Do Microfinance Companies Really Help Even the Poorest of the Poor?

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Microfinance institutions are designed to help alleviate poverty in some of the world’s poorest countries, microfinance initiatives provide loans to entrepreneurs and small businesses, hoping this will help the poor to work themselves out of desperate poverty.

However, a lot of questions are being asked as to whether these microfinance institutions are really helping the poor. Microfinance, or the provision of small loans to the poor with the aim of lifting them out of poverty, is a key poverty reduction strategy that has spread rapidly and widely over the last 20 years, currently operating in more than 60 countries.

According to many researchers and policymakers, microfinance encourages entrepreneurship, increases income-generating activity thus reducing poverty, empowers the poor (especially women in developing countries), increases access to health and education, and builds social capital among poor and vulnerable communities

What are Microfinance Institutions?
What Is The Idea Behind Microfinance
5 Thing to Know About Microfinance Companies
History of Microfinance
What Does Microfinance Mean For You?
What Are the Benefit of Microfinance?
Challenges Faced by Microfinance Institutions
What Are The Top Microfinance Institutions
Does Microfinance Improve The Lives of The Poor?

What are Microfinance Institutions?

Microfinance, also called microcredit, is a type of banking service provided to unemployed or low-income individuals or groups who otherwise would have no other access to financial services.

While institutions participating in the area of microfinance most often provide lending—microloans can range from as small as $100 to as large as $25,000—many banks offer additional services such as checking and savings accounts as well as micro-insurance products, and some even provide financial and business education. The goal of microfinance is to ultimately give impoverished people an opportunity to become self-sufficient.

In 2007, the microfinance market served more than 33 million borrowers and 48 million savers. Statistics provided by Unitus, an organization devoted toward fighting global poverty show that 80% of the potential market has not yet been reached.

What is The Idea Behind Microfinance

Microfinance services are provided to unemployed or low-income individuals because most of those trapped in poverty, or who have limited financial resources, do not have enough income to do business with traditional financial institutions.

Despite being excluded from banking services, however, those who live on as little as $2 a day do attempt to save, borrow, acquire credit or insurance, and they do make payments on their debt. Thus, many poor people typically look to family, friends, and even loan sharks (who often charge exorbitant interest rates) for help.

Microfinance allows people to take on reasonable small business loans safely, and in a manner that is consistent with ethical lending practices. Although they exist all around the world, the majority of microfinancing operations occur in developing nations, such as Uganda, Indonesia, Serbia, and Honduras. Many microfinance institutions focus on helping women in particular.

5 Thing to Know About Microfinance Companies

1. Microfinance delivers financial services to poor individuals

Microfinance specifically offers services to those who don’t have adequate credit or who are otherwise “unbanked”, meaning they do not have access the services of a traditional financial institution like a bank.

This may be because they lack the assets needed to get a loan, are deemed too poor to merit targeting, or live in a remote area where there are no financial institutions.

Microfinance institutions (MFIs), however, adapt their services to cater to these populations and get them financial credit; MFIs also typically have an explicitly “social” goal of helping these people lift themselves out of poverty. Microfinance exists all over the world (including in the United States), but is focused on the developing world due to poorer populations and lesser penetration of traditional banks.

2. Microfinance includes more than business loans

As you can see if you browse around Kiva, most microfinance takes the form of business loans, where an entrepreneur asks for an amount of loan capital to start or expand a productive business. This is the prototypical image of microfinance that many people have.

However, not all people are successful entrepreneurs just because they can get credit Microfinance comes in many other forms as well. For instance, microsavings can afford poor individuals a secure place to keep their cash earnings, and actually earn interest on their savings.

Other microfinance loan products might be specifically designed for housing (in a format like a traditional mortgage, just on a much smaller scale), or to pay for children’s school fees. This range of services helps provide clients with the products most needed to pay for (or save for) important things in their lives.

3. Kiva works through partnerships

Kiva works exclusively through Field Partners. These are the MFIs on the ground in developing countries that actually give out and administer the loans you see on Kiva.

If Kiva was the organization actually taking pictures of borrowers, giving out loans, collecting repayments, and authoring journal updates in countries stretching from Mexico to the Philippines, we think they need a few million employees. Instead, they work with MFIs in these countries to do these tasks, then provide them with interest-free loan capital every month that comes from their contributions to the website.

4. Microfinance is not “the answer” to poverty

With the rise in popularity of the Grameen Bank in the 1990s, microfinance became a familiar concept to people all over the world and a newly favored strategy for poverty alleviation. This lead some organizations and analysts to rosily portray it as a wholesale answer to poverty in the developing world.

However, microfinance is not a be-all, end-all “poverty solution.” Entrepreneurs in developing countries still have to deal with a multitude of problems that reinforce persistent poverty, such as poor public infrastructure, lack of health services, gender and social inequity, and unrepresentative governments.

These problems might prevent entrepreneurs from getting their products to market, require them to spend all their profits on medicines, or otherwise inhibit the beneficial effects of microfinance. Microfinance is, however, an excellent means to provide populations in the developing world with a means to develop their own enterprises and solutions to local poverty.

5. Microfinance empowers borrowers

This leads to the next point – microfinance is empowering for borrowers. It enables them to create homegrown solutions that address poverty in its own environment, instead of being told what to do by an outside entity that pays for a poverty intervention (usually an aid agency).

In this way microfinance not only obviates the problem of aid dependency that plagues many well-intentioned programs in the developing world, but also gives borrowers the pride of responding to poverty themselves instead of depending on the assistance of outsiders.

Microfinance is also socially empowering for the disadvantaged target groups it often serves (women, refugees, minority ethnic groups) by giving them a means to become financially independent.

History of Microfinance

Microfinance is not a new concept. Small operations have existed since the 18th century. The first occurrence of microlending is attributed to the Irish Loan Fund system, introduced by Jonathan Swift, which sought to improve conditions for impoverished Irish citizens. In its modern form, microfinancing became popular on a large scale in the 1970s.

The first organization to receive attention was the Grameen Bank, which was started in 1976 by Muhammad Yunus in Bangladesh. In addition to providing loans to its clients, the Grameen Bank also suggests that its customers subscribe to its “16 Decisions,” a basic list of ways that the poor can improve their lives.

The “16 Decisions” touch upon a wide variety of subjects ranging from a request to stop the practice of issuing dowries upon a couple’s marriage, to keeping drinking water sanitary. In 2006, the Nobel Peace Prize was awarded to both Yunus and the Grameen Bank for their efforts in developing the microfinance system.

India’s SKS Microfinance also serves a large number of poor clients. Formed in 1998, it has grown to become one of the biggest microfinance operations in the world. SKS works in a similar fashion to the Grameen Bank, pooling all borrowers into groups of five members who work together to ensure that their loans are repaid.

What Does Microfinance Mean For You?

The development and growth of the microfinance market affects more than just those who are engaging in or contemplating microfinance services. Here’s how it may affect you:

As an investor

Return-focused institutional investors are now making microfinance-related investments. In addition, major rating agencies are rating microfinance transactions. For example, Morgan Stanley issued a microfinance backed bond, which contained tranches and was rated “AA” by S&P.

This shows that microfinance is beginning to provide investment opportunities for all investors. The Micro Banking Bulletin reports that 63 of the world’s top MFIs have an average return (after adjusting for inflation and after taking out subsidies programs received) of about 2.5% of total assets.

Local and regional banks are generally the first to integrate microfinance investments into their portfolios, while large international banks currently prefer to provide financing to other banks, MFIs or NGOs. As mentioned earlier, even consumer finance companies may have exposure to microfinance activities.

As an investor, you may wish to look to see whether the companies you are investing in have exposure to microfinance and if so, whether the risk-return characteristics of those activities appeal to you. Visit the MIX market for current information on the supply, demand and facilitation of capital within the microfinance market.

As a finance professional

Microfinance requires highly specialized financial knowledge as well as a unique combination of skills, such as knowledge of social science, local languages and customs. New careers are emerging to fit these unique demands.

For finance professionals, this means that new careers are opening up for those who have these unique combinations of skills and experiences. Moreover, traditional career roles are blurring as microfinance brings together professionals with varied backgrounds to work in collaborative teams.

For example, development professionals (such as people who have worked for the Asian Development Bank or other development agencies) can now be found working side by side with venture capitalists. A wide range of microfinance career opportunities can be found at Microfinance Gateway.

As an individual

Some believe that we are living in a time when poverty may be eradicated. Studies support that belief. According to the Virtual Library on Microcredit, during an eight-year period, among the poorest in Bangladesh with no credit service of any type, only 4% pulled themselves above the poverty line.

But with individuals and families with microcredit from an MFI, more than 48% rose above the poverty line. What poverty eradication means to you as an individual depends largely upon your personal philosophy. You might welcome it as a key achievement in the history of humanity.

You also might celebrate the possibility that we each can all buy and sell to one another. Individuals who seek to be a part of this poverty eradication phenomenon may now loan money to a micro-entrepreneur in another part of the world through the non-profit online service Kiva.

What Are the Benefit of Microfinance?

1. Access

Banks simply won’t extend loans to those with little or no assets, and generally don’t engage in the small size of loans typically associated with microfinancing. Microfinancing is based on the philosophy that even small amounts of credit can help end the cycle of poverty. Many women and girls have trouble accessing formal financial institutions as they don’t have appropriate identification or certification of land and house ownership.

2. It allows people to better provide for their families.

Microfinance allows for an added level of resiliency in the developing world. Even when households are able to work their way out of poverty, it often takes just one adverse event to send them right back into it. It’s often a health care issue that causes a return to poverty. By allowing entrepreneurs to become more resilient through their own efforts at their own business, it gives them the opportunity to make it through times of economic difficulty.

Most of the households that take advantage of the microfinance offers that are available in developing countries live in what would be considered “abject poverty.” This is defined as living on $1.25 per day or less – though some definitions extend this amount to $2 per day or more. About 80% of that amount goes to the purchase or creation of food resources.

By offering microfinance products that can be repaid with that remaining 20%, more households have the opportunity to expand their current opportunities so that more income accumulation may occur.

3. It serves those who are often overlooked in society

In many developing nations, the primary recipient of microloans tends to be women. Up to 95% of some loan products are extended by microfinance institutions are given to women. Those with disabilities, those who are unemployed, and even those who simply beg to meet their basic needs are also recipients of microfinance products that can help them take control of their own lives.

Women are key figures in leadership roles in business, even in the developed world. Catalyst has reported that companies with female board directors are able to obtain returns that are up to 66% better in returns on invested capital and 42% better in terms of sales returns than companies with male board members only.

Women also develop others more frequently when it comes to entrepreneurial roles. This comes from coaching, feedback, or investments. Even in the developed world, women helping women is an economic force that poverty can’t stop.

4. It creates the possibility of future investments

The problem with poverty is that it is a cycle that perpetuates itself. When there is a lack of money, there is a lack of food. When there is a lack of clean water, there is a lack of sanitary living conditions. When people are suffering from malnutrition, they are less likely to work. A lack of sanitation creates the potential of illness that prevents working days.

Microfinance changes this by making more money available. When basic needs are met, families can then invest into better wells, better sanitation, and afford the time it may take to access the health care they need.

As these basic needs are met, it also means that there are fewer interruptions to the routine. People can stay more productive. Kids can stay in school more consistently. Better healthcare can be obtained. This creates a lower average family size because there are more guarantees of survival in place.

And when that happens, the possibility of future investments will occur because there is more confidence in being able to meet basic needs.

5. It offers a better overall loan repayment rate than traditional banking products

When people are empowered, they are more likely to avoid defaulting on a loan. Women are also statistically more likely to repay a loan than men are, which is another reason why women are targeted in the microfinance world. There’s also the fact that for many who receive a microloan, it is their only real chance to get themselves out of poverty, so they’re not going to mess things up.

Zenger Folkman published a survey regarding ratings of high integrity and honesty in leadership roles that was separated by gender. The mean percentile of women displaying these traits was 55%, while for men, it was just 48%. In business, the bottom line is this: integrity matters. Microfinance institutions have recognized this and approached women because of this.

As a side effect of this approach, many developing countries are taking a new look at what role women should play in society. Instead of treating a woman as a second-class citizen, or the “barefoot in the kitchen and pregnant” attitude that has been prevalent in the past, the success of women in bring their households out of poverty is evidence that proves women not only have an initiative to get things done, but they produce consistent results.

For these reasons, microfinance institutions see total repayment rates of higher than 98%, though there can be several accounts that are overdue at any given time.

6. It can create real jobs

Microfinance is also able to let entrepreneurs in developing countries be able to create new employment opportunities for others. With more people able to work and earn an income, the rest of the local economy also benefits because there are more revenues available to move through local businesses and service providers.

It’s not just the entrepreneurial level that benefits from job creation through microfinance. Grameen Bank in Bangladesh employs over 21,000 people and their primary financial products are related to microfinance. That’s tens of thousands of jobs that are created by the industry with the sole purpose of being able to drag people up and out of poverty.

7. It encourages people to save

Microloans are an important component of microfinance, but so is saving money. When people have their basic needs met, the natural inclination is for them to save the leftover earnings for a future emergency. This creates the potential for more investments and ultimately even more income for those who are in the developing world.

Some microfinance institutions have seen an extraordinary number of savings occur when products are extended. The Unit Desai of Bank Rakyat Indonesia counts 28 million savers to just 3 million microloan borrowers.

Now saving isn’t always seen, especially from borrowers, but this is part of the expected microfinance process. Small loans make small financial improvements for households living in poverty. The difference between making $1.90 per day and $2.30 per day is not much in reality, but by definition, that amount takes someone out of extreme poverty.

Instead of big improvements, microfinance allows for small improvements. When enough of those improvements occur, then there is a safe place for people to store their income thanks to this industry.

8. It offers significant economic gains even if income levels remain the same

The gains from participation in a microfinance program including access to better nutrition, higher levels of consumption, and consumption smoothing. There is also an unmeasurable effect which occurs when women are empowered to do something in their society when they might not normally be allowed to do so.

As spending occurs, these benefits also extend outward to those who may not be participating in the program so that the entire community benefits.

The most important weakness of microfinance is that the effects of raising income levels for the poor can often be questionable. Although it raises the possibility of income accumulation and savings, microfinance products also raise the possibility of creating a further indebtedness that may potentially extend the cycles of poverty for an infinite period of time.

Although some may look at consumption in a negative view, those who have gone without for so long will see improved consumption as a sign that things are getting better. Consumption smoothing allows an entire community to realize the benefits that microfinance can provide.

It isn’t always about the money. Sometimes economic success comes from stability.

Yet if you were to ask the average person who was the recipient of a microloan how they felt about the experience, you would be told that they were happy the loan was available. This happiness is reflected in the high repayment rates that are almost always seen in programs offered within developing countries. That in itself shows that the benefits of microfinance, at a core level, are almost always leaving a positive effect.

Challenges Faced by Microfinance Institutions

Microfinance institutions serving retail customers have to face quite a specific set of challenges, which cannot be addressed with solutions meant for commercial banks. These challenges include:

Cost of outreach – reaching the unbanked populations of the world means servicing small loan amounts and servicing remote and sparsely populated areas of the planet, which can be dangerously unprofitable without high rates of process automation and mobile delivery.
Lack of scalability – smaller microfinance systems often struggle to preserve the profitability and performance in these markets, as FI’s experience high growth rates that result from getting the service delivery right. This results in thwarting the growth of these organizations.
Quality of SHGs (Self Help Groups) – Due to the fast growth of the SHG-Bank Linkage Programme, the quality of MFIs has come under stress. This is due to various reasons such as:

The intrusive involvement of government departments in promoting groups
Diminishing skill sets on part of the MFIs members in managing their groups.
Changing group dynamics.

Geographic Factors – Around 60% of MFIs agree that the Geographic factors make it difficult to communicate with clients of far-flung areas which create a problem in growth and expansion of the organization.
Diverse business models – Supporting the very wide range of features and lending activities is difficult and requires a considerable amount of cost and efforts.
High Transaction Cost – High transaction cost is a big challenge for microfinance institution. The volume of transactions is very small, whereas the fixed cost of those transactions is very high.
KYC and security challenges – The customers serviced by Microfinance instructions are usually the ones having none or very limited official identification or able to provide tangible security, this makes it extremely difficult for institutions to offer any banking services.
Limited budgets – Making provisions for large upfront investments is not possible for most of the MFIs which limits their capability to purchase world-class banking solutions that can help them fulfil their requirements and support their growth targets.

No doubt, microfinance institutions have shown impressive growth and have been instrumental in the cause of financial inclusion, but a lot remains to be achieved.

What Are The Top Microfinance Institutions

Here are the five largest and most influential MFIs today.

1. 51Give

Founded in 2007 in Beijing, 51Give provides microfinance solution services for other MFIs. The organization offers an e-commerce platform that offers both online and mobile technology designed to connect individuals, companies, organizations and institutions with local MFIs, thus facilitating donations, investments and the delivery of microfinancing services. As of 2020, 51Give’s platform was being used by more than 100 charitable organizations^.

2. Bank Raykat Indonesia

Bank Raykat (ticker: BBRI.JK:, DR250), also known as Bank Raykat Indonesia, is the oldest Indonesian bank, founded in 1896 in Jakarta, and has established itself as one the country’s largest financial institutions, while operating primarily as a small-scale and microfinance lender, with more than 30 million retail banking clients conducting business with the bank through thousands of branches and rural service posts throughout southeast Asia. Bank Raykat Indonesia is 56.75% government-owned.

3. BRAC

One of the oldest existing MFIs is BRAC, founded in 1972 in Bangladesh. BRAC provides a broad range of services in the areas of human rights, education, health and economic development, including grants and small business loans, housing assistance and microsavings services. BRAC operates in a dozen developing countries, stretching from Haiti to Myanmar to the Philippines. According to the 2018 annual report, its microfinance loan program had more than $2.3 billion in assets.

4. Grameen Bank

Grameen Bank, founded in Bangladesh in 1983, holds the distinction of being a Nobel Peace Prize-winning MFI. It originated as a result of the work of its founder, Muhammad Yunus, whose research pioneered the concept of providing micro-banking services and non-collateralized loans for the poor in order to alleviate poverty.

As of 2020, Grameen Bank has more than nine million borrowers and a loan portfolio in excess of $20 billion. In addition to providing microcredit and other banking services, the bank also has a low-cost housing program that won a World Habitat award in 1998. In 2008, Grameen also extended operations to the United States.

5. Kiva

Founded in 2005 and headquartered in San Francisco, Kiva Microfunds is a nonprofit MFI that operates in the United States and more than 80 other countries worldwide. Kiva’s operational method for providing microfinance lending is through establishing crowdfunding, or peer-to-peer (P2P) lending, the platform that allows individuals to lend directly to borrowers in other countries who lack access to traditional financing sources.

Kiva provides interest-free financing for small businesses, education, and health services such as clean water. As of 2020, Kiva has extended more than $1.4 billion in microloans to 3.5 million borrowers and has a network of approximately 1.8 million lenders and approximately two million borrowers.

Does Microfinance Improve The Lives of The Poor?

There are strong reasons to believe that clients around the world value financial services as coping tools the same way that the financial diary households described in Portfolios do. The evidence comes mainly from the observed
the behavior of hundreds of millions of clients who demonstrate how important microfinance is to them by “voting with their feet.

So how does microcredit help people, if not by raising their incomes on average? Research that looks closely at the financial lives of people living on $2 or less per day, such as the work of researchers Daryl Collins, Jonathan Morduch, Stuart Rutherford, and Orlanda Ruthven in Portfolios of the Poor, shows that credit often plays a crucial role in borrowers’ lives.

Part of that story is that people very often use microcredit for their day-to-day needs, rather than for business loans, as Yunus had originally envisioned. They may have a need for cash to meet emergencies, or for a big purchase, or even just to provide an inflow of money to put food on the table when income fluctuates — and microcredit helps to meet that need.

In fact, microcredit organizations are far from the only source of credit — people often take small loans from friends and family, or from local shopkeepers, for example.

But a really valuable aspect of microcredit is its reliability: People can depend on getting a loan at a certain time, then commit to the small, regular repayments so that they can get a further loan.

There are also other potential benefits of increasing access to credit. In Due Diligence, Roodman also points to Nobel Laureate economist Amartya Sen’s view about the value of increased freedom, in the sense of greater agency in one’s life. By giving the poor a greater number of options in how to navigate their financial lives, Roodman suggests, microcredit can increase this kind of freedom.

Roodman emphasizes that the details matter — some ways of offering microcredit might offer more freedom than others. For example, he writes that group microcredit “emerges in a surprisingly negative light” when looking at financial diaries. Groups that are “responsible for each other’s loans can generate ‘peer support’ in times of difficulty — or peer pressure to pay no matter what.”

There’s also some evidence — from a study in the Philippines by economists Xavier Giné and Dean Karlan — that group liability might not be necessary to achieve high repayment rates. Over time, some institutions have moved toward individual loans instead, while still keeping the group meetings.

Finally, there’s evidence that suggests that microcredit may be playing a broader positive role. For example, economists Emily Breza and Cynthia Kinnan studied what happened in Andhra Pradesh, India, when microcredit institutions were shut down in 2010.

They found that this was followed by a notable decrease in wages in rural areas. They write that this result “shows that microfinance, despite its small loan sizes, can have meaningful impacts on rural economies.” It also suggests that the full picture of microcredit isn’t captured in studies that only look at individual borrowers.

Final Thoughts

Whether or not one concludes that microcredit beats cash transfers or other ways to help the poor, there’s still reason to believe that microcredit has done — and continues to do — a lot of good, at fairly low cost.

Beyond that, there’s reason to believe that there may be ways to make small loans (as well as broader financial services such as micro-savings and micro-insurance) even more useful to those living on very low incomes.

To some, the new vision of microcredit — helping poor people to better face their financial challenges — may not hold the simple allure of the old one.

But the researchers who wrote Portfolios of the Poor and looked closely at the lives of those living on $2 per day find the new narrative inspiring nonetheless: “Whether or not the microfinance movement was right to stress loans for microenterprises, or has been too slow to embrace savings and other services, its greatest contribution is, to us, beyond dispute. It represents a huge step in the process of bringing reliability to the financial lives of poor households.”

The story of microcredit illustrates that even where a program doesn’t live up to the hype, it can still be a success.