Microfinance 101

On December 2, 2009, I had the pleasure of making a presentation about microfinance to the Japanese Students Business Association (JSBA) at Bellevue College in Bellevue, Washington. My presentation focused on providing an overview, and outlining the benefits and challenges of microfinance. Upon sharing the highlights of the presentation with friends and colleagues, I learned that while many of us have heard the term "microfinance," very few understand its components. This post will provide a summary of microfinance and the people it serves. In a subsequent posts, I will discuss microfinance's benefits and challenges. (Photo of me with members of the JSBA is courtesy of Mr. Takahara Tsuyoshi)

I find the Washington, DC-based Consultative Group to Assist the Poor, CGAP, an independent policy and research center dedicated to advancing financial access for the world's poor, a great resource by explaining microfinance as a mechanism that "offers poor people access to basic financial services such as loans, savings, money transfer services and microinsurance." Having traveled around the world, whether in industrialized or developing countries, I agree with CGAP's assertion that people living in poverty, like everyone else, need a diverse range of financial services to run their businesses, build assets, smooth consumption, and manage risks."

Microfinance facilitates the accessibility of financial services to economically underserved populations. CGAP explains, "Poor people usually address their need for financial services through a variety of financial relationships, mostly informal. Credit is available from informal moneylenders, but usually at a very high cost to borrowers. Savings services are available through a variety of informal relationships like savings clubs, rotating savings and credit associations, and other mutual savings societies. But these tend to be erratic and somewhat insecure. Traditionally, banks have not considered poor people to be a viable market."

Many microfinance schemes are administered through a microfinance institution (MFI), an organization that provides financial services to the poor. MFIs include small nonprofit organizations that provide small loans, to commercial banks that, according to CGAP, "have large existing branch networks, vast distribution outlets like automatic teller machines, and the ability to make significant investments in technology that could bring financial services closer to poor clients." CGAP adds, "While this is a very broad definition that includes a wide range of providers that vary in their legal structure, mission, and methodology...all share the common characteristic of providing financial services to clients who are poorer and more vulnerable than traditional bank clients."

Ownership structures of MFIs vary from government-owned entities to member-owned credit unions or socially minded shareholders to profit-maximizing shareholders. In its summary about MFIs, CGAP says the types of services offered by MFIs "are limited by what is allowed by the legal structure of the provider: non-regulated institutions are not generally allowed to provide savings or insurance."

Who are the clients of microfinance? Most surveys report two-thirds of microfinance clients are women, which is very important considering women often have difficulty in accessing basic services. Microfinance clients, men and women alike, seek loans across for a variety of reasons including working capital for small provide businesses, larger loans for durable goods, student loans, and to cover emergencies. Microfinance clients work on farms or work for themselves in fishing, carpentry, vegetable selling, small shops, transportation, etc.

Microfinance offers a great opportunity for people to overcome the challenges of living in poverty. There are some benefits that are worth exploring, which include increasing personal income, enabling individuals to build assets, and reducing the vulnerability to economic stress. There are significant problems, however, with the application of microfinance such as little or no access for goods or services produced by borrowers to reach global (and more profitable) markets, extraordinarily high interest rates, and creating a cycle of debt as the entrepreneur attempts to manage (micro)enterprise growth. I will provide details and examples of the benefits of microfinance in a blog post on December 20, 2009 and I will discuss the challenges of microfinance on a posting dated December 22, 2009.