Many of the world’s poor do not have access to the banking solutions that many in the developed world now take for granted. This makes it difficult for families, individuals and small business owners to earn, save and grow their money.
At a macro level, the lack of access to banks presents major obstacles to sustainable economic development.
But there is one positive trend at play: Increasingly, the world’s poor are able to securely borrow small amounts of money through microfinance institutes. This is proving to be an essential element of growth for poor or rural populations and their businesses.
“Microcredit” – or the extension of very small loans to those without access to traditional banks – is generally considered to have originated in the mid-1970s when a young economics professor began examining the escalating poverty in his home country of Bangladesh. Based on a brief survey of the country’s social and economic climate, Muhammad Yunus (pictured below) determined that small loans given directly to poor people will enable them to help themselves by encouraging entrepreneurship and liberating them from their exploiters. In his case, a single loan of 27 dollars made to 42 women helped them purchase bamboo to make stools — which in turn allowed them to repay their loans and start supporting their families.
Based on this finding, the Grameen Bank was born in Bangladesh. Through a very simple framework, Yunus designed a credit delivery system to provide banking services targeted to the rural poor, especially women. The system was so successful it spread rapidly to hundreds of villages and now serves more than four million borrowers. In 2006, Muhammad Yunus was awarded the Nobel Peace Prize for the microcredit project.
The initial success of Grameen Bank stimulated the establishment of several other microcredit programs, gaining worldwide recognition as an effective way to help the poor become self-employed and thus escape poverty. Many of these programs provide credit using social mechanisms, such as group-based lending, to reach the poor and other clients who lack access to formal financial institutions.
The Shift from Credit to Savings
In the three decades since Mohammed Yunus gave his first loan to that group of Bangladeshi women, microcredit borrowers have turned the movement into a global industry, now coined, “microfinance.”
With increasing assistance from the World Bank and other global donors, the industry began changing when its institutions recognized the importance of savings, not just loaning, as an asset-building strategy.
Around the world, microfinance now refers to the provision of a suite of sophisticated financial services to help the world’s poor build and preserve wealth and manage risk. BancoSol in Bolivia and Mibanco in Peru are excellent examples of organizations that started as small NGOs and developed into commercial banks, changing form so that they could offer savings accounts as part of a full range of financial services, including money transfers and microinsurance. Banco Sol now has nearly twice as many savers (235,000) as borrowers (120,000).
One bright spot in African microfinance is the emergence of retail microfinance investment opportunities such as kiva.org. Investors on these sites actually seek out investments in high-risk areas such as Africa because the social impact is that much greater. In the past, institutional investors have taken a more cautious approach and invested their capital in more established micro-finance regions like Latin America. As the retail microfinance investment comes of age, microfinance in Africa will begin to mature as well.
Having been led by non-profits for years, one of today’s challenges now lies in encouraging the broader private sector to act more like the non-profit sector – balancing social and financial interests to achieve suitable, but not excessive, return on investment.
Citigroup and Deutsche Bank now operate dedicated microfinance businesses. Visa is exploring new distribution channels to bring the “cashless economy” to the poorest, most remote entrepreneurs. Standard & Poor’s is developing an international rating standard for microfinance institutions that will likely draw mainstream investors.
Despite their development and popularity, microfinance programs still face limitations. In his book Half the Sky, Nicholas Kristof cautions that while microfinance has done more to bolster the status of women in developing countries than any law ever did, it remains an imperfect solution.
Current loan structures have a difficult time reaching dispersed populations. As such, they have been the least successful in Africa, where perhaps they are needed most. Since poor, rural populations often face serious health threats, loan delinquencies persist, which acts to undermine the model. It’s also expensive to make small, or “micro” loans, so borrowers often pay very high interest rates. This works fine if the business for which the loan was intended is up and running. If the business fails, a cycle of debt often follows.
Finally, when it comes to measuring the success of microfinance programs, it’s often done with a macroeconomic stick. Microfinance has a microeconomic impact on the people who receive the services. To base the success of microfinance on the macroeconomic health of a country or a continent is like trying to value a single stock using U.S. GDP.
Since the early days of small lending capabilities, microfinance has become a robust instrument for reducing poverty and delivering financial services to the poor, worldwide. But without supporting health and education infrastructure, ongoing empirical research and the support of local governments, it should be seen as one of many tools available, rather than the silver bullet.