Microfinance is a lending practice that has as its primary goal ending poverty by making credit (loans of money) available to the poor. Since the early 1980’s, microfinance, often called microcredit, has changed the lives of millions in poor countries by making loans to people who are unable to borrow from such conventional sources as traditional banks. Muhammad Yunus, a Bangladeshi banker and the founder of Grameen Bank, is recognized as the father of microfinance. Yunus and Grameen won the Nobel Peace Prize in 2006 for their groundbreaking work in lending to the poor of Bangladesh.
The world’s poor often live on as little as a dollar per day. No traditional bank would loan money to people so poor. Usually, when a bank loans money, it requires the borrower to offer certain property as collateral. The borrower agrees that this property, such as an automobile or a piece of land, will be given to the bank if the borrower cannot repay the loan. Extremely poor people often own little and have nothing to offer as collateral.
People in developing countries, however, and particularly people in rural areas, often do have strong social ties. Drawing on these ties, microfinance loans are made to an individual organized into a group with a few of his or her neighbors. A borrower is motivated to pay back his or her loan because other members of the group cannot get a loan until the first loan is paid back or, in some cases, partially paid back.
Women make up the majority of the world’s poor, and most microfinance borrowers are women. Many prospective microfinance borrowers cannot read or write and lack familiarity with basic business practices. To improve this situation, successful microfinance institutions (MFI’s) provide literacy education and an overview of business practices. Microfinance borrowers need to understand the separation between their personal and working lives. Without the necessary education, borrowers tend to use loan money to help their family, instead of investing that money in a financial enterprise that would earn enough to buy what their family needs and repay their loan. It is crucial that borrowers understand the money they receive is not charity and must be repaid with interest.
Access to credit can give the poor the opportunity to lift themselves out of poverty. Some borrowers do well and borrow increasingly larger sums of money as they expand their businesses. When they develop sufficient collateral and require larger loans, they may begin to borrow from traditional banks. Microfinance provides for this transition. As MFI’s have developed, loans to individuals instead of to individuals within a group have become more common, and the size of the average microfinance loan has increased. Consequently, some microfinance lenders have drifted away from their original intent to help the poorest.
Making many small loans and providing education to prospective borrowers is expensive. MFI’s charge high interest rates—often over 30 percent—on loans, but most MFI’s do not cover their costs. MFI’s are financed with donations and loans and, in some countries, by government grants.
By 2010, some nations began to question the value of microfinance. In India, for example, some politicians claimed that poor lending practices and harsh collection methods by for-profit microlenders had driven some borrowers to suicide. Members of certain Indian political parties urged borrowers to stop making repayments to lenders. The lenders denied the charges.
See also Yunus, Muhammad .
