorsed by CGAP and
its 31 member donors, and further endorsed by the Group of
Eight leaders at the G8 Summit on 10 June 2004.
Objectives of Micro Finance
• A relatively new branch of financial services, microfinance
aims to promote self-sufficiency and economic development
among people who don't have access to the traditional
financial sector.

• They do this primarily by extending small loans without the


strict requirements of traditional lenders.

• Recipients are usually the poor and "unbanked," but they


also include people who are not poor but who lack the
credit standing to borrow money to start or grow a business.
Access to Capital
• When people can't tap into the mainstream financial
services system for capital to start a business, they're forced
to turn to "informal" sources -- relatives, friends and even
black-market lenders, or "loan sharks."

• Such sources are often unreliable, and they can also be


expensive, charging high interest rates.

• By lending money to such people, microfinance institutions


provide access to capital.
Entrepreneurship and Self-Sufficiency
• Underprivileged people may have potentially profitable
business ideas, but they cannot put them into action because
they lack sufficient capital for start-up costs.

• "Microcredit" loans give clients just enough money to get


their idea off the ground so they can begin turning a profit.

• They can then pay off their micro loan and continue to gain
income from their venture indefinitely.
Improved Standards of Living
• Microcredit ultimately aims to give poor people enough
financial stability to move from simply surviving to accruing
savings.

• This gives them a certain amount of protection from sudden


financial problems.

• Savings also allow for educational investment, improved


nutrition, better living conditions and reduced illness.

• Micro insurance, another segment of the microfinance sector,


provides people the ability to pay for health care when
needed, so they can receive treatment for health conditions
before they become serious and more costly to treat.
Women's Economic Advancement
• Women make up a large proportion of microfinance
beneficiaries.

• Traditionally, women (especially those in underdeveloped


countries) have been unable to readily participate in economic
activity.

• Microfinance provides women with the financial backing they


need to start business ventures and actively participate in the
economy.

• The aim is to improve their status and make them more active in
decision-making, thus encouraging gender equality.

• According to the international Consultative Group to Assist the


Poor, microfinance institutions have even reported a decline in
violence against women in areas targeted by microfinance
programs.
Trickle-Down Benefits

• Microfinance lenders hope to improve not just the lives of


their direct clients, but also the health of their clients'
communities.

• New business ventures can provide jobs, thereby increasing


income among community members and improving their
overall well-being.
Objectives of Micro Finance

• Access to Capital

• Entrepreneurship and Self-Sufficiency

• Improved Standards of Living

• Women's Economic Advancement

• Trickle-Down Benefits
Characteristics of Microfinance
Microfinance services are aimed at the poor clients, who do not have
access to formal financial sources. Microfinance has its unique
characteristics, which are as follows:

• Mostly it is collateral free


• MFIs go to clients rather than clients going to MFIs
• Simplified savings and loan procedures
• Small size of loans and savings
• Repeat loans
• Loan size increases in the repeated loans or subsequent cycles
• Interest rate is usually in between money lenders and formal banks
• Free use of loans (no restrictions on specified purpose)
• Repayment considers incomes from business as well as other sources
• Loan and savings products within manageable numbers.
Questions for Assignment & Discussion

1. What is needed for microfinance to


reach its full potential?

2. What can donors do to support the


new vision of financial services for
the poor?
Benefits of Microfinance
The micro finance provided to the poor would enable
them to start new productive ventures that would help
in generating income.

This improves the financial status of the concerned


person leading to better education for children, better
nutrition among family members and better standard
of living.

This would ultimately help in reducing the income


inequality and social exclusion that is faced by the
rural poor.
The Main Advantages of Microfinance

• Microfinance provides financial services at the doorsteps of the


poor, which is not done by the formal institutions.

• Microfinance involved less paper work compared to traditional


banks.

• It is more accessible to the poor.

• Involvement of middlemen in the transactions is eliminated.

• They are characterized by non-collateral loans and easy


repayment options.

• Loans provided by the MFIs are generally cheaper than that of


the regional moneylenders.

• The processing time of loans by the MFIs is less


Benefits of Microfinance in Developing Countries

• Majority of the world is forced to survive on the


equivalent of just $2 per day, microfinance
becomes a solution that can help more people be
able to improve their living conditions.

• These are the benefits of microfinance in


developing countries and why everyone should
consider getting involved in this form of lending.
It allows people to better provide for their families.

• Most of the households that take advantage of the


microfinance offers that are available in developing
countries live under “abject poverty.”

• This is defined as living on $1.25 per day or less –


though some definitions extend this amount to $2 per
day or more. About 80% of that amount goes to the
purchase or creation of food resources.

• By offering microfinance products that can be repaid


with that remaining 20%, more households have the
opportunity to expand their current opportunities so
that more income accumulation may occur.
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.
It serves those who are often overlooked in society.
• In many developing nations, the primary recipient
of microloans tends to be women.

• Up to 95% of some loan products are extended


by microfinance institutions are given to women.

• Those with disabilities, those who are unemployed,


and even those who simply beg to meet their
basic needs are also recipients of microfinance
products that can help them take control of their
own lives.
It offers a better overall loan repayment rate than
traditional banking products
• When people are empowered, they are more
likely to avoid defaulting on a loan.

• Women are also statistically more likely to repay


a loan than men are, which is another reason why
women are targeted in the microfinance world.

• There’s also the fact that for many who receive a


microloan, it is their only real chance to get
themselves out of poverty, so they’re not going to
mess things up.
It provides families with an opportunity to provide an
education to their children

Children who are living in poverty are more likely to


have missed school days or to not even be enrolled in
school at all.

This is because the majority of families who live in


poverty are working in the agricultural sector.

The families need the children to be working and


productive so their financial needs can be met.

By receiving microfinancing products, there is less of a


threat of going without funding, and that means more
opportunities for children to stay in school.
It creates the possibility of future investments
• The problem with poverty is that it is a cycle that perpetuates itself.
• When there is a lack of money, there is a lack of food. When there is
a lack of clean water, there is a lack of sanitary living conditions.
• When people are suffering from malnutrition, they are less likely to
work.
• A lack of sanitation creates the potential of illness that prevents
working days.

• Microfinance changes this by making more money available. When


basic needs are met, families can then invest into better wells, better
sanitation, and afford the time it may take to access the health care
they need.

• As these basic needs are met, it also means that there are fewer
interruptions to the routine. People can stay more productive. Kids can
stay in school more consistently. Better healthcare can be obtained. This
creates a lower average family size because there are more
guarantees of survival in place.

• And when that happens, the possibility of future investments will occur
because there is more confidence in being able to meet basic needs.
It is a sustainable process
Repayments are reinvested into communities so that
the benefits of microfinance can be continually
enhanced.

Each repayment becomes the foundation of another


potential loan.
It can create real jobs
• Microfinance is also able to let entrepreneurs in
developing countries be able to create new
employment opportunities for others.

• With more people able to work and earn an


income, the rest of the local economy also benefits
because there are more revenues available to
move through local businesses and service
providers.
It encourages people to save

• Microloans are an important component of


microfinance, but so is saving money.

• When people have their basic needs met, the


natural inclination is for them to save the leftover
earnings for a future emergency.

• This creates the potential for more investments


and ultimately even more income for those who
are in the developing world.
It reduces stress

• There is a valid argument to be made that some


microloans go to cover household expenses instead of
business needs.

• Some are using these loans to pay bills or purchase


food. It’s true.

• Yet without this product available, there wouldn’t be an


ability to pay bills or purchase food.

• So even though it may not always be used for business


purposes, it still serves a purpose by reducing stress.
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 consumption smoothing.

• There is also an unmeasurable effect which occurs


when women are empowered to do something in their
society when they might not normally be allowed to do
so.

• As spending occurs, these benefits also extend outward


to those who may not be participating in the program
so that the entire community benefits.
https://vittana.org/12-benefits-of-microfinance-in-
developing-countries