Frequently Asked Questions
What is microfinance?
Microfinance is the practice of extending small loans to individual borrowers who have been traditionally denied access to credit. Over the past decade, microfinance has become one of the most popular anti-poverty strategies in the world. Microlenders help low-income individuals start or expand businesses.
When people can’t find work, they create tiny business or “microenteprises” to support their families. Microenterprise businesses can include making jewelry, selling clothes, or making food. Yet with little or no capital to grow their businesses, the entrepreneurial poor remain trapped in a cycle of poverty. To keep their businesses open, many borrow from loan sharks or pay higher prices to get goods on credit. What they need to break free is access to financial services, which is where microfinance comes into play. Microfinance offers an alternative to loan sharks by providing loans with low interest rates. Many microfinance lenders also provide loan recipients with a network of support to help them successfully grow their business.
Microfinance is Not a Silver Bullet
- Microfinance is but one strategy battling an immense problem
- 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.
While microfinance can not reach all economic segments of society, it has been shown to reach segments previously un-serviced by other financial markets.
Examples of Some Alternative Strategies
- Investments in infrastructure, such as roads, communications, and education, provide a foundation for economic activities. Community-level investments in commercial or productive infrastructure (such as market centers or small-scale irrigation schemes) also facilitate business activity.
- Employment programs prepare the poor for self-employment. Food-for-work programs and public works projects fit this model. In many cases, these programs may be out of reach for cash-strapped local governments but within the purview of donors.
- Non-financial services range from literacy classes and community development to market-based business-development services. While non-financial services should be provided by separate institutional providers, there are clear, complementary links with the demand for and impact of microcredit.
- Legal and institutional reforms can create incentives for microfinance by improving the operating environment for both microfinance providers and their clients. For example, streamlining micro-enterprise registration, abolishing caps on interest rates, loosening regulations governing non-mortgage collateral, strengthening the judicial system, and reducing the cost and time of property and asset registration can foster a supportive climate for microfinance.