Microfinance is a term that refers to small loans or lines of credit that are extended to people who need help financing their business operations. These loans are typically offered in small amounts of $25, $50, or even $100, and can change people’s lives in more ways than the average person might imagine.
Sure, you’ve probably had days where an extra $100 could make a big difference in your life, but have you ever been in a situation where getting a $50 loan could change your entire economy and the future of your business? That’s the type of person that these loans are for. They are typically given to people in developing villages and areas who aren’t privy to traditional lending institutions and banking.
Some of the places where microfinance is used might not even use a cash exchange system regularly, which makes it nearly impossible for businesses to get funding or supply inventory when they are limited to trade. Not only that, but the local trade cycles, like predatory lending and loan sharks online, lead to a vicious cycle of debt—microfinance was designed to help stop that cycle and give people a chance to help their nation develop for the future.
How did we get here, though, and what can we learn from this unique process? Let’s take a look at the history and then we’ll explore the modern-day use of these loans a little further.
History of Microfinance
This industry started some years ago, and while microfinance loans have technically been around for centuries, the modern industry as we know it is attributed to one Dr. Muhammad Yunus, who won the Nobel Prize for his Grameen Bank, or “Village Bank” that was created of the need for these types of small loans.
Microfinance has been around, quite literally, for centuries. There have been people who have been lending small amounts of money to others in an effort to help them stimulate their economy or build their lives, and it has been going on in countries like Asia for thousands of years. The modern world of microfinance that we know, however, evolved during the 1970s after Yunus realized that there was a group of women in a local village who were being taken advantage of quite unwittingly.
These women—there were 42 of them in total—they worked together to build and sell bamboo stools. Despite their best efforts, they had a hard time keeping up with demand and were unable to buy supplies properly, so they were caught in a vicious debt cycle. Local traders would give them the materials that they needed, but then limit them to selling the stools for just a bit more than the cost of materials, trapping them in the cycle of repayment and only really helping those supplying the materials.
The Birth of the Modern Microfinance Loan
Yunus talked to the women and realized that all they needed to break this cycle was $27. They weren’t making a billion-dollar business deal or even trying to get a loan for $5,000 or $10,000—they needed less than $30 to get out of debt, fund their business operations, and get moving in a profitable direction.
Yunus initially lent the money to them out of his own pocket with no interest charges. Then, he started the Grameen Bank, which was his solution to helping people in developing nations with loans like these. Thanks to his efforts, the industry continued to evolve in the later half of the 21st century and today it funds business operations and daily living costs for more than six million borrowers around the world who have come to these loans as a means of getting out of debt or helping to stimulate their economy.
How Microfinance Works
This process is fairly simple—it’s like regular lending but on a much smaller scale. As already discussed, the terms are based on much smaller dollar amounts and needs. Microfinance is not a product for the average person, but in countries where $50 could make a difference, it’s changing people’s lives.
Lenders are capable of deciding to whom they will lend and how the terms will be decided. They will be able to determine the dollar amount of the loan, the interest that is charged, and the repayment terms, including when the loan is due and what people can do to get more funds in the future.
The process is evolving and changing even today, but it works much the same way that it always has. It once relied heavily on grants and other funds to create the loans for people, but today banks and lenders are starting to invest in their own products and means for micro-lending, allowing everyone to get the financing that they need. Today, even major lenders like Citigroup, Credit Suisse, and Deutsche Bank have entered the world of microcredit, trying to help people and nations who need a better way to finance their existence when traditional banks and lending are not an option.
Traditional lending is fine and good, but it doesn’t always fit the bill. The micro-entrepreneur or small business vendor in a rural village might not have access to a working capital loan from a bank, for example. Some villages and communities don’t even exchange cash regularly, which makes it hard for people to get help funding their business, getting supplies and materials, and helping their own economy.
Traditional banks and lenders profit from their efforts and will earn more for lending more. Therefore, they’re going to provide standard business loans and funds of $1,000 or more, and often don’t have room for the little $50 or $200 loans that remote villages could use to change their entire future. Enter the world of microfinance, which gives people options when they might not have any ties to traditional lending.
It’s as simple as giving people the resources that they need, but it’s also a bit more complex than that. The industry is growing and expanding, and as the Internet makes it easier to stay connected globally, you will find that these loans just continue to become more popular.
Just as there are big businesses, there are also small ones. Informal business is the basis of life in the developing world and the entrepreneurs in these markets and shops are the ones who need the most assistance. Street vendors and farmers that produce or generate local goods often don’t have the means to transport their goods, or to even produce them in the quantities needed to stimulate the economy.
Micro-entrepreneurs are the people running these businesses. They’re the ones who could benefit from a $25 loan or a $50 investment. They are the people who are building the future of developing nations and until now, they were often left to their own devices. By addressing the level of poorness in the world and scaling banking to a place where it’s actually useful for many, microfinance is helping these micro-business owners get what they need and find the solutions that will fuel the future of their economy.
Today, there are more than 150 micro-entrepreneurs are benefiting from these loans. More importantly, it is estimated that there are as many as 500 million entrepreneurs that are limited or excluded from traditional financial services, making the case for these loans even more important. This diverse group of people has the capability to change the world. Thanks to microlending, they can now do it without the worry of where they will find the means.
The Benefits of Micro Banking
In the world of microfinance, there are several parks to be had. It’s a completely different industry than standard lending. There are several benefits to be had from this type of financing, including:
- Access to these funds could change the way that economies function, allowing people in developing areas to stimulate their own economies.
- The loans allow people to be self-reliant and create economic sustainability.
- They can help small businesses start, fund, or expand their operations with just a few dollars.
- Insurance products and savings can help offer additional security and protection
- Some microfinance providers even offer money transfers that make it easy for families to pass money across borders.
The biggest perk here, of course, is that this lending goes outside of the traditional structure of banking. Therefore, it’s going to be available to a lot more people and it’s going to offer a lot more solutions than you would find elsewhere.
Microfinance is going to allow people and nations to develop further than they could on their own. Plus, this lending is even making its way into developed areas where there might still be a need, such as in inner cities of the U.S. where banks and lenders might not be able to help people, but that $500 micro loan could help a family save their corner store and keep the local economy going.
Basically, this lending is making it a more level playing field when it comes to development and financing. For countries and areas where currency isn’t even exchanged regularly, the means to build or grow a business could be impossible to come by. With these loans, everyone now has access to financial capital, whether they need $25,000 or just a quick $20 loan.
Are There Drawbacks?
Of course, the next question that people have is whether there are any disadvantages to the world of microfinance. Microlending programs do have some considerations that are important to factor in before deciding whether it’s the right choice, but for the most part, they offer everything that people need.
Microfinance is not as regulated and in developing countries, it might not be as easy for people to get access to money. Therefore, less than reputable lenders might be lurking, waiting to take advantage of people that find themselves in a position where they are in need of assistance. This is much less common today, of course, because the world of microfinance has become such a big player in the global economy. in fact, it was designed specifically to help people avoid situations like these.
For developing nations where $20 can change the economy, these loans might be the only option. For those who need something more, however, it’s not going to be the best route to go.
By and large, the biggest drawback to this industry is that the lending terms can often be varied and difficult to regulate. Some lenders will charge higher fees or interest because they know that these funds are desperately needed. Others will have strict repayment requirements or ask people to provide proof of the economic improvement or stimulation that was created by the loan. This isn’t always the case, but it’s something to consider.
Like any lending, it’s really all just about taking the time to know what you are getting into and finding the right lending products. Unless you’re in a developing nation or a neighborhood where small change can make a big impact, though, you’re probably not going to encounter microfinance and microlending in your lifetime directly.
The Future of Microfinance is Bright
Of course, that may be different if you decide that you want to get involved in microfinance from a lending standpoint. Companies are offering investors the chance to pool their efforts and work through the platform to help crowd fund and offer these loans to entrepreneurs and those in less developed areas where they are trying to stimulate the economy and help things grow. Today, the industry has changed significantly and it’s only going to continue to grow and develop, giving everyone the solutions that they need and helping the global economy in a way that traditional loans may not be able to.
The world of lending is constantly changing. Those who are in a dire situation or who have more limited options for lending might consider things like microfinance or trying to find a loan shark, but you should be warned that these are not ideal options for every situation.