Table of Contents Hide
- What Is Microfinance?
- What Is the Purpose of Microfinance?
- Microfinance Loan Terms
- History Of Microfinance
- What Are The Benefits of Microfinance?
- What Are Microfinance Loans?
- How Do Microfinance Loans Work?
- Types of Microfinance Loans
- Advantages And Disadvantages Of Microfinance Loans
- What Is A Microfinance Company?
- Top Microfinance Companies
- What Is The Difference Between Bank And Microfinance?
- What Is Another Name For Microfinance?
- In Conclusion,
Microfinance is a method of providing small amounts of funding, savings, insurance, and other relevant financial services to underbanked working individuals or families, entrepreneurs, and small enterprises who do not have access to regular financial bank services. The primary activity of most microfinance companies is to provide small loans, known as microloans or microcredit, to entrepreneurs or the working poor in developing countries, often in the range of a few hundred dollars. Here, we’ll explain the meaning of microfinance, its history, and the top microfinance companies in the world.
What Is Microfinance?
Microfinance, often known as microcredit, is a sort of banking service offered to unemployed or low-income individuals or groups who would not otherwise have access to financial services.
While institutions involved in microfinance typically provide lending—microloans can vary from $100 to $25,000—many banks also provide additional services such as checking and savings accounts, micro-insurance products, and financial and business education. The ultimate purpose of microfinance is to provide underprivileged people with the opportunity to become self-sufficient.
What Is the Purpose of Microfinance?
Microfinance is intended to give financial services to persons who are “usually excluded from typical banking channels due to their low, irregular, and uncertain income,” according to ING, a global financial institution with a major European presence. According to ING, the goal of microfinance is to help disadvantaged households and entrepreneurs gain access to affordable financial services to help them finance income-generating activities, accumulate assets through savings, provide for family needs, and protect themselves against daily risks such as illness, death, theft, and natural disasters.
Microfinance, whether for-profit or charity, attempts to aid the poor, and microfinance institutions seek to be the poor’s bankers. For-profit microfinance firms regard this area as underserved and ripe for profit. Nonprofit microfinance organizations, on the other hand, support the needy for altruistic motives.
Microfinance Loan Terms
Microfinanciers, like traditional lenders, must charge interest on loans and implement specified repayment plans with payments due at regular intervals. Some lenders demand loan recipients save a portion of their earnings in a savings account that can be used as insurance if the consumer defaults. If the borrower successfully repays the debt, they have simply amassed extra savings.
Empowering women in particular, as many microfinance companies do, may lead to greater family stability and success.
Because many applicants lack collateral, microlenders frequently pool borrowers as a cushion. Following loan receipt, participants repay their debts collectively. Because the program’s success is dependent on everyone’s contributions, this provides a type of peer pressure that can aid in payback.
For example, if a person is having difficulty using their money to develop a business, they can seek assistance from other group members or the loan officer. Loan receivers begin to build a strong credit history through repayment, which permits them to acquire larger loans in the future.
Surprisingly, despite the fact that these borrowers frequently qualify as very poor, repayment amounts on microloans are frequently higher than the average repayment rate on more traditional types of finance. The microfinance institution Opportunity International, for example, recorded repayment rates of around 98 percent.
History Of Microfinance
Microfinance is not a novel idea. Since the 18th century, small businesses have existed. The earliest instance of microlending is ascribed to Jonathan Swift’s Irish Loan Fund scheme, which intended to ameliorate conditions for disadvantaged Irish citizens. Microfinancing, in its contemporary form, became widely popular in the 1970s.
The Grameen Bank, founded in 1983 by Muhammad Yunus in Bangladesh, was the first to garner prominence. In addition to loans, Grameen Bank recommends that its customers subscribe to its “16 Choices,” a basic list of ways that the poor can improve their lives.
The “16 Decisions” include a wide range of topics, from a request to end the tradition of issuing dowries upon a couple’s marriage to keeping drinking water clean. Yunus and the Grameen Bank were both given the Nobel Peace Prize in 2006 for their contributions to the development of the microfinance system.
SKS Microfinance in India also serves a huge number of low-income consumers. It was founded in 1998 and has evolved to become one of the world’s largest microfinance operations. SKS operates similarly to Grameen Bank, grouping all borrowers into groups of five people who collaborate to guarantee that their loans are returned.
Other microfinance operations exist all throughout the world. Several larger organizations collaborate closely with the World Bank, while others operate in separate countries. Some organizations allow lenders to pick and choose who they wish to support, categorizing borrowers based on factors such as poverty level, geographic region, and type of small business.
What Are The Benefits of Microfinance?
According to the World Bank, more than 500 million people have profited directly or indirectly from microfinance activities. The Consultative Group to Help the Poor, a global nonprofit organization located in Washington, forecasts that by 2021, more than 120 million people would have directly benefited from microfinance-related operations. These procedures, however, are only available to a subset of the world’s poor, while an estimated 1.7 billion individuals lack access to basic financial accounts.
In addition to providing microfinance choices, the IFC has assisted developing countries in establishing or improving credit reporting bureaus. It has also lobbied for the addition of suitable regulations governing financial activities in developing countries.
The advantages of microfinance go beyond simply providing them with a source of capital. Entrepreneurs who start successful enterprises provide jobs, trade, and overall economic growth in their communities.
What Are Microfinance Loans?
Microfinance loans are a type of financing that assists persons with low or no regular income in gathering funds to meet their financial needs. These alternatives have been developed for those who are unable to meet the tougher standards of conventional lending options.
Microfinance loans can be used to meet both personal and commercial financial obligations. It enables individuals with low income to live a self-sufficient lifestyle while assisting start-ups with limited resources in raising money. Microfinance institutions (MFIs) are available to assess the requirements of these individuals or groups of individuals and provide the necessary financial help.
How Do Microfinance Loans Work?
Microfinance loans are for people who do not qualify for traditional financing options or who are unable to access other loan alternatives due to tougher eligibility requirements. Individuals from low-income groups or with restricted earnings can use microfinance to open savings accounts, receive financial transfers, obtain microcredit, and so on.
In 1976, Muhammad Yunus, an economist from Bangladesh, introduced microfinance because he believed it would help the society’s financially underprivileged population obtain financial freedom. Furthermore, while people use these loans to meet their needs, start-ups use them as working capital loans.
MFIs that provide these loans began as non-profit organizations. Yet, because there is a great need for money in developing nations, operating as a non-profit venture was difficult to continue. As a result, they became for-profit businesses.
Microfinance loans have higher interest rates than traditional financing sources. This is due to the risk that lenders assume by lending to the economically disadvantaged segments of society. The higher the interest rate, the greater the danger. Furthermore, the administrative costs for these loans are enormous, accounting for approximately 10-15% of the loans. And, because the loans are for such a short period of time, the institutions strive to compensate the administrative costs with higher interest rates.
Currency fluctuations and inflation are other key drivers of financial institution losses. As a result, they preserve a minimum of operational profits for themselves, which cover a 5-10% margin. As a result, currency fluctuations and inflation have no effect on their losses. Nonetheless, they have a major impact on the interest rates of microcredit choices.
Types of Microfinance Loans
These loans work on two models, which divide the financing possibilities into two types of microfinance loans. The first is a model based on relationships, and the second is a collective model. Because of the good terms they create with the bank, the former assists entrepreneurs and small enterprises have their loans granted. On the contrary, the latter allows for the facilitation of services for a group of people when they apply for the loan jointly.
Advantages And Disadvantages Of Microfinance Loans
Microfinance loans assist many low-income groups in becoming financially stable in terms of their personal and professional needs. Yet, there are a few hazards associated with allowing these financial solutions. Understanding the benefits and drawbacks aids in understanding the concept of microfinance loans. Let’s take a brief look at them:
- Aids in the financial independence of society’s poorest members; promotes entrepreneurship and the start-up ecosystem
- Encourages consumers to pursue financial education in order to fully comprehend the schemes.
- Ideal for those who live in distant areas and do not have access to other forms of finance.
- Loans with higher interest rates
- Lenders may profit from the scenario.
What Is A Microfinance Company?
A microfinance company is primarily a non-profit organization that makes loans to low-income clientele, such as micro-businesses and the self-employed, who do not have access to traditional sources of funding from banks. Nonetheless, there has recently been a growth in the number of profit-seeking microfinance institutions that will seek a clear return for investors. However, they are mostly found outside the United States.
Microfinance companies typically make small loans for short periods of time, sometimes a year or less. The distinction between company loans and bank loans is that company loans are not secured by collateral assets. As a result, the services supplied by these companies are most appealing to people from lower socioeconomic backgrounds. The mission of microfinance institutions is to promote social and economic development. As a result, they are more concerned with the environmental and social hazards associated with their transactions, and they take specific precautions to manage them.
Top Microfinance Companies
#1. Pacific Community Ventures, Inc.
Pacific Community Ventures, which was created in 1998, makes microloans for small businesses in California. Loan amounts range from $10,000 to $20,000, with the purpose of establishing quality jobs and social investments. To realize its goal of a better community, the company collaborates with businesses, policymakers, and impact investors. Pacific Community Ventures, in addition to giving loans to small businesses, attempts to provide advice and mentorship to help small businesses succeed. The corporation has made loans totaling $25 billion.
#2. The CDC Small Business Finance Corporation.
CDC Small Business Finance Corp., founded in 1978, provides cash, loans, and financial services to small businesses in Arizona, California, and Nevada, regardless of their business cycle. This comprises both new and established businesses. The company has made $20.7 billion in loans and employed 269,000 people.
#3. BRAC USA
BRAC, formed in 1972 in Bangladesh, is one of the oldest existing MFIs. The North American affiliate is BRAC USA. BRAC USA offers a variety of services in the areas of human rights, education, health, and economic development, such as grants and small business loans, housing aid, and microsavings. BRAC USA serves 100 million people throughout 11 nations. Loans totaling $2.3 billion have been made available by the company.
#4. Grameen Americas, Inc.
Grameen Bank, founded in Bangladesh in 1983, is a Nobel Peace Prize-winning microfinance institution. It sprang from the study of its creator, Muhammad Yunus, who pioneered the notion of offering micro-banking services and non-collateralized loans to the underprivileged in order to alleviate poverty. In addition to microcredit and other banking services, the bank maintains a low-cost housing program that was recognized by World Habitat in 1998.
Kiva, founded in 2005 and based in San Francisco, is a nonprofit microfinance institution that operates in the United States and more than 80 other countries across the world. Kiva’s operational strategy for delivering microfinance loans is to set up a crowdfunding or peer-to-peer (P2P) lending platform that allows users to lend directly to borrowers in other countries who do not have access to traditional financial sources. Kiva offers interest-free loans to small enterprises, education, and health services like clean water. Kiva has made loans totaling more than $1.6 billion.
What Is The Difference Between Bank And Microfinance?
Microfinance serves the financial needs of the poor and micro enterprises and is typically a collateral-free short-term facility. On the other hand, commercial banks typically serve corporate clients, SMEs, and individuals with higher income levels and extend financing facilities primarily based on collateral and the borrower’s ability to repay.
What Is Another Name For Microfinance?
Microfinance can also be called microcredit, or microloan.
Microfinance is a sort of banking service offered to unemployed or low-income individuals or groups who would not otherwise have access to financial services. Microfinance is important because it provides much-needed financial services to low-income households, entrepreneurs, and start-up firms that would not otherwise have access to such services.
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