Microfinance institutions provide many functions for some of the poorest people on the planet. At the most basic level, they provide access to cheap capital. The cheap capital can be used to start a business, expand a business or buy in bulk, allowing entrepreneurs to enjoy improved margins and higher profitability. Microfinance institutions don't only provide access to cheap capital, they also look to improve communities.
The Beginning of Microfinance Institutions
The history of the modern microfinance institution can be traced back to Bangladesh and the launch of Grameen Bank by Professor Muhammad Yunus in the late 1970s. Through Grameen Bank, Yunus was able to provide access to very small amounts of capital with no collateral requirements. Grameen provided this capital at a very low interest rate, which was almost unheard of when lending to the poor.
Group Lending
No collateral and low interest rates seem like the way to high delinquency rates, but most microfinance institutions actually have lower default rates than major commercial banks. To help ensure repayment, many microfinance institutions require borrowers to form groups. These groups provide a support network for each other, and each member guarantees the debt for every other member. Doing so allows the microfinance institution to achieve two things: It creates an instant support group for when a borrower has a problem and it creates efficiencies for the bank when collecting the weekly payments.
Providing Education
In addition to lending to groups, microfinance institutions also provide basic education on running a business and managing money. Quite often they will mandate that borrowing groups must complete the education before they are eligible for loans.
Emphasizing Women
A lot of research has gone into the effects of lending to women. The research shows that lending to women is better for the broader community. It was observed that the profits a woman made as a result of the loan were more frequently invested back into her family. Women were more likely than men to use the proceeds to pay for an education for her kids, make improvements to the home or buy better quality food for the family. The other benefit to lending to women experienced by microfinance institutions around the world is the empowerment and the strides toward gender equality that have been achieved in the household and the local community.
Connecting the World
Microfinance institutions were originally founded to alleviate poverty and improve local communities. That mission hasn't changed, but due to the ever-present need for money to fund the microloans, some organizations have figured out a way to connect ordinary donors in the developed world with microcredit borrowers in the Third World. Kiva.org was one of the leading pioneers; it has created a platform that allows anyone to lend $25 to an individual or group in need of capital. Lenders don't earn interest, but they do get progress updates along with the repayment of their money. For most people, knowing they helped change a life is worth forgoing the interest they could have earned elsewhere.
