Microfinance: Philanthropy Through Industry
According to Mercy Corps, in 2008, one out of every six people on the planet lives on one dollar a day or less. It has long been a challenge for interested parties, such as government officials, non-governmental organizations (NGO) and philanthropists to find a way to help the poor have better access to financial resources that can help them increase their incomes.
Most of those trapped in poverty do not have enough income to open accounts with traditional banks. As a result, many look for loans from family, friends and even loan sharks exploiting the black market. One way to help the world's poorest comes in the form of microfinance, which brings basic banking tools to the worlds most needy.
Microfinance groups lend to customers who have low incomes and, at least anecdotally, have helped many of those trapped in the most extreme form of poverty better their lives by loaning them amounts of money many others would consider a paltry sum. They also provide their borrowers with access to education, credit and basic savings accounts. Read on to find out how microfinance works and the evidence behind its claims to helping the poorest people lift themselves out of poverty. (For more, read Microfinance Has Major Impact.)
How It Works
According to the International Fund for Agricultural Development (IFAD), a specialized agency of the United Nations, 65 of the world's top microfinance issuers got an average rate of return of 2.5% of total assets, which is comparably to returns in the commercial banking sector. So how do these organizations get people with virtually no personal assets (or collateral) to make good on loans?
Many microfinance proprietors look to educate the destitute groups they serve about how basic banking services work. In many instances, people looking to join microfinance organizations are first required to take a basic money management class. Lessons focus on ways to develop savings, debt management, how banks work, how to budget and how to manage cash flow. (For more tips on saving, read Five Ways To Save Without Trying and Get Your Budget In Fighting Shape.)
Once educated on how the process works, customers are then allowed access to loans. Just as one would find at a traditional bank, a loan officer approves and helps borrowers with loan applications and oversight. The typical loan - usually $100 or less - does not seem like much too many in the developed world, but to people trapped in rural poverty, this figure is enough to start a business or engage in other profitable activities. (For related reading, see Different Needs, Different Loans.)
In most cases, many potential borrowers cannot offer any collateral. As a buffer, microlending operations often pool people seeking loans together. After receiving loans, recipients repay their debts together. Because the success of the program depends on everyone's contributions, a form of peer pressure exists to help ensure loan repayment. For example, if an individual is having trouble using his or her money to start a business, that person can seek help from other group members or from the loan officer. Through repayment, loan recipients start to develop credit, allowing them to obtain larger loans down the line. (To learn more about credit, read, The Importance Of Your Credit Rating.)
Also, many microfinance operations require loan recipients to set aside parts of their income toward a savings account used as insurance in case of a loan default. Others also require borrowers to allocate a portion of their income to a personal savings account for use at a later date.
Who Provides the Services?
The concept of microfinance started in the late '70s and early '80s. The first organization to receive attention for its success was the Grameen Bank, which was started by Muhammad Yunus inBangladesh
India India
There are other microfinance operations around the world. Some larger organizations work closely with the World Bank, while other smaller groups operate in different nations around the world. Most were formed with the simple goal of improving lives with funding from donations, grants and other forms of generosity. (For more insight, see What Is The World Bank?)
But a new trend has emerged in the world of microfinance - one where groups seek to use microfinance not just to help others, but to also turn a profit.
For Profit
One of the largest, and most controversial, microfinance firms isMexico
Banco Compartamos makes loans like most other microfinance companies in that its clients are mostly women, its customers are pooled into groups, and loans are issued in relatively small amounts. However, Banco Compartamos differs from other groups when clients repay their loans. Nonprofit institutions take a more philanthropic bent with the profits, using them to expand the organization's reach or create more programs; Banco Compartamos is a publicly owned company, meaning the company's management team has to ultimately answer to its shareholders.
As a result, Banco Compartamos has been criticized by many. The most visible opponent of the bank is the grandfather of microfinance himself, Muhammad Yunus. Yunus, and others, argue that a for-profit organization works against the original mission of microfinance, which put helping the poor above all else. Compartamos argues that by becoming a profitable business, it will be able to extend its reach and help more ofMexico
In addition to Banco Compartamos, many of the world's major financial institutions and other large corporations have launched for-profit microfinance projects as they eye a chance to turn a profit by lending small amounts to the poor. CitiGroup (NYSE:C), Barclay's (NYSE:BCS), General Electric (NYSE:GE) and others have started microfinance divisions in many countries. Other companies have issued funds that invest primarily in microfinance firms, which provide money to microfinance lenders in exchange for a cut of the profits in return.
Other Criticisms
On top of the divide between non- and for-profit microfinance enterprises, other criticisms exist. Because microfinance loans are typically in the range of $100 or less, some critics say this is not enough money to provide stability while also keeping recipients working in subsistence-level trades. They cite the examples of China and India, where millions have emerged from the lowest levels of poverty due to the development of large industries. The jobs created by the construction of new factories and the production of new goods have led to stable employment and higher wages for employees.
Other critics have said that microfinance can hurt the poor by charging high interest rates. There are borrowers who cannot, or do not, repay loans. The added debt can make microfinance clients poorer that when they started, leaving them in debt and living hand-to-mouth. That said, according to IFAD, these rates are well below what local moneylenders would charge, making these micro loans a viable alternative for financing.
Does It Work?
Statistics about the success of microfinance are hard to come by, but those that are available suggest some positive results. An eight-year World Bank study in Bangladesh found that 48% of poor households with access to micro loans rose above the poverty line. Another study by Grameen Bank found that 5% of borrowers were able to lift themselves beyond the poverty line each year, and maintain these gains over time. However, other work, such as a 2005 article by Steve Beck and Tim Ogden in the Harvard Business Review, warn that there is little concrete evidence to suggest that micro borrowers escape poverty directly or permanently and that borrowers may not spend the money they obtain through microcredit on any kind of investment.
Conclusion
Microfinance provides small loans to the world's poorest people, either through nonprofit organizations or through larger commercial lenders. Whether providing financial services to groups that traditionally could not access them helps these people or only puts them further in debt is still up for debate. What is certain is that this relatively new industry is in it for the long haul.
Most of those trapped in poverty do not have enough income to open accounts with traditional banks. As a result, many look for loans from family, friends and even loan sharks exploiting the black market. One way to help the world's poorest comes in the form of microfinance, which brings basic banking tools to the worlds most needy.
Microfinance groups lend to customers who have low incomes and, at least anecdotally, have helped many of those trapped in the most extreme form of poverty better their lives by loaning them amounts of money many others would consider a paltry sum. They also provide their borrowers with access to education, credit and basic savings accounts. Read on to find out how microfinance works and the evidence behind its claims to helping the poorest people lift themselves out of poverty. (For more, read Microfinance Has Major Impact.)
How It Works
According to the International Fund for Agricultural Development (IFAD), a specialized agency of the United Nations, 65 of the world's top microfinance issuers got an average rate of return of 2.5% of total assets, which is comparably to returns in the commercial banking sector. So how do these organizations get people with virtually no personal assets (or collateral) to make good on loans?
Many microfinance proprietors look to educate the destitute groups they serve about how basic banking services work. In many instances, people looking to join microfinance organizations are first required to take a basic money management class. Lessons focus on ways to develop savings, debt management, how banks work, how to budget and how to manage cash flow. (For more tips on saving, read Five Ways To Save Without Trying and Get Your Budget In Fighting Shape.)
Once educated on how the process works, customers are then allowed access to loans. Just as one would find at a traditional bank, a loan officer approves and helps borrowers with loan applications and oversight. The typical loan - usually $100 or less - does not seem like much too many in the developed world, but to people trapped in rural poverty, this figure is enough to start a business or engage in other profitable activities. (For related reading, see Different Needs, Different Loans.)
In most cases, many potential borrowers cannot offer any collateral. As a buffer, microlending operations often pool people seeking loans together. After receiving loans, recipients repay their debts together. Because the success of the program depends on everyone's contributions, a form of peer pressure exists to help ensure loan repayment. For example, if an individual is having trouble using his or her money to start a business, that person can seek help from other group members or from the loan officer. Through repayment, loan recipients start to develop credit, allowing them to obtain larger loans down the line. (To learn more about credit, read, The Importance Of Your Credit Rating.)
Also, many microfinance operations require loan recipients to set aside parts of their income toward a savings account used as insurance in case of a loan default. Others also require borrowers to allocate a portion of their income to a personal savings account for use at a later date.
Who Provides the Services?
The concept of microfinance started in the late '70s and early '80s. The first organization to receive attention for its success was the Grameen Bank, which was started by Muhammad Yunus in
But a new trend has emerged in the world of microfinance - one where groups seek to use microfinance not just to help others, but to also turn a profit.
For Profit
One of the largest, and most controversial, microfinance firms is
Banco Compartamos makes loans like most other microfinance companies in that its clients are mostly women, its customers are pooled into groups, and loans are issued in relatively small amounts. However, Banco Compartamos differs from other groups when clients repay their loans. Nonprofit institutions take a more philanthropic bent with the profits, using them to expand the organization's reach or create more programs; Banco Compartamos is a publicly owned company, meaning the company's management team has to ultimately answer to its shareholders.
As a result, Banco Compartamos has been criticized by many. The most visible opponent of the bank is the grandfather of microfinance himself, Muhammad Yunus. Yunus, and others, argue that a for-profit organization works against the original mission of microfinance, which put helping the poor above all else. Compartamos argues that by becoming a profitable business, it will be able to extend its reach and help more of
In addition to Banco Compartamos, many of the world's major financial institutions and other large corporations have launched for-profit microfinance projects as they eye a chance to turn a profit by lending small amounts to the poor. CitiGroup (NYSE:C), Barclay's (NYSE:BCS), General Electric (NYSE:GE) and others have started microfinance divisions in many countries. Other companies have issued funds that invest primarily in microfinance firms, which provide money to microfinance lenders in exchange for a cut of the profits in return.
Other Criticisms
On top of the divide between non- and for-profit microfinance enterprises, other criticisms exist. Because microfinance loans are typically in the range of $100 or less, some critics say this is not enough money to provide stability while also keeping recipients working in subsistence-level trades. They cite the examples of China and India, where millions have emerged from the lowest levels of poverty due to the development of large industries. The jobs created by the construction of new factories and the production of new goods have led to stable employment and higher wages for employees.
Other critics have said that microfinance can hurt the poor by charging high interest rates. There are borrowers who cannot, or do not, repay loans. The added debt can make microfinance clients poorer that when they started, leaving them in debt and living hand-to-mouth. That said, according to IFAD, these rates are well below what local moneylenders would charge, making these micro loans a viable alternative for financing.
Does It Work?
Statistics about the success of microfinance are hard to come by, but those that are available suggest some positive results. An eight-year World Bank study in Bangladesh found that 48% of poor households with access to micro loans rose above the poverty line. Another study by Grameen Bank found that 5% of borrowers were able to lift themselves beyond the poverty line each year, and maintain these gains over time. However, other work, such as a 2005 article by Steve Beck and Tim Ogden in the Harvard Business Review, warn that there is little concrete evidence to suggest that micro borrowers escape poverty directly or permanently and that borrowers may not spend the money they obtain through microcredit on any kind of investment.
Conclusion
Microfinance provides small loans to the world's poorest people, either through nonprofit organizations or through larger commercial lenders. Whether providing financial services to groups that traditionally could not access them helps these people or only puts them further in debt is still up for debate. What is certain is that this relatively new industry is in it for the long haul.
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