FAQ's About Microfinance for the Poor

What is microfinance?

Microfinance means providing very poor families with very small loans (microcredit) to help them engage in productive activities or grow their tiny businesses. Over time, microfinance has come to include a broader range of services (credit, savings, insurance, etc.) as it has been recognized that the poor who lack access to traditional formal financial institutions require a variety of financial products. Microcredit came to prominence in the 1980s, although early experiments date back 30 years in Brazil, Bangladesh and a few other countries. The important difference of microcredit was that it avoided the pitfalls of an earlier generation of targeted development lending, by insisting on repayment, by charging interest rates that could cover the costs of credit delivery, and by focusing on client groups whose alternative source of credit was the informal sector.

What is a microfinance institution (MFI)?

A microfinance institution is an organization that offers financial services to low-income populations. Almost all of these offer microcredit and only take back small amounts of savings from their own borrowers, not from the general public. Within the microfinance industry, the term microfinance institution has come to refer to a wide range of organizations dedicated to providing these services: NGOs, credit unions, cooperatives, private commercial banks and non-bank financial institutions (some that have transformed from NGOs into regulated institutions) and parts of state-owned banks, for example.

What is the difference between microfinance and microcredit?

Microcredit is a small amount of money loaned to a client by a bank or other institution. Microfinance refers to loans, savings, insurance, transfer services, microcredit loans and other financial products targeted at low-income clients. Microcredit has been changing the lives of people and revitalizing communities worldwide since the beginning of time.

Who are the clients of microfinance?

The clients of microfinance are generally poor and low-income people. They may be female heads of households, pensioners, artisans or small farmers.

How do financial services help poor and low-income people?

Anyone who has access to savings, credit, insurance and other financial services is more resilient and better able to deal with everyday demands. Microfinance helps poor and low-income clients deal with their basic needs. For example, with access to microinsurance, poor people can cope with sudden expenses associated with serious illness or loss of assets. Merely having access to formal savings accounts has also proved to be an incentive to save. Clients who join and stay in microfinance programs have better economic conditions than non-clients.

What is an inclusive financial sector?

An inclusive financial sector allows poor and low-income people to access credit, insurance, remittances and savings products. In many countries, the financial sectors do not provide these services to lower income people. An inclusive financial sector will support the full participation of the lower income levels of the population.

How can poor people afford such high interest rates?

Microcredit interest rates are set to provide viable, long-term financial services on a large scale, while subsidized interest rates generally benefit only a small number of borrowers for a short period. Studies conducted in India, Kenya and the Philippines found that the average annual return on investments by micro-businesses ranged from 117 to 847 per cent. These high returns are commonplace among microentrepreneurs, and while the interest rates seem high, they usually represent only a small portion of microentrepreneurs’ total returns. Interest rates charged by informal moneylenders are overwhelmingly higher than those of MFIs.

Do poor people save?

Poor people save all the time, although mostly in informal ways. They invest in assets such as jewelry, domestic animals, building materials and things that can be easily exchanged for cash. Access to secure, formal savings services provides a cushion when families need more money for seasonal expenses and in difficult times. Secure savings accounts allow people to guard against unexpected expenses associated with illnesses, build assets, prepare for old age or pay for school fees, marriages and births.

Why is microfinance so important for women?

In a world where most poor people are women, studies have shown that access to financial services has improved the status of women within the family and the community. Women have become more assertive and confident. Furthermore, as a result of microfinance, women own assets, including land and housing, play a stronger role in decision-making, and take on leadership roles in their communities.

Are commercial banks involved in microfinance?

Yes. Increasingly, formal financial institutions are recognizing the benefits of serving poorer clients. For detailed information, see the following resournces:

* ACCION's publications (managed by the Center for Financial Inclusion): http://resources.centerforfinancialinclusion.org;
* CGAP: 227 Formal Financial Institutions: http://microfinancegateway.org/content/article/detail/18156
* 30 global examples of commercial banks and formal financial institutions with established microfinance services: http://microfinancegateway.org/content/article/detail/21504

How effective is microfinance?

The best examples of microfinance in the countries with the most advantageous circumstances have demonstrated profitability after many years of experimentation and development. These best-case examples represent about 150 microfinance institutions of the more than 10,000 operating worldwide. Together they serve approximately 40-50 million clients, of the estimated 500 million to 1 billion poor people who could benefit from microfinance services.