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What Is Microfinancing?


Thanks to Muhammad Yunus and his Grameen Bank, microfinancing is a household term.

In many developing nations, microfinance has opened up brand new channels of funding.

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It is, in fact, a lifeline for low income and many unemployed people across the world.

It works on the basic premise that low income should not be a criterion to stop anyone from starting a business.

A successful and well-provided life is a relative term.

MicrofinancingBut often many people are not even able to aspire for it because of the fund constraints.

In this context, microfinance is almost a bonanza for many in the low income group category.

No more of unscrupulous lenders and steep interest rate, microfinancing opens up a brand new avenue of opportunity.

The core idea is to facilitate a better life for the customers availing this loan.

The main objective is to empower them in a way that the customers can eventually shift to conventional bank loans.

So you can also look at it as a form of microcredit at the customer’s convenience.

One interesting explanation about microfinance was, ‘it is the appropriate option for impoverished dreamers.’

It is about bringing money forward where the need is most.

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Definition of Microfinance

That is what brings us to the need to define microfinance a lot more succinctly.

In simple terms, it is a kind of banking service for low-income individuals.

This is specifically for this group who do not have easy access to conventional banking services for a variety of reasons.

As the name micro indicates, the loan amount is never too large.

Compared to conventional bank loans, it is quite minuscule.

The loans in microfinance may range from $100 to even as much as $20,000.

Lending is the primary service provided by these microfinance firm.

But certain organizations may also offer a range of additional facilities.

These may include a checking account and savings account for those interested.

So, the main aim is to empower people and help them become self-sufficient.

So typically you can look at this kind of financing as a method to avoid falling into the trap of loan sharks.

This financing is primarily for those below the poverty line and with very limited financial options.

Needless to mention that this services the unemployed and low income groups on priority.

In fact, the whole concept is deeply embedded in the thought to bring these people at par in society.

Traditional financial institutions do not support them.

Often their financial needs may be really limited.

But in the absence of common alternatives, they are forced to pay steep interest and often mortgage their belongings.

So, in many ways, it provides a safe loan option for people with limited financial means.

It follows conventional lending norms and does not resort to unethical practices.

As a result, the borrowers can be a little bit more relaxed.

All they need to be is consistent with their payment plans.

You have a variety of such organizations world over.

Historical Insight

It’s time to delve a bit into the history of microfinancing firms.

The idea was recently popularized after Bangladesh’s Muhammad Yunus bagged the Nobel Prize for his initiatives.

But the core idea has been there for centuries now.

Globally, different countries and cultures have been using some or other format of it for a long now.

However, it is true that Yunus and his Grameen Bank pioneered the modern format.

It is essentially formalizing a crowdfunding initiative for microlending purpose.

Yunus’ Grameen Bank was the first modern variant of this initiative.

There are many others who were actively engaged in developing module.

One of the most important names in this context is Joseph Blatchford.

He is a UC Berkeley law student and former Peace Corps chief.

He created a volunteer non-profit project, Accion in 1960s.

By 1973, they started offering small loans to interested entrepreneurs across Brazil.

Over the next 10 years, they expanded their operation across 14 Latin American countries.

Close to 900 loans were created and 1000+ stable job opportunities generated.

It is needless to mention that Accion brought about a significant change in the socio-economic construct in these countries.

It is interesting to see how microfinance firms have typically thrived in developing nations.

A very important reason for this is the economic challenges that abound in this region.

The huge rift between the haves and have-nots also played a pretty significant role.

Moreover, in terms of sheer number, the need for financing is much larger amongst the low income groups in these countries.

Whether you look at South Asia, Africa or Latin America, they have a huge population of low income workforce without access to proper resources.

As a result, microfinancing is like a glimmer of hope amidst complete darkness for them.

How Do Microfinance Firms Work?

That brings us to the crucial question about how do these firms work?

How are they able to provide loans to the low income group and recover the loans in time too.

Yes, indeed the default rates in microfinancing are much lower than conventional banking.

But that raises even more question about how they work.

Usually, you have many variants of microfinance facilities.

These may deal with only women and children.

Some may provide exclusively for certain types of SMEs.

Basically, this keeps changing from region to region and the unique needs there.

However, the basic functioning remains more or less similar.

It offers a variety of loans from startup funds to last mile funding.

They even organize awareness programs to educate people about investing with them

Often these programs focus on key skills like managing cash, bookkeeping and other associated aspects of investing.

Accounting and professional management of funds is as important as getting funds.

So these organizations do not just arrange funds but also make the customers capable of using them.

So, this is quite different from a typical loan firm.

There the lender is only bothered about the loan collateral and repayment terms.

But microfinancing goes a step beyond this.

They also arm the investor with the necessary know-how to help them succeed.

They make them aware of conventional financial lessons and basic money management classes.

Investors and entrepreneurs also learn how to manage their funds and run the business.

Once they are confident about their dealings, these people perform a lot better and experience relative success.

Though the loan amount may not be huge, this can be life-changing for many families.

In that context, microfinancing is also a type of philanthropic initiative towards a better tomorrow.

Modus Operandi

Most times, you will observe that these microfinance firms are based locally.

Instead of roping in big names, they bet on expertise.

The local flavor ensures that there is a much better understanding of the existing problems.

Moreover, these firms then go about strengthening their on-ground presence.

They form partnerships and enlist experts in their team.

They help create a conducive environment for robust business growth.

Moreover, they are able to organize businesses in a way more convincing format.

The investment in the case of these firms cannot be only measured in money terms.

For example, almost 70-80% of loans are taken by women entrepreneurs across developing nations.

They do not just look at the creating physical forms of revenue generation.

Often you see these women reinvesting the amount in the health and education of their children.

They are able to afford nutritious food and not forced to discontinue their education.

As a result, this offers an opportunity for these women to move up the scale in years to come.

Most microfinance groups also have an accountability team in some form.

They support entrepreneurs closely but also demand accountability at a personal level.

This helps in maintaining a disciplined and financially prudent approach.

Once an entrepreneur repays the loan, it is available to the next person.

That way, this money keeps circulating from one person to another in a comfortable circle of convenience.

The amount of money in circulation also increases.

The money gradually increases from $1 to $10 in a steady manner.

So, in essence, it is never just about the loan for these firms.

Often it transcends beyond the complexity of conventional loans.

It is a personal and rather unique experience for many.

The microfinance firm becomes a pillar of support for a wide network of needy individuals.

How Different Are the Microfinance Loan Terms?

Many people may wonder that these firms are dealing with really low income group individuals.

So does it mean that they have more relaxed terms of payment?

Or do they have to be stricter for better recovery and the lower rate of defaults?

Well, most microfinance organizations operate like conventional banks.

They charge a pre-decided interest rate on their loans and also institute a well lined out repayment plan.

The payment for the loan will be due at regular intervals and individuals will have to stick to these deadlines.

There are some lenders who make it mandatory for the beneficiaries to deposit some amount in the savings account.

This sum often acts as an insurance against potential default.

On the plus side, if they are able to repay the loan on time, they have additional savings.

Many times, these borrowers in a microfinance firm are not able to offer collateral like a conventional bank.

That is why these firms sometimes pool the borrowers in a team.

That acts as a buffer and reduces chances of potential default.

These borrowers repay their loans together.

As they operate as a team, there is also a certain degree of peer pressure in this format.

Everyone’s interest is interlinked in this case.

Therefore, the repayment also becomes a team effort and everyone helps everyone to achieve success.

Once the borrowers are able to develop a definitive credit history, it plays to their advantage.

They are able to apply for bigger loans in the future if required.

It also builds a certain degree of credibility in their operation module.

Probably this is why these loans have a generally higher percentage of repayment history.

This is true across the globe and transcends boundaries like culture, country and socio-economic challenges.

Advantages of Microfinancing

Therefore, you can understand that there are many advantages of this kind of loan plans.

Apart from the fact that it helps the lower strata of the society come at par, there are many other benefits too.

1. Better Access To Credit

Often the biggest problem that low income individuals face is the lack of credible resources.

Given their poor track-record and insufficient means, they are not able to approach conventional banks.

Traditional means of loans are nearly out of bounds for them.

So, microfinancing helps these individuals get access to credit in a respectable way.

They do not have to bend down to unscrupulous practices or unethical means to secure funding.

As a result, this helps them to break the vicious cycle of poverty in a slow and steady manner.

2. Customer Friendly Terms and Rates

Most microfinance firms have the option to customize their interest rates and the repayment terms.

It is typically based on the investor profile and strategic positioning.

In this way, both the financial institutions and individuals are able to achieve a higher rate of success.

3. Better Quality Of Life

It will be wrong to judge just the financial returns that these loans yield.

The actual benefit goes beyond the mere monetary advantages.

Microfinance helps many families to gradually work their way out of the poverty-stricken conditions.

Be it healthcare, education or a nutritious diet, microfinance becomes the single biggest catalyst for a sustained change.

It helps entrepreneurs and their families to develop a degree of resilience.

More households can afford a better living condition for their families.

The fact they do not have to run pillar to post looking for funding means they can utilize their resources constructively.

All of these guarantee a distinct improvement in their overall lifestyle.

Disadvantages of Microfinance

However, that does not mean that microfinance is without its share of controversy.

This also does not mean that this loan system is without its demerits.

As the popular saying goes, every coin has two sides.

Though the microfinance industry now services close to 200 million customers globally, their rate of interest is never at par with conventional banks.

It is distinctly higher compared to traditional financial institutions.

But the only positive there is this amount will be less than what the loan sharks demand.

Moreover, the repayment options are invariably a lot more rational.

But that is only the tip of the iceberg.

Many experts believe that the loan amount that these firms offer is never adequate to start a business.

A successful business is rather cash intensive in initial years.

These microfinance firms do not have the wherewithal to support such large operations.

The money they are able to offer only addresses daily needs like food, shelter and accommodation.

On the contrary, they believe that these loans can push these individuals further into a deadly loan cycle.

Extracting them from that zone may be difficult eventually.

For customers who already lack adequate resources and funding, this is a challenging situation.

There is one group that believes that compared to loan sharks, the rate of interest is lot less.

So it can help them save some additional interest payment.

But how successfully they can launch a business is more of an individual effort than the role of any microfinance firm.

Grouping borrowers together for repayment may address the situation to some extent.

But there are also reports of some scam and forceful fund recovery by some players.

That sure is a sore point that needs to be addressed in a constructive manner by the authorities over a point of time.

Conclusion

The financial world is full of various instruments of convenience and caution.

There are some that work to your interest while others may not.

You have to analyze the microfinancing concept in the same vein.

The final degree of success will depend on the way this financial instrument is operated.

But for the low income individuals, these microfinance firms surely hold out a ray of hope.

As you have seen in the case of Grameen Bank, the microfinance concept can work towards alleviating many poverty-related ills.

It is never just about providing adequate funding for the people.

The concept of creating an alternative source of funding led to the rise in microfinancing.

But easy access to credit at all times at convenient terms is the biggest advantage of microfinance.

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