Microfinance is the establishment of micro-financial services such as loans, savings, insurance, and training to people living in poverty. It is one of the great success stories in the developing world in the last 30 years and is widely recognized as a sustainable effort in the battle against global poverty.
This tool offers micro-sized financial resources to enable the poor to break poverty cycles. Collateral-free microloans provide the poor entrepreneur the opportunity to start and grow income-generating businesses. With newfound income, the poor entrepreneur is empowered to support the family, improve the futures for their children, and pay back the initial loan capital. Those repaid funds are then lent to a new borrower in the community to start a business. One simple loan can cause a ripple effect within an entire community.
Read the story of Rosa to better understand the impact of microfinance on a poor entrepreneur.
When Rosa was a girl, she learned to make hand-made dresses from her mother. Guatemalan dresses are well known to be a very extravagant and colorful craft. Rosa was required to help her mother and sew dresses instead of going to school. With little opportunity in her small village in rural Guatemala, Rosa used her only skill to make money for years. However, she could only afford enough fabric and string to make one dress every couple of months.
Then Rosa heard that some of her friends had joined a microfinance institution in Guatemala called FAPE. She decided to join her friends and with her first loan, she bought more material so she could produce more dresses each month. With her second loan, she was able to afford buying a sewing machine and she could produce 4 dresses every month. After 8 loans, she now has a room full of sewing materials and she has even hired a few assistants to help her. The profits from Rosa’s business have allowed her to build a sturdier concrete house. But most importantly, she is able to pay school fees to send each of her children to school.
Access to appropriate and sustainable financial services enables the poor to increase incomes, build assets and reduce their vulnerability to external shocks. Microfinance allows poor households to move from everyday survival to planning for the future, investing in better nutrition, improved living conditions, and children’s health and education.
A Video about Microfinance from our Kiva Partner
Bottoms up vs. Top down Development
Microfinance is a long-term investment in human potential. Many third-party institutional aid programs have tried to direct development in emerging nations from the top down. They have tried to provide governments the financial means to improve whichever infrastructure is most needed. However, too many of these efforts have historically failed. Microfinance has the promise of promoting in-country development from the bottoms up. The key factor is focusing on improving the capacity of motivated local communities—the very people who are most invested in promoting long term and lasting economic improvements for their families, communities, and countries. Microfinance gives those who desire improvements the lever to lift themselves out of the poverty trap existing in so many developing countries.
Due to the industry's focus on the poor, microfinance institutions often use non-traditional methodologies, such as group lending or other forms of collateral not employed by the formal financial sector. For example, the idea of group lending encourages a culture of financial responsibility where peer-support leads to over 98% rate of repayment (far higher than bank rates of repayment in developed countries). The group also serves as a social network of voluntary mutual support. While members are individually responsible for the repayment of their own loans, they are expected to provide support and assistance to their peers when needed.
More than a loan
More broadly, microfinance refers to a movement that envisions a world in which low-income households have permanent access to a range of high quality and affordable financial services offered by a range of retail providers to finance income-producing activities, build assets, stabilize consumption, and protect against risks. These services include savings, credit, insurance, remittances, and payments, and others.