What is microfinance?
Microfinance means financial services (credit, savings, insurance and payments) for people who are poorly served by mainstream banks. These are usually low-income households and owners of very small businesses.
Why banks struggle to serve the poor
Lending is cheap per dollar when loans are large. A $100 loan needs roughly the same paperwork, visits and follow-up as a $10,000 loan, but earns a fraction of the interest. Low-income clients also tend to:
- have no formal collateral, such as land titles or salaried income;
- have no credit history that lenders can check;
- live in rural or informal areas far from bank branches;
- need small, frequent transactions that branch-based banks find uneconomic.
Microfinance developed techniques to get around each of these barriers.
The core techniques
- Collateral substitutes. Group lending uses joint liability and peer screening in place of physical guarantees.
- Dynamic incentives. Borrowers start with small loans and qualify for larger ones by repaying on time.
- Frequent, small repayments. Weekly or fortnightly instalments match irregular incomes and give early warning of trouble.
- Low-cost delivery. Loan officers travel to clients, and more recently agents and mobile phones carry out transactions.
More than credit
The field began with microcredit, but research and practice showed that poor households often value safe places to save, insurance against shocks and cheap ways to send money just as much. That is why the broader term financial inclusion is now common.
Who provides microfinance?
Providers range from informal savings groups to NGOs, credit unions and cooperatives, non-bank financial companies, specialised microfinance banks, commercial banks and mobile network operators.
Does it work?
Microfinance helps many households smooth consumption, manage risk and run businesses. Rigorous studies, however, find that the effect of microcredit on average incomes is modest. See What the evidence says.