What is microfinance?
Microfinance are small, low cost financial services – loans (known as microcredit), savings, insurance and money transfers, available to poor people for whom these services are not generally available. Access to microfinance enables poor families, particularly women, to invest in small businesses, better nutrition, improved living conditions, and the health and education of their children and so climb out of the cycle of poverty.
The beginnings of microfinance
The idea of microfinance was developed as a survival strategy for the poor. Ela Bhatt established the Self-Employed Women’s Association (SEWA) in India in 1974, while in 1976 Mohammed Yunus founded the Grameen Bank project in Bangladash. Ela Bhatt’s first loan was $1.50 to a woman who sold herbs, while Mohammed Yunus’ initial outlay was a total of $27 to forty-two poor people.
How microfinance works
Poor people often live from day to day, and have few reserves for major expenses such as illness, weddings, house repairs or education. They are often unable to save for these expenses, or have been unable to open a bank account that would enable them to build their savings, and therefore need to borrow, frequently at exorbitant rates, to meet these unexpected costs, further worsening their economic situation. Microcredit provides poor people with access to small loans at more manageable interest rates, and can lead to self-sufficiency and poverty alleviation. There are many models of microcredit. A common model is for small groups to form a collective and with a start up grant to provide an initial pool of money, which is augmented with regular savings and interest members pay on their small loans. One or two members take loans to develop small businesses, and, when they have repaid their loan, others are able to draw on the collective fund. They may be supported with business and other training to help make these micro-enterprises successful. The outside support and group pressure leads to a low default on repayments.
Where poor people are able to build their savings, they can often use these savings to meet their needs for lump sums of money, either to meet emergencies or to finance a productive investment. This is less risky than relying on credit, because it doesn’t involve going into debt. Saving and borrowing are really different ways of turning small amounts of money into lump sums. Saving involves building a lump sum by first accumulating smaller amounts; borrower is taking the lump sum first and then ‘saving’ afterwards in the form of loan repayments.
How does microfinance address poverty?
With less interest to repay, more profitable businesses and autonomy, poor people have been able to reduce debt burdens and break the cycle of poverty.
Studies of the impact of microfinance in more than 24 countries have found dramatic improvements in household income levels. These improvements take place mainly through growth in the borrower’s business. Access to microfinance allows the borrower to reduce costs with lower interest rates and bulk purchasing of raw materials. Income increases as the number of goods or services offered is expanded and reduced product costs increase sales.
Is it all good news?
Microfinance is not appropriate in all contexts.
For extremely poor people, providing essential infrastructure and basic health and education and reducing other barriers to economic participation may need to take place before microfinance has a role.
Maintaining a sustainable small loans program is costly, and the high interest rates take their toll on borrowers.
Microfinance fosters self-employment, but the self-employed are extremely vulnerable to fluctuations in the marketplace. Literacy and numeracy education, business training and support can be important so that loans can be effectively used.
While women have taken a high percentage of the loans and invested in their households, improving the health and education of their children, this has had a cost. Running a business has added to their workload and changed their role in the family, sometimes putting a strain on their marriage. Moreover, in some cases husbands have used the loans, but expected the women to repay them. It is important to include gender training as part of the microfinance program to address these problems.
Microfinance programs may enable poor people to improve their situation, but they do not eliminate the need for other basic social and infrastructure services. Microfinance can help poor households to reduce their vulnerability to economic shocks, but they do not eliminate such shocks. It helps the poor to take advantage of economic opportunities, but it does not create such opportunities. Microfinance can only ever be one part of a broader process of social and economic development.
Microfinance are small, low cost financial services – loans (known as microcredit), savings, insurance and money transfers, available to poor people for whom these services are not generally available. Access to microfinance enables poor families, particularly women, to invest in small businesses, better nutrition, improved living conditions, and the health and education of their children and so climb out of the cycle of poverty.
The beginnings of microfinance
The idea of microfinance was developed as a survival strategy for the poor. Ela Bhatt established the Self-Employed Women’s Association (SEWA) in India in 1974, while in 1976 Mohammed Yunus founded the Grameen Bank project in Bangladash. Ela Bhatt’s first loan was $1.50 to a woman who sold herbs, while Mohammed Yunus’ initial outlay was a total of $27 to forty-two poor people.
How microfinance works
Poor people often live from day to day, and have few reserves for major expenses such as illness, weddings, house repairs or education. They are often unable to save for these expenses, or have been unable to open a bank account that would enable them to build their savings, and therefore need to borrow, frequently at exorbitant rates, to meet these unexpected costs, further worsening their economic situation. Microcredit provides poor people with access to small loans at more manageable interest rates, and can lead to self-sufficiency and poverty alleviation. There are many models of microcredit. A common model is for small groups to form a collective and with a start up grant to provide an initial pool of money, which is augmented with regular savings and interest members pay on their small loans. One or two members take loans to develop small businesses, and, when they have repaid their loan, others are able to draw on the collective fund. They may be supported with business and other training to help make these micro-enterprises successful. The outside support and group pressure leads to a low default on repayments.
Where poor people are able to build their savings, they can often use these savings to meet their needs for lump sums of money, either to meet emergencies or to finance a productive investment. This is less risky than relying on credit, because it doesn’t involve going into debt. Saving and borrowing are really different ways of turning small amounts of money into lump sums. Saving involves building a lump sum by first accumulating smaller amounts; borrower is taking the lump sum first and then ‘saving’ afterwards in the form of loan repayments.
How does microfinance address poverty?
With less interest to repay, more profitable businesses and autonomy, poor people have been able to reduce debt burdens and break the cycle of poverty.
Studies of the impact of microfinance in more than 24 countries have found dramatic improvements in household income levels. These improvements take place mainly through growth in the borrower’s business. Access to microfinance allows the borrower to reduce costs with lower interest rates and bulk purchasing of raw materials. Income increases as the number of goods or services offered is expanded and reduced product costs increase sales.
Is it all good news?
Microfinance is not appropriate in all contexts.
For extremely poor people, providing essential infrastructure and basic health and education and reducing other barriers to economic participation may need to take place before microfinance has a role.
Maintaining a sustainable small loans program is costly, and the high interest rates take their toll on borrowers.
Microfinance fosters self-employment, but the self-employed are extremely vulnerable to fluctuations in the marketplace. Literacy and numeracy education, business training and support can be important so that loans can be effectively used.
While women have taken a high percentage of the loans and invested in their households, improving the health and education of their children, this has had a cost. Running a business has added to their workload and changed their role in the family, sometimes putting a strain on their marriage. Moreover, in some cases husbands have used the loans, but expected the women to repay them. It is important to include gender training as part of the microfinance program to address these problems.
Microfinance programs may enable poor people to improve their situation, but they do not eliminate the need for other basic social and infrastructure services. Microfinance can help poor households to reduce their vulnerability to economic shocks, but they do not eliminate such shocks. It helps the poor to take advantage of economic opportunities, but it does not create such opportunities. Microfinance can only ever be one part of a broader process of social and economic development.
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