"One day our grandchildren will go to museums to see what poverty was like"
What Is Microfinance?
Microfinance is a broad term referring to a number of financial services offered to underprivileged people around the world including credit, savings, insurance, and fund transfers. Currently, the most widely known form of Microfinance is Microcredit, or the provision of small, short term loans to underprivileged entrepreneurs unable to secure other forms of credit due to limited or no credit history, or a lack of sufficient collateral.
How do loans offered through Microcredit differ from a traditional loan?
Loans offered through Microcredit institutions differ from a traditional loan in several important ways:
- Size of the loan: Unlike many major banks, Microcredit institutions are able to offer loans in very small denominations, such as a $25 loan over a 6-12 month repayment period. Small loans may be used to expand a business, purchase new equipment, or increase economies of scale by purchasing the necessary supplies for products in greater quantities.
- Repayment Period: As compared to other loans, Microcredit is able to offer loans with relatively long repayment periods as compared to the total loan amount. For example, a loan for $25 may be repayed over a period of 12 months or greater!
- Percent interest: Loans provided by Microcredit institutions also typically have comparatively high interest rates as compared to other loans. Rates may be as low as 30%, or as high as 50% or more! Although these high interest rates exist for a number of reasons, one significant contributor is low loan size; by offering very small loans, the overhead incurred by Microcredit institutions per dollar is very high. For example, while $20,000 could easily be a single loan in the United states (and incur a proportionally smaller overhead due to the reduced number of clients), the same $20,000 at a Microcredit institution may serve as many as 800 clients!
- Repayment Rates: Despite the lack of credit history or collateral, Microcredit institutions typically see very high repayment rates -- significantly higher than most commercial banks, that can approach 100% repayment.
Group Repayment: Another loan innovation used by Microcredit is the concept of support groups for borrowers. Rather than lending money to a single individual, Microcredit institutions often ask potential borrows to form groups with 4-5 other potential borrowers. in the event that a single borrower cannot make a loan repayment on time, the other group members can temporarily cover the repayment. The creation of a tight knit group of borrowers that depend on each other decreases the likelihood of any one member defaulting on their loan. In addition, the increased "collateral" provided by the group also allows Microcredit institutions to offer loans at reduced interest rates.
I just want some quick facts about Microfinance!
Some information about the current status of Microfinance:
- No collateral is required. Instead, joint liability between 4-5 borrowers is used
- Repayment rates exceed 95% (2006)
- The Majority of borrowers are women, due to significantly higher repayment rates
- $23 billion loaned to 52 million people
- 500 million poor 'micro-entrepreneurs' worldwide
- ‘High’ interest rates
- Short loan terms