Financial institutions offer different types of services to meet the needs of their diverse customer base. In this guide, we will focus on microfinance. Read on to learn how this service works and its history.
Defining Microfinance
Also known as microcredit, Microfinance is a banking service intended for low-income groups or individuals who are not served by big financial institutions. Banks that provide microfinancing services lend loans ranging from $50 to $50,000. Moreover, they provide extra services like savings and checking accounts.
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The goal of microfinance is to allow people making as little as $3 a day to access credit and save. So, instead of low-income earners seeking loans from shylocks who charge exaggerated interest rates, they can acquire credit at reasonable rates from banks offering microfinancing services.
Although the microfinance concept is adopted worldwide, it’s popular in developing countries like Cambodia, Bangladesh, Indonesia, the Democratic Republic of Congo, Ecuador, Indonesia, India, and Afghanistan.
Besides offering loans and various types of accounts, many microfinancing institutions also provide educational programs that educate their clients on the principles of investing. As a customer, you can learn vital skills such as cash-flow management, bookkeeping, and accounting, among others.
Before taking loans from a microfinance provider, you are required to learn about interest rates, budgeting, managing debt, and how loan agreements work. After that, you can apply for a loan. The lending process is similar to that of a conventional loan. First, the customer submits a loan application., which the lender reviews. After reviewing, the lender approves or rejects the application. If your loan request is approved, you will be notified and required to agree to the loan terms before the lender transfers the loan amount to your bank account.
Loan Terms in Microfinancing
Like traditional lenders, providers of microfinancing services charge loan interest and impose repayment plans. In some cases, borrowers are required to maintain a specific amount in their savings accounts as collateral. However, since most borrowers cannot provide collateral, lenders usually pool them together as a shield. That means when the borrowers receive their loans, they repay them together. Since the success of microfinancing services relies on each borrower’s contribution, this helps exert pressure that ensures everyone makes repayments.
Like conventional loans, microfinance loans have an effect on the borrowers’ credit history. Those who repay their debt on time stand a chance of qualifying for a bigger loan in the future.
Notably, repayment rates on loans taken from microfinancers have been reported to be higher than those on traditional loans. For instance, Bangladesh-based microlender Grameen Bank reported a 98% average repayment rate in 2023.
History of Microfinance
One might think that microfinance is a new concept. However, it has been in existence since the eighteenth century. Jonathan Swift, a financial expert, was the first to introduce it. He intended to make it possible for low-earners in Ireland to access funds. The microfinance concept became more popular in the 1980s.
Grameen Bank was among the first banks to adopt microfinance. On top of providing loans to the underserved, Grameen Bank launched an education program dubbed “16 Decisions,” which taught customers of its microfinancing services on how to improve their lives. In 2006, the bank won a Nobel Peace Prize for its efforts to better people’s lives through microfinancing.
Benefits of Microfinance
According to a report released by a US-based nonprofit organization called the Consultative Group to Assist the Poor, microfinancers have helped more than 150 million underserved individuals access credit. However, over 1.5 billion people who lack access to setting up financial accounts are yet to benefit from microfinance loans.
Criticism About Microfinance
Some critics of microfinance argue that the loan amounts offered by microfinancers are too little to provide financial independence. Instead, they only cover basic needs such as shelter and food. Others want microfinancing institutions to offer interest-free loans, claiming that the rates are a burden to borrowers who only make a few dollars per day.