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What is Microfinance?

what is a microfinance

Microfinance Background

What are microcredit, microfinance, and microenterprise?

Microcredit is the provision of tiny loans at competitive interest rates for the very poor.

Microfinance includes microcredit as well as other financial services (such as a safe place to save money and insurance) to the very poor so they can pull themselves out of poverty. Microfinance began as a way to finance self-employment ventures in places where poor people could not find satisfactory employment or obtain needed credit. It has since expanded to cover all the ways poor households can manage their finances through credit for such things as enterprise, education, housing, health care, as well as through protective services such as savings and insurance.

Generally speaking, microenterprise focuses exclusively on enterprises and includes enterprise credit plus additional financial services such as business development. The U.S. Agency for International Development’s microfinance and microenterprise program is called the Office of Microenterprise Development.

When referring to financial services for the poor, especially related to RESULTS' work, it is most accurate to use the term “microfinance.”

Who are the “very poor”?

Recently updated World Bank estimates reveal that $1.4 billion people live on less than $1.25 a day.[1] The measure of extreme poverty was revised from $1 a day to $1.25 a day because 2008 data show that the cost of living in developing countries, as measured by purchasing power parity (PPP), is higher than previously thought.

Why is microfinance important for the very poor?

The very poor do not have access to traditional financial services. Microloans, often averaging less than $150, allow people to start and expand tiny businesses without depending on moneylenders who demand exorbitant interest rates. Loans can also be used to finance health and education needs. Both borrowers and non-borrowers need a safe place to save their incomes, and insurance programs are critical to help protect the poor from falling further into poverty should an unforeseen event financially impact their lives.

Microfinance provides the poor with the tools they need to reap the benefits of their skills and hard work and gives people the capacity to improve the quality of their lives and the futures of

their children. Extra money earned is typically used by families to obtain better food, housing, and education. As a result, the returns benefit the entire community.

Does microfinance really work?

Microfinance has proven to be an effective tool in addressing the worst aspects of poverty, even among the very poor.

According to the State of the Microcredit Summit Campaign Report 2009 :[2]

  • Microfinance institutions (MFIs) have reached 155 million clients, 106 million of whom were among the poorest when they took their first loan. Assuming five persons per family, 533 million family members were affected by these loans.
  • Of these 106 million poorest clients, 83 percent, or 88 million, are women.

What makes microfinance a smart investment?

High repayment rates. Microfinance is an economically sustainable method of fighting poverty. In developing countries, the rate of repayment of well-established microfinance programs can be in the 90 percent range. Repayment rates are high because, through a system of peer support and pressure used in many microfinance models, borrowers are responsible for each other’s success, and they help ensure that every member of their group is able to pay back their loans. Moreover, loans provide borrowers with a dignified way to improve their lives, and for many, paying back their loans and being finically independent is a source of pride.

Cost-effectiveness and financial self-sufficiency. With support to grow and become self-sufficient, microfinance programs in developing countries need less grant money, can utilize loans and loan guarantees, and eventually get linked into the formal financial system. Well-run microfinance organizations in developing countries are eventually able to sustain their operations through interest income. Organizations have been able to cover 100 percent of operational costs with the interest income generated by loan repayments. In 1995, the Grameen Bank in Bangladesh began making a profit.

[1] Chen S, Ravallion M. The Developing World is Poorer Than We Thought, But No Less Successful in the Fight Against Poverty; Policy Research Working Paper 4703. Washington, DC: World Bank; August 2008.

[2] Microcredit Summit Campaign. State of the Microcredit Summit Campaign Report. Washington, DC: RESULTS Educational Fund; 2009. Available at: .

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