Microfinance
What is microfinance? Microfinance started with Nobel Peace Prize Laureate Mohammed Yunus, who began with a simple but revolutionary concept: Loan poor people money on terms that are suitable to them and teach them sound financial principles so they can achieve financial self-sufficiency.
Grameen Bank (The word "Grameen" is derived from the word "gram", which means "village" in Bangla language) was created in 1976 when Professor Muhammad Yunus, then head of the Rural Economics Program at the University of Chittagong, loaned $27 from his own pocket to 42 people in the tiny Bangladeshi village of Jobra. These women only needed just enough credit to purchase the raw materials for their trades. The borrowers repaid his small loans promptly and inspired Yunus to establish the Grameen Bank Project, which then spread among villages and districts across Bangladesh with the help of his devoted students and has now spread around the world and transformed the lives of many poor people.
Microfinance is considered one of the most effective and flexible strategies in the fight against global poverty. Microfinance provides basic financial services such as loans, savings, money transfer services, and micro insurance to clients that have been previously ignored by more traditional financial services providers.
Providers of microcredit and microfinance services range from formal, for-profit non-bank microfinance institutions to non-governmental organizations, credit unions and cooperatives, commercial and state banks, post offices, wire services, insurance and credit card companies.
Conventional wisdom has dictated that poor and other underserved clients who had been shut out by traditional financial services providers could not or would not pay back their loans. Yet decades of experience among providers of microfinance services has shown that microfinance clients repay loans at higher rates than traditional bank clients.
Why is this different from other loan programs? Unlike other loan programs, microcredit promotes the following:
Credit as a human right
Mission to help the poor, especially women, help themselves to overcome poverty
No collateral is taken from clients to receive loans. Loans are based on ‘trust’. This allows individuals in need of financing
who would not qualify for traditional bank loans to receive credit.
It is offered to create self employment for income generating activities as opposed to consumption.
Microcredit institutions provide door to door services, as opposed to traditional banks where clients go to the bank, A few
use focal centers where clients gather to conduct financial transactions and receive other social services are also common.
Loans are offered to individuals who are in a group. The peer support system practiced by many microfinance programs is
another unique feature. When clients gather to make loan payments, they share successes and discuss ideas for solving
business and personal problems. Maybe most importantly, they empower each other to stay on the path out of poverty.
In addition, MFI staff members share vital information and resources to improve their clients’ well being. Some MFIs provide additional support in health services, literacy training, business development, and other areas that improve client livelihoods and increase opportunities to succeed in their businesses.
Why do microfinance institutions focus on women? Women have proven to be the best poverty fighters. Experience and studies have shown that women are more likely to reinvest their earnings in the business and in their families. In general, repayment rates are higher for women than men and women are a stronger credit risk. As families cross the poverty line and micro-businesses expand, their communities benefit. Jobs are created, knowledge is shared, civic participation increases, and women are recognized as valuable members of their families and communities.
Why do MFIs charge higher rates of interest than other financial institutions? Like other financial institutions, MFIs charge interest for the loans they offer to their clients. The interest charged to microcredit clients is higher due to the high operational cost associated with processing micro loans. The interest covers the high cost of processing very small loans, door to door service provided by loan officer in the field, providing personalized service to each client and covers the cost of managing the peer support group process. It may include the provision of information on social services, personal development, health, and other critical information that helps clients improve their lives and the future of their families.
Where do MFIs get their capital for loans to clients? MFIs rely on a variety of sources to generate capital for the loans they offer to clients. In countries where it is legal for MFIs to capture savings deposits, MFIs redirect a large portion of these savings funds toward lending. Whether or not they are capturing savings, young MFIs that have not yet achieved financial sustainability also rely on grants from donors and subsidized loans from funder organizations and social investors.
As institutions become sustainable and reach a certain scale, donor funding becomes no longer adequate to support their growth. At this stage, they turn to commercial sources of funding, including loans from commercial banks and other more sophisticated debt structures. MFIs that become regulated financial institutions may also raise equity through international capital markets.
An equally important part of microfinance is the recycling of funds. As loans are repaid, usually in six months to a year, they are re-loaned. This continual reinvestment multiplies the impact of each dollar loaned.
Grameen-Jameel supports the financing efforts of microfinance institutions at all stages of their development, providing loans for early-stage MFIs and guarantees for MFIs seeking to access local-currency commercial loans. As of November 2010, Grameen-Jameel works with 15 microfinance institutions in 9 countries in the MENA region, and by end of 2011 it aims to reach one million new clients through its partners.