What Is Microfinance?

Answer:
Microfinance refers to financial services that are provided to low income clients.

On a broader level, it describes a movement that has as its goal “a world in which as many poor and near-poor households as possible have permanent access to an appropriate range of high quality financial services, including not just credit but also savings, insurance, and fund transfers” (CGAP Occasional Paper, July 2004). It is believed that this access will help poor people pull themselves out of poverty.

In general, banks have avoided loans to people with little or no income due to the fixed costs of servicing the loans. The poor usually falls below the bank’s break even point, under which every transaction will be at a loss. Another problem is that most poor people have very little collateral with which to secure the loan. This gives the bank very little protection in the case of default. Because of this, poor people often had to pay exorbitant fees and rates to second tier lenders.

Microfinance generally refers to any effort to increase access to, or improve the quality of, financial services poor people currently use or could benefit from using. There are not any black and white lines that distinguish microfinance from other similar activities. Improving access is best done through expanding the number of financial institutions that are available to the poor. Recent years has also seen a focus on expanding the diversity of those institutions, as different types of institutions will be able to service different needs.

In 2004, the Consultative Group to Assist the Poor (CGAP) listed the general principles of microfinance, and these principles were endorsed by the G8 leaders at the G8 Summit on June 10, 2004. These principles are as follows:

1. Poor people do not need only loans. They also need savings, insurance, and money transfer services.

2. Microfinance must be useful to poor households, helping them to raise their income, build up their assets, and/or cushion themselves against external shocks.

3. Subsidies from donors and government are scarce and uncertain, so in order to reach large numbers of people, microfinance must pay for itself.

4. Microfinance requires building permanent local institutions.

5. Microfinance also means integrating the financial needs of poor people into the country’s mainstream financial system.

6. The job of government is to enable financial services, not to provide them.

7. Donor funds should complement private capital, not compete with it.

8. The key bottleneck is the shortage of strong institutions and managers. Donors should focus their efforts on capacity building.

9. Interest rate ceilings hurt poor people by preventing microfinance institutions from covering their costs, which chokes off the supply of credit for them.

10. Microfinance institutions should measure and disclose their performance, both financially and socially.

Microfinance is also different from charity. It is better to give grants to families that are too destitute to repay a loan.

Currently, 70% of microfinance clients are in Asia, 20% are in Latin America, and the rest are in other parts of the world.


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