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.

Microfinance began in the 1970s when social entrepreneurs began lending money on a large scale to the working poor. One individual who gained worldwide recognition for his work in microfinance is professor Muhammad Yunus who, with Grameen Bank, won the 2006 Nobel Peace Prize.

Yunas and Grameen Bank demonstrated that the poor have the ability to pull themselves out of poverty. Yunus also demonstrated that loans made to the working poor, if properly structured, had very high repayment rates. His work caught the attention of both social engineers and profit-seeking investors.

• What are the Features of Efficient and Effective Microfinance System?
• Microfinance standards and principles
• Microfinance debates and challenges
• Microfinance & Macrofinance: What’s the Difference?

What are the Features of Efficient and Effective Microfinance System?

Microfinance defined as credit and savings to provide other financial services such as transfers, insurance, consumer loans, marriage loans, technical assistance, credit cards, payment services.

Read Also: Microfinance is Empowering Women Across the Globe

Microfinance programs focus on two main components:

– The need to provide a variety of financial services, not only lending services;

– Provide such diverse financial services to poor people who are able to slice the creation of income-generating projects.

What can be said from the foregoing is that the concept of microfinance is intended to those programs that focus on providing a variety of financial services, not only lending services to individuals who do not have the ability to get those services from formal financial institutions, who at the same time to start investment projects income-generating, in the sense that it comes to addressing the problem of poverty and unemployment, in addition to addressing the problem of economic and social exclusion experienced by many individuals with low profitability and high risk from the standpoint of formal financial institutions.

Microfinance properties

Working in the field of microfinance institutions programs following characteristics and Judith Lawrence characterized (1998):

• provide small and short-term loans for working capital purposes;
• simple and easy evaluation of the investments of borrowers;
• the use of innovative alternatives Kaldmanat collective style mandatory savings instead of using collateral;
• potential borrower for new loans will depend on the extent of fulfilling its obligations to repay previous loans;
• payment simplified and rapid loan installments as a method of payment weekly or monthly, or daily payment method in some microfinance programs;
• high collection rates for the loan installments loan collection rates compared to the level of some of the traditional financial institutions;
• use voluntary savings as a way of tools increases the borrower’s ability to meet its own needs situational;
• impose high interest rates to cover the high costs involved in microfinance transactions prices;
• use of alternative approaches to collateral;
• appropriate location and timing of the payment;
• appropriate financial services in terms of speed, timing and value.

Microfinance gives access to financial and non-financial services to low-income people, who wish to access money for starting or developing an income generation activity. The individual loans and savings of the poor clients are small.

Microfinance came into being from the appreciation that micro-entrepreneurs and some poorer clients can be ‘bankable’, that is, they can repay, both the principal and interest, on time and also make savings, provided financial services are tailored to suit their needs.

Microfinance as a discipline has created financial products and services that together have enabled low-income people to become clients of a banking intermediary. The characteristics of microfinance products include:

• Little amounts of loans and savings.
• Short- terms loan (usually up to the term of one year).
• Payment schedules attribute frequent installments (or frequent deposits).
• Installments made up of both principal and interest, which amortized in course of time.
• Higher interest rates on credit (higher than commercial bank rates but lower than loan-shark rates), which reflect the labor-intensive work associated with making small loans and allowing the microfinance intermediary to become sustainable over time.
• Easy entrance to the microfinance intermediary saves the time and money of the client and permits the intermediary to have a better idea about the clients’ financial and social status.
• Application procedures are simple.
• Short processing periods (between the completion of the application and the disbursement of the loan).
• The clients who pay on time become eligible for repeat loans with higher amounts.
• The use of tapered interest rates (decreasing interest rates over several loan cycles) as an incentive to repay on time. Large size loans are less costly to the Microfinance Institution, so some lenders provide large size loans on relatively lower rates.
• No collateral is required contrary to formal banking practices. Instead of collateral, Microfinance intermediaries use alternative methods, like, the assessments of clients’ repayment potential by running cash flow analyses, which is based on the stream of cash flows, generated by the activities for which loans are taken.

Microfinance standards and principles

Poor people borrow from informal moneylenders and save with informal collectors. They receive loans and grants from charities. They buy insurance from state-owned companies.

They receive funds transfers through formal or informal remittance networks. It is not easy to distinguish microfinance from similar activities. It could be claimed that a government that orders state banks to open deposit accounts for poor consumers, or a moneylender that engages in usury, or a charity that runs a heifer pool are engaged in microfinance.

Ensuring financial services to poor people is best done by expanding the number of financial institutions available to them, as well as by strengthening the capacity of those institutions. In recent years there has also been increasing emphasis on expanding the diversity of institutions since different institutions serve different needs.

Some principles that summarize a century and a half of development practice were encapsulated in 2004 by CGAP and endorsed by the Group of Eight leaders at the G8 Summit on 10 June 2004:

• Poor people need not just loans but also savings, insurance, and money transfer services.
• Microfinance must be useful to poor households: helping them raise income, build up assets, and/or cushion themselves against external shocks.
• “Microfinance can pay for itself.” Subsidies from donors and government are scarce and uncertain and so, to reach large numbers of poor people, microfinance must pay for itself.
• Microfinance means building permanent local institutions.
• Microfinance also means integrating the financial needs of poor people into a country’s mainstream financial system.
• “The job of the government is to enable financial services, not to provide them.”
• “Donor funds should complement private capital, not compete with it.”
• “The key bottleneck is the shortage of strong institutions and managers.” Donors should focus on capacity building.
• Interest rate ceilings hurt poor people by preventing microfinance institutions from covering their costs, which chokes off the supply of credit.
• Microfinance institutions should measure and disclose their performance – both financially and socially.
• Microfinance is considered a tool for socio-economic development and can be clearly distinguished from charity. Families who are destitute, or so poor they are unlikely to be able to generate the cash flow required to repay a loan, should be recipients of charity. Others are best served by financial institutions.

Microfinance debates and challenges

There are several key debates at the boundaries of microfinance.

Loan Pricing

Before determining loan price one should take these two costs; Administrative costs by the bank(MFI) and transaction cost by the client/customer. Customers, on the other hand, may have expenses for traveling to the bank branch, acquiring official documents for the loan application, and loss of time when dealing with the MFI (“opportunity costs”).

Hence, from a customer’s point of view, the cost of a loan is not only the interest and fees she/he has to pay but also all other transaction costs that she/he has to cover.

One of the principal challenges of microfinance is providing small loans at an affordable cost. The global average interest and fee rate is estimated at 37%, with rates reaching as high as 70% in some markets. The reason for the high-interest rates is not primarily cost of capital.

Indeed, the local microfinance organizations that receive zero-interest loan capital from the online microlending platform Kiva charge average interest and fee rates of 35.21%. Rather, the main reason for the high cost of microfinance loans is the high transaction cost of traditional microfinance operations relative to loan size.

Microfinance practitioners have long argued that such high interest rates are simply unavoidable, because the cost of making each loan cannot be reduced below a certain level while still allowing the lender to cover costs such as offices and staff salaries.

For example, in Sub-Saharan Africa credit risk for microfinance institutes is very high, because customers need years to improve their livelihood and face many challenges during this time. Financial institutes often do not even have a system to check the person’s identity.

Additionally, they are unable to design new products and enlarge their business to reduce the risk. The result is that the traditional approach to microfinance has made only limited progress in resolving the problem it purports to address: that the world’s poorest people pay the world’s highest cost for small business growth capital.

The high costs of traditional microfinance loans limit their effectiveness as a poverty-fighting tool. Offering loans at interest and fee rates of 37% mean that borrowers who do not manage to earn at least a 37% rate of return may actually end up poorer as a result of accepting the loans.

According to a recent survey of microfinance borrowers in Ghana published by the Center for Financial Inclusion, more than one-third of borrowers surveyed reported struggling to repay their loans. Some resorted to measures such as reducing their food intake or taking children out of school in order to repay microfinance debts that had not proven sufficiently profitable.

In recent years, the microfinance industry has shifted its focus from the objective of increasing the volume of lending capital available, to address the challenge of providing microfinance loans more affordably.

Microfinance analyst David Roodman contends that, in mature markets, the average interest and fee rates charged by microfinance institutions tend to fall over time. However, global average interest rates for microfinance loans are still well above 30%.

The answer to providing microfinance services at an affordable cost may lie in rethinking one of the fundamental assumptions underlying microfinance: that microfinance borrowers need extensive monitoring and interaction with loan officers in order to benefit from and repay their loans.

The P2P microlending service Zidisha is based on this premise, facilitating direct interaction between individual lenders and borrowers via an internet community rather than physical offices.

Zidisha has managed to bring the cost of microloans to below 10% for borrowers, including interest which is paid out to lenders. However, it remains to be seen whether such radical alternative models can reach the scale necessary to compete with traditional microfinance programs.

Use of loans

Practitioners and donors from the charitable side of microfinance frequently argue for restricting microcredit to loans for productive purposes—such as to start or expand a microenterprise.

Those from the private-sector side respond that, because money is fungible, such a restriction is impossible to enforce, and that in any case it should not be up to rich people to determine how poor people use their money.

Reach versus depth of impact

There has been a long-standing debate over the sharpness of the trade-off between ‘outreach’ (the ability of a microfinance institution to reach poorer and more remote people) and its ‘sustainability’ (its ability to cover its operating costs—and possibly also its costs of serving new clients—from its operating revenues).

Although it is generally agreed that microfinance practitioners should seek to balance these goals to some extent, there are a wide variety of strategies, ranging from the minimalist profit-orientation of BancoSol in Bolivia to the highly integrated not-for-profit orientation of BRAC in Bangladesh.

This is true not only for individual institutions but also for governments engaged in developing national microfinance systems. BRAC was ranked the number one NGO in the world in 2015 and 2016 by the Geneva-based NGO Advisor.

Women

Microfinance provides women around the world with financial and non-financial services, especially in the most rural areas that do not have access to traditional banking and other basic financial infrastructure. It creates opportunities for women to start-up and build their businesses using their own skills and talents.

Utilizing savings, credit, and microinsurance, Microfinance helps families create income-generating activities and better cope with risk. Women particularly benefit from microfinance as many microfinance institutions (MFIs) target female clients, as 70% of the worlds poor are women.

Most microfinance institutions (MFIs) partner with other organizations like Water.org and Habitat for Humanity to provide additional services for their clients.

Microfinance is a sustainable process that creates real jobs, opens opportunities for future investments and helps the women clients provide for the education to their children. Microfinance generally agree that women should be the primary focus of service delivery. Evidence shows that they are less likely to default on their loans than men.

Industry data from 2006 for 704 MFIs reaching 52 million borrowers includes MFIs using the solidarity lending methodology (99.3% female clients) and MFIs using individual lending (51% female clients). The delinquency rate for solidarity lending was 0.9% after 30 days (individual lending—3.1%), while 0.3% of loans were written off (individual lending—0.9%).

Because operating margins become tighter the smaller the loans delivered, many MFIs consider the risk of lending to men to be too high.

This focus on women is questioned sometimes, however a recent study of microentrepreneurs from Sri Lanka published by the World Bank found that the return on capital for male-owned businesses (half of the sample) averaged 11%, whereas the return for women-owned businesses was 0% or slightly negative.

Microfinance’s emphasis on female-oriented lending is the subject of controversy, as it is claimed that microfinance improves the status of women through an alleviation of poverty. It is argued that by providing women with initial capital, they will be able to support themselves independent of men, in a manner which would encourage sustainable growth of enterprise and eventual self-sufficiency.

This claim has yet to be proven in any substantial form. Moreover, the attraction of women as a potential investment base is precisely because they are constrained by socio-cultural norms regarding such concepts of obedience, familial duty, household maintenance and passivity.

The result of these norms is that while micro-lending may enable women to improve their daily subsistence to a more steady pace, they will not be able to engage in market-oriented business practice beyond a limited scope of low-skilled, low-earning, informal work.

Part of this is a lack of permissivity in the society; part a reflection of the added burdens of household maintenance that women shoulder alone as a result of microfinancial empowerment; and part a lack of training and education surrounding gendered conceptions of economics.

In particular, the shift in norms such that women continue to be responsible for all the domestic private sphere labour as well as undertaking public economic support for their families, independent of male aid increases rather than decreases burdens on already limited persons.

If there were to be an exchange of labor, or if women’s income were supplemental rather than essential to household maintenance, there might be some truth to claims of establishing long-term businesses; however when so constrained it is impossible for women to do more than pay off a current loan only to take on another in a cyclic pattern which is beneficial to the financier but hardly to the borrower.

This gender essentializing crosses over from institutionalized lenders such as the Grameen Bank into interpersonal direct lending through charitable crowd-funding operations, such as Kiva.

More recently, the popularity of non-profit global online lending has grown, suggesting that a redress of gender norms might be instituted through individual selection fomented by the processes of such programs, but the reality is as yet uncertain. Studies have noted that the likelihood of lending to women, individually or in groups, is 38% higher than rates of lending to men.

This is also due to a general trend for interpersonal microfinance relations to be conducted on grounds of similarity and internal/external recognition: lenders want to see something familiar, something supportable in potential borrowers, so an emphasis on family, goals of education and health, and a commitment to community all achieve positive results from prospective financiers.

Unfortunately, these labels disproportionately align with women rather than men, particularly in the developing world.

The result is that microfinance continues to rely on restrictive gender norms rather than seek to subvert them through economic redress in terms of foundation change: training, business management and financial education are all elements which might be included in parameters of female-aimed loans and until they are the fundamental reality of women as a disadvantaged section of societies in developing states will go untested.

Organizations supporting this work

FINCA
NWTF
akhuwat Foundation Pakistan
Alkhidmat Foundation Pakistan
Whole Planet Foundation
Kiva
MCPI
Women’s World Banking

Benefits and limitations

Microfinancing produces many benefits for poverty-stricken and low-income households. One of the benefits is that it is very accessible. Banks today simply won’t extend loans to those with little to no assets, and generally don’t engage in small size loans typically associated with microfinancing.

Through microfinancing small loans are produced and accessible. Microfinancing is based on the philosophy that even small amounts of credit can help end the cycle of poverty. Another benefit produced from the microfinancing initiative is that it presents opportunities, such as extending education and jobs. Families receiving microfinancing are less likely to pull their children out of school for economic reasons.

As well, in relation to employment, people are more likely to open small businesses that will aid the creation of new jobs. Overall, the benefits outline that the microfinancing initiative is set out to improve the standard of living amongst impoverished communities.

There are also many social and financial challenges for microfinance initiatives. For example, more articulate and better-off community members may cheat poorer or less-educated neighbours. This may occur intentionally or inadvertently through loosely run organizations.

As a result, many microfinance initiatives require a large amount of social capital or trust in order to work effectively. The ability of poorer people to save may also fluctuate over time as unexpected costs may take priority which could result in them being able to save little or nothing some weeks. Rates of inflation may cause funds to lose their value, thus financially harming the saver and not benefiting the collector.

Microfinance & Macrofinance: What’s the Difference?

Microfinance and macrofinance are often confused. Microfinance is an individual-focused, community-based approach to provide financial services to poor individuals who lack access to the mainstream finances. Microfinance services include microcredit, microsavings, and microinsurance.

Microfinance aims to make individuals self-sufficient by offering timely funding, helping them learn skills, and establishing a stable means of livelihood. Macrofinance deals with the overall economy at the larger regional or national level.

It involves drafting policies, initiating programs like subsidies, or funding and operating multi-year development plans with an aim to generate employment. Macrofinance aims for overall economic development more broadly.

A $100 loan to an uneducated slum-dweller enabling her to buy necessary equipment for making and selling paper envelopes would be an example of microfinance; while a government building a million-dollar hydropower dam and employing thousands of people is an example of macrofinance.

How Microfinance Works

Microfinance starts by educating borrowers about the basics of how money and credit work, how to budget and manage debt, and how to best utilize cash flows. Following this, the borrowers are provided access to the capital. Loans are not backed by collateral due to the small amounts and the borrowers’ lack of access to collateral.

Read Also: The Negative Impact of Microfinance in Developing Countries

Default risk is mitigated by pooling borrowers in groups (of, say, five or 10 people), which improves repayment rates due to peer pressure. Pooling also builds individual credit rating and enables assistance among group members.

How Macrofinance Works

Macrofinance works on a larger scale aimed at widespread benefits involving multiple entities. A state may offer multi-year tax benefits to businesses, which in turn, setup factories employing the local population. The government benefits because there is long-term overall development and because the locally employed population is now paying taxes. Financing is assisted by banks or through public-private partnerships.

The Differences

Here are other major differences between microfinance and macrofinance:

• Microfinance starts with a focus on individuals, while macrofinance starts with a focus on the regional or national level.
• Microfinance institutions (MFI), self-help groups (SHG), and non-governmental organizations (NGO) are the primary funders in the microfinance sector. However, public sector banks, for-profit organizations, and private consumer finance companies are starting to be involved as well. On the other hand, macrofinance involves bigger entities such as governments, local authorities, large corporations, banks, and established businesses.
• The amount of money involved in macrofinance is significantly larger compared to microfinance initiatives. And the scale of operations vary widely – microfinancing can provide a $300 loan to a daily-wager mason to set up his own brick kiln, while macrofinancing for large projects like a dam or road construction offers hundreds of local masons employment for a few years.
• Microfinancing is usually a continuous ongoing activity without any defined end. A $50 loan available today to a fisherman for buying fishing nets can be extended to $500 tomorrow to help him buy a boat; OR once this fisherman becomes self-reliant and repays his microfinance loan, the money can be moved to another eligible individual. However, macrofinance projects have a definitive time period, such as subsidies offered only for three years or a road-building project to be completed in five years.
• Microfinance aims at making individuals self-reliant. For example, a Bangladeshi tailor may take $100 loan to buy a sewing machine. As his tailoring business progresses, he may establish a showroom and even employ few individuals. On the other hand, macrofinance aims to improve the overall economy. For example, the government offering subsidies on fertilizers to all cotton farmers aims to increase cotton cultivation, build a textile industry, and help everyone economically.
• Microfinancing has the risk of default by individuals, while macrofinancing faces challenges from non-implementation of efficient policies or failed programs.
• Microfinancing offers other social benefits imposed by terms of loan. For example, the load might stipulate that borrowers save a part of their income for the future or spend no part of the loan on alcohol. Macrofinancing, on the other hand, enables large-scale employment and development of new sectors and businesses, but does not guarantee the betterment of an individual.

The Bottom Line

Both microfinance and macrofinance have shown to be effective. While macrofinance initiatives ensure overall economic development at the national or regional levels, microfinance has enabled financial self-reliance for individuals. Both need to be balanced with the right policies and measures to achieve the desired goals.