What is Microfinance?

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What is microfinance?

Microfinance refers to financial services for poor and low-income clients. Although most attention has been on the provision of small loans, microfinance in fact also includes the provision of other basic financial services such savings, money transfer and insurance for poor people. Improving access to such services allows poor and low-income people to finance income-generating activities, build assets, stabilize consumption and protect against risks. Microfinance is now widely recognized as a powerful solution to alleviating poverty among the working poor.
Who is microfinance aimed at?

Microfinance is usually aimed at economically active poor and low-income people who have limited or no access to the services provided by formal financial intermediaries such as banks. Since there are so few salaried work opportunities, they are usually self-employed microentrepreneurs often working from home. Typically, they operate small businesses such as grocery shops, market stalls, car repair, carpentry or other workshops, and in rural areas they tend to focus on food processing, agriculture and raising livestock and poultry. Around two-thirds of microfinance clients worldwide are women.

Why has microfinance become so popular?

Primarily because it has been proven that microfinance is a long-term and sustainable solution to alleviating poverty. After nearly four decades of experience it has been shown that when poor people have access financial services – loans, savings, insurance and money transfer facilities – they can lift themselves out of poverty. Poor people in general and poor women in particular, are a good credit risk. They invest their loans wisely, not only in income generating activities, but also in the welfare of their families. Microfinance is not charity and builds on the principal that teaching someone to fish is absolutely better than simply giving them fish. It focuses directly on helping poor people to work and become more self-sufficient. Although the relationship between access to microfinance and poverty is complicated, microfinance has become popular because it can create a virtuous cycle of investment and increased income and thereby break the cycle of poverty in which many poor people are trapped. With access to successful loans over a longer period of time and through the cycle of further investment and increased income, poor entrepreneurs can through their own efforts gradually climb out of poverty.

How important are money transfers?

Remittances are a significant source of income for many poor people who often have relatives working in a different part of the country or even abroad. Enabling cheaper, faster money transfer services is of great benefit for many poor families who currently spend significant proportions of their earnings to move money between different places – for example, it might cost $ 30 to send just $ 200, that is 15%. This is an amount that poor people can ill afford to pay.

How does micro-insurance work?

As with normal insurance, micro-insurance is a service that protects poor people against certain risks in return for a fee or premium. The service is offered to low-income individuals and businesses and is characterized by low insurance premiums, often a small fixed proportion of the loan amount, and low coverage limits – for example if a famer's crop sufferers a loss of $ 100 as a result of flooding , the insurance policy may just compensate him or her for half this amount.

What types of institutions provide microfinance services?

Most microfinance initiatives were started by non-governmental organizations (NGOs), like CARE. These often developed into formal microfinance institutions or MFIs which activities are regulated by the relevant national banking or microfinance authorities. An increasing number of MFIs are now organized as for-profit entities, often because it is a requirement to obtain a license from banking authorities to offer savings services. For-profit MFIs may be organized as non-bank financial institutions, specialist commercial microfinance banks, or microfinance departments of larger commercial banks. In addition to insurance and money transfer facilities in recent years some MFIs have also begun providing social services, such as basic healthcare and education for their clients and their families.

When is microfinance NOT an appropriate tool?

Microfinance can be a very powerful tool in helping poor people; however it may not always be appropriate. For example, when small loans are to be used for business purposes, microcredit is most useful for those entrepreneurs who have already identified a productive and profitable economic opportunity, can capitalize on it if they have access to credit and are capable of making the regular repayments in order to have continued access. The very poorest people may be unable to repay even a small loan and providing them with a grant to help them build assets or start an enterprise may be more appropriate. In fact, they are generally more in need of help in meeting their basic needs such as food and shelter. Providing credit to those who can not use it productively could push already vulnerable poor people into debt and in fact worsen their situation.

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