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Microfinance – Definition, Sources and Problems

microfinance institution definition

Bono once put an interesting twist to an old adage: Give a man a fish and he’ll eat for a day. Give a woman microcredit, she, her husband, her children and her extended family will eat for a lifetime. The simple quote sums up the power of microfinance. to develop entire societies in a bottom-up manner instead of just the top-down manner traditionally employed by the commercial sector.

What is Microfinance?

According to Forbes, microfinance is probably the best known means of helping small business owners in developing countries move out of poverty. As the name suggests, microfinance is the field of offering financial services to people on a small (micro) scale, such as businesses with low or moderate incomes. The definition for according to The Asian Development Bank (ADB) is any financial service targeted toward the poor, such as:

Microfinance Institutions (MFIs) provide micro services through a variety of lending models. while Micro Entrepreneurs use these services. The theory is that if the poor have access to these services, their financial lives will be more stable, predictable and secure, allowing them to plan and improve their livelihoods through education, healthcare and empowerment.

In other words, microfinance converts poverty into an economic opportunity that evades the idea of exploitation.

What are the Sources of Microfinance?

Microfinance providers come in various forms which can be broadly grouped as follows:

  • Formal Microfinance Institutions – rural/microfinance/village banks, commercial banks, telecom firms, and cooperatives (see examples)
  • Semi-formal Microfinance Institutions – nongovernmental organizations (see examples)
  • Informal Microfinance Sources – money lenders and shopkeepers

This list was taken from ADB’s website.

Problems Faced by Microfinance

Despite good intentions, microfinance still has several hurdles to face:

  • perceived high risk of lending to the poor
  • technology-related hurdles, such as the high costs involved

    in small transactions for microfinance providers (Read about technology-related solutions ) 

  • lack of awareness about sources of funds for microfinance providers to pass on to the poor
  • the poor’s inability to offer marketable collateral for loans to MFIs
  • difficulty in measuring the social performance of MFIs (Read about tools to help measure the social impact of microfinance )
  • mixing of charity with business by microfinance providers (this is an issue of poor governance)
  • high interest rates for microcredit
  • lack of customized solutions/ microfinance models for the poor
  • inappropriate targeting of poor households by microfinance programs
  • lack of microfinance training for MFIs
  • poor distribution system of MFIs, i.e. a need to spread out into rural areas
  • lack of information about microfinance investment opportunities (Possible solution through AppLab )
  • poor institutional viability of microfinance ventures
  • dual mission of MFIs to be financially sustainable as well as development oriented

These problems can be grouped according to whether they’re caused by MFIs or caused by micro entrepreneurs. You can read about them in greater detail at these links.

Just like any other new venture, microfinance too faces obstacles that will eventually be ironed out as governments alter their priorities, and as the commercial sector understands the economic viability of the development sector, considering the relative immunity of the microfinance sector to the global financial meltdown. Already, a few encouraging trends have emerged in the microfinance sector .

As Kofi Annan once put it, microfinance not only recognizes the needs of the poor, it also empowers them and taps into their remarkable reservoir of energy and knowledge. In short, microfinance has tremendous potential, its time is now and is here to stay.

You can read other articles about microfinance theory and practice here. Please remember to leave a comment. I would love to hear your views.

Category: Payday loans

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