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What is Microfinance?

microfinance
Microfinance institutions give microloans to entrepreneurs who otherwise don't qualify for a standard bank loan.
Credit: isak55 | Shutterstock

Microfinance refers to an array of financial services, including loans, savings and insurance, available to poor entrepreneurs and small business owners who have no collateral and wouldn't otherwise qualify for a standard bank loan. Most often, microloans are given to those living in still-developing countries who are working in a variety of different trades, including carpentry, fishing and transportation.

Microloans typically are not more than several hundred dollars. Examples of uses include money for tools to start work in construction, or makeup and other supplies needed to become a cosmetologist. Because they are the ones that commonly use their profits toprovide for their families with things like food, clothing, shelter and education, women currently comprise roughly two-thirds of all microfinance clients. The goal of microfinancing is to provide individuals with money to invest in themselves or their business to help get them out of poverty. When providing loans, microfinancing institutions do not require collateral, but do insist that the loan is repaid within six months to a year.

Microfinancing institutions

Microfinance is available through microfinance institutions, which range from small non-profit organizations to larger banks. Microfinance institutions include both for-profit companies, like General Electric Consumer Finance and Citi Microfinance, as well as non-profit organizations, such as Accion and BRAC. Among the services they offer are small loans, help setting up and maintaining a savings account and money transfers, as well as help obtaining insurance for a variety of needs, such as death, illness or loss or property.

In order to keep their services running, microfinance institutions typically charge significantly higher interest rates than those on a traditional bank loan. While many for-profit microfinance institutions have come under fire cashing in on the difficulties of the poor, research from the Consultative Group to Assist the Poor found that the majority of clients borrow from microfinance institutions that charge less than 30 percent interest rates and realize less than 30 percent return on their equity.

The most recent data from the World Bank estimates there are more than 7,000 microfinance institutions worldwide, serving 16 million clients. In total, the microfinance institutions have provided more than $2.25 billion in loans and other financial help.

History of microfinance

While the concept has been used globally for centuries, it's Bangladesh's Muhammad Yunus who is credited with being the pioneer of the modern version of microfinance. While working at Chittagong University in the 1970s, Yunus began offering small loans to destitute basket weavers. Yunus carried on this mission for nearly a decade before forming the Grameen Bank in 1983 as a way to reach a much wider audience.

Today, the Grameen Bank's 2,500 branches serve more than 8 million borrowers in roughly 81,000 villages. According to Grameen Bank, its clients, 97 percent of whom are women, repay loans more than 97 percent of the time, a recovery rate higher than any other banking system. In 2006, Yunus and Grameen Bank were jointly awarded the Nobel Peace Prize for their microfinancing work.

Joseph Blatchford is also credited with helping build up the modern-day microfinancing efforts. Blatchford, a University of California law student, founded the non-profit organization Accion, which began offering small loans to entrepreneurs in Brazil to see if a one-time influx of money could help lift them out of poverty. The operation was a success, with the organization's 885 loans helping create or stabilize 1,386 new jobs. Accion expanded the model to 14 other Latin American countries over the next decade. Today, Accion serves more than 5 million clients in 21 countries.

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