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What is 'Microfinance'

Microfinance is a type of banking service that is provided to unemployed or low-income individuals, or groups who otherwise have no other access to financial services. Ultimately, the goal of microfinance is to give low-income people an opportunity to become self-sufficient by providing a way to save money, borrow money and get insurance.

BREAKING DOWN 'Microfinance'

Microfinancing provides options to customers with limited resources to promote participation in productive activities or to support a small business. While institution participating in the area of microfinance are most often associated with lending, some microfinance companies offer additional services, including bank accounts and insurance. Additionally, some institutions provide information in the areas of financial literacy, such as understanding interest rates and managing financial risks.

Microfinancing is not a new concept. Small microcredit operations have existed since the 18th century. The first occurrence of microlending was attributed to the Irish Loan Fund system, introduced by Jonathan Swift, which sought to improve conditions for impoverished Irish citizens.

Microfinance Loan Terms

Like conventional banking operations, microfinance lenders must charge interest on loans, and they institute specific repayment plans with payments due at regular intervals. Not all applicants qualify, depending on the amount of default risk the institution attributes to potential borrowers and the terms of the loans for which the borrowers are applying.

Concerns Regarding the Microfinance Industry’s Practices

While these interest rates are generally lower than those offered by normal banks, some opponents of this concept raise concern that microfinance operations are making profits off of the poor. Not all funds provided through microfinancing are used for productive activities; some may be used for covering needs, such as food and shelter.

Microfinancing Operating Locations

The majority of microfinancing operations occur in developing nations, such as Uganda, Indonesia, Serbia and Honduras. Even though the borrowers often qualify as very poor, repayment rates are often seen to be higher than the average repayment rate on more conventional forms of financing. For example, the microfinancing institution Opportunity International reported repayment rates of approximately 98.9% in 2016.

International Finance Corporation Estimates

The International Finance Corporation (IFC), part of the larger World Bank Group, estimates that more than 130 million people have directly benefited from microfinance-related operations as of 2014. However, it is only available to approximately 20% of the 3 billion people who qualify as part of the world’s poor.

In addition to providing microfinancing options, the IFC has assisted developing nations in the creation or improvement of credit reporting bureaus in 30 nations. It has also advocated for the addition of relevant laws governing financial activities in 33 countries.