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About Microfinance
Microfinance is a general term to describe financial services to low-income individuals or to those who do not have access to typical banking services. Microfinance is also the idea that low-income individuals are capable of lifting themselves out of poverty if given access to financial services. While some studies indicate that microfinance can play a role in the battle against poverty, it is also recognized that is not always the appropriate method, and that it should never be seen as the only tool for ending poverty. Table of Contents I. Overview I. What is microfinance? II. The history of modern microfinance II. Microfinance providers I. Microfinance Institutions II. Why don't banks serve poor people? III. Costs, interest rates and sustainability I. Interest rates (they're high) II. Profitability and sustainability of MFIs IV. Microfinance impact and outcomes I. Evidence that microfinance works II. Microfinance: a good tool for empowering women III. Microfinance is not a silver bullet IV. Examples of some alternative strategies V. How can I learn more? I. Additional resources II. Become a Kiva lender
Florinda Agustina Garcia Lopez sells aprons in Guatemala. She takes out microloans to grow her business and hopes to provide improved living conditions for her children.
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Since then, innovation in microfinance has continued and providers of financial services to the poor continue to evolve. Today, the world bank estimates that about 160 million people in developing countries are served by microfinance. (http://web.worldbank.org) back to top
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III. Costs, interest rates and sustainability Interest rates (they're high)
There are three kinds of costs the MFI has to cover when it makes microloans. The first two, the cost of the money that it lends and the cost of loan defaults, are proportional to the amount lent. For instance, if the cost paid by the MFI for the money it lends is 10%, and it experiences defaults of 1% of the amount lent, then these two costs will total $11 for a loan of $100, and $55 for a loan of $500. An interest rate of 11% of the loan amount thus covers both these costs for either loan." The third type of cost, transaction costs, is not proportional to the amount lent. The transaction cost of the $500 loan is not much different from the transaction cost of the $100 loan. Both loans require roughly the same cosmetics business and plans to use amount of staff time for meeting with the borrower to appraise the loan, part of her profits to finance the processing the loan disbursement and repayments, and follow-up schooling of her three children. monitoring. Suppose that the transaction cost is $25 per loan and that the loans are for one year. To break even on the $500 loan, the MFI would need to collect interest of $50 + 5 + $25 = $80, which represents an annual interest rate of 16%. To break even on the $100 loan, the MFI would need to collect interest of $10 + 1 + $25 = $36, which is an interest rate of 36%. At first glance, a rate this high looks abusive to many people, especially when the clients are poor. But in fact, this interest rate simply reflects the basic reality that when loan sizes get very small, transaction costs loom larger because these costs can't be cut below certain minimums. (http://www.cgap.org/about/faq)
Sikiratou Salami is from Togo, she took a loan out to purchase supplies for her
"Gun Keshari has become a regular borrow er of [an MFI] and over time, w ith
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Gun Keshari has seen a dramatic
Access to credit allows poor people to take advantage of economic opportunities. While increased earnings are by no means automatic, clients Nepal have overwhelmingly demonstrated that reliable sources of credit provide a fundamental basis for planning and expanding business activities. Many studies show that clients who join and stay in programs have better economic conditions than non-clients, suggesting that programs contribute to these improvements. A few studies have also shown that over a long period of time many clients do actually graduate out of poverty. By reducing vulnerability and increasing earnings and savings, financial services allow poor households to make the transformation from "every-day survival" to "planning for the future." Households are able to send more children to school for longer periods and to make greater investments in their children's education. Increased earnings from financial services lead to better nutrition and better living conditions, which translates into a lower incidence of illness. Increased earnings also mean that clients may seek out and pay for health care services when needed, rather than go without or wait until their health seriously deteriorates. (http://www.cgap.org/about/faq) Empirical evidence shows that, among the poor, those participating in microfinance programs who had access to financial services were able to improve their well-being-both at the individual and household level-much more than those who did not have access to financial services. In Bangladesh, Bangladesh Rural Advancement Committee (BRAC) clients increased household expenditures by 28% and assets by 112%. The incomes of Grameen members were 43% higher than incomes in nonprogram villages. In El Salvador, the weekly income of FINCA clients increased on average by 145%. In India, half of SHARE clients graduated out of poverty. In Ghana, 80% of clients of Freedom from Hunger had secondary income sources, compared to 50% for nonclients. In Lombok, Indonesia, the average income of Bank Rakyat Indonesia (BRI) borrowers increased by 112%, and 90% of households graduated out of poverty. In Vietnam, Save the Children clients reduced food deficits from three months to one month." (http://cgap.org) Microcredit may be inappropriate where conditions pose severe challenges to loan repayment. For example, populations that are geographically dispersed or have a high incidence of disease may not be suitable microfinance clients. In these cases, grants, infrastructure improvements or education and training programs are more effective. For microcredit to be appropriate, the clients must have the capacity to repay the loan under the terms by which it is provided. (http://yearofmicrocredit.org)
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"Today I'm a very respected w oman in the community. I have come out of the crow d of w omen w ho are looked dow n upon. Due to the loan that I received... you have made me to be a champion out of nobody." - Rose Athieno, Produce Reseller, Uganda
In the last two decades, substantial progress has been made in developing techniques to deliver financial services to the poor on a sustainable basis. Most donor interventions have concentrated on one of these services, microcredit. For microcredit to be appropriate however, the clients must have the capacity to repay the loan under the terms by which it is provided. Otherwise, clients may not be able to benefit from credit and risk being pushed into debt problems. This sounds obvious, but microcredit is viewed by some as "one size fits all." Instead, microcredit should be carefully evaluated against the alternatives when choosing the most appropriate intervention tool for a specific situation. Microcredit may be inappropriate where conditions pose severe challenges to standard microcredit methodologies. Populations that are geographically dispersed or nomadic may not be suitable microfinance candidates. Microfinance may not be appropriate for populations with a high incidence of debilitating illnesses (e.g., HIV/AIDS). Dependence on a single economic activity or single agricultural crop, or reliance on barter rather than cash transactions may pose problems. The presence of hyperinflation, or absence of law and order may stress the ability of microfinance to operate. Microcredit is also much more difficult when laws and regulations create significant barriers to the sustainability of microfinance providers (for example, by mandating interest-rate caps). (http://www.cgap.org/about/faq) While microfinance can not reach all economic segments of society, it has been shown to reach segments previously un-serviced by other financial markets.
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