Microfinance Explained
The original goal of microfinance was the alleviation of poverty. Microfinance institutions (MFIs) began lending money to the poor on a large scale a few decades ago. Loan funds could be used to start micro-businesses and over time, borrowers would become empowered. Through their investments in micro-enterprises, the poor would gain more disposable income and, in turn, improve their standard of living. As such, microfinance became a tool to foster economic growth and development among the poor.
Microfinance was initially conceived as a development tool that would leverage micro-business loans to increase business activity which would subsequently raise the incomes of micro-entrepreneurs.
In 2006, economist Muhammad Yunus and Grameen Bank were awarded the Nobel Peace Prize for their efforts to create economic and social development through small long-term loans on easy terms. For some in the development field, Yunus and Grameen’s microcredit work came to represent the panacea they had been searching for – a remedy that could be applied universally to help alleviate poverty and improve well-being. Given that millions of people around the globe did not have access to capital, and had difficulties borrowing, saving, and investing, microcredit and microfinance became promising solutions.
Microfinance and MFIs have evolved over time and now offer much more than small loans. While institutions participating in the area of microfinance most often provide lending (microloans), many financial institutions offer additional services, such as checking and savings accounts, and micro-insurance products; and some even provide financial and business education.
Microfinance services are provided to unemployed or low-income individuals many of whom are trapped in poverty, or who have limited financial resources. Many individuals and families do not have enough income to do business with traditional financial institutions. Thus, many turn instead to family, friends, and even loan sharks, who often charge exorbitant interest rates. Microfinance is intended to allow people to take on reasonable small business loans without the risk of paying excessive interest rates.
Microfinance institutions support a large number of activities that range from providing checking and savings accounts, to startup capital for small business entrepreneurs, and educational programs that teach basic principles of business. These educational programs often focus on such skills as bookkeeping, cash-flow management, and basic accounting. Unlike typical financing situations, in which the lender is primarily concerned with the borrower having enough collateral to cover the loan, several microfinance organizations focus on supporting entrepreneurs.
FINCA
An organization, FINCA, explains that that concept of microfinance has helped millions of people to build businesses, increase their incomes and improve their lives.
FINCA’s programs and services seek to expand financial inclusion, strengthen local communities and create opportunities for those who remain excluded from the benefits of global economic growth.
FINCA uses a financial inclusion model through which it provides people with access to credit and savings. FINCA explains that ‘Microfinance’ refers to the financial services provided to low-income people, traditionally to support self-employment. This includes small loans, savings plans, insurance, money transfers and other basic financial services.
FINCA points out that traditional banks often do not serve the ‘micro’ loan segment or even the small business segment in developing countries, because it is too costly for them, or because they do not know how to serve people working in the informal economy.
Below is an example of how another organization, Kiva, administers its lending program.
KIVA
Kiva, an international nonprofit, has the mission of expanding financial access to help underserved communities thrive. According to Kiva, their process works as follows:
A borrower applies for a loan. Kiva loans are facilitated through two models, partner and direct. For partner loans, borrowers apply to a local Field Partner, which manages the loan on the ground. For direct loans, borrowers apply through the Kiva website.
The loan then goes through the underwriting and approval process. Partner loans are facilitated by local nonprofits or lending institutions, which approve the borrower’s loan request. Kiva does due diligence and ongoing monitoring for each of these Field Partners. Direct loans are approved through “social underwriting," where trustworthiness is determined by friends and family lending a portion of the loan request, or by a Kiva approved Trustee vouching for the borrower.
Once approved, the loan is posted to the Kiva website for lenders to support. Individual lenders will crowdfund the loan. Once the crowdfunding process is complete, the borrower receives the loan.
Then, the borrower repays the loan. Lenders receive repayments over time, based on the given repayment schedule and the borrower’s ability to repay. The repayments go into the lenders’ Kiva accounts.
Finally, lenders use repayments to fund new loans, donate or withdraw the money.
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