Introduction
The sad reality of today is that inequality continues to be on the rise across the globe. While some countries have managed to reduce the number of people living in extreme poverty, economic gaps within countries continue to grow with the wealthiest 1 percent owning 44 percent of the world’s wealth, according to the Credit Suisse Global Wealth Report. Data also indicates that adults with less than $10,000 in wealth make up 56.6 percent of the world’s population and yet hold less than 2 percent of global wealth.
Over 2 billion adults and 800 million young people worldwide do not have access to formal financial services. It, therefore, becomes difficult to imagine how these individuals survive or make a living for themselves.
In recent years, the role of microfinance, also called microcredit, has become more prevalent in developing countries struggling with poverty. Pioneered by Nobel-Prize winner Muhammad Yunnus, this type of financing is offered to individuals that lack access to traditional banking services such as unemployed or low-income individuals working towards financial independence. Like traditional sources of financing, microfinancing involves extending small loans, savings, and even micro-insurance products and financial and business education. This form of financing not only allows millions of people to achieve financial stability, but it also empowers individuals and gives them the support needed to create employment opportunities, ultimately benefiting the local economy.
According to the 2019 Microfinance Barometer, in 2018, 139.9 million borrowers benefitted from the services of microfinance institutions compared to the 98 million individuals in 2009. In addition, the credit portfolio grew 8.5 percent from 2017 to 2018, with the portfolio estimated at $124.1 billion.
History
In 1983, Yunus founded the Grameen Bank, which was a pivotal moment for microfinance. The model included a few core elements. First, after a microfinance loan is granted, repayment begins immediately with frequent and regular payments over the course of a year. Secondly, group loans were possible for borrowers from different households, putting pressure on members to help each other repay the loan. Finally, the model cuts overhead costs by having loan officers visiting villages for disbursement and collecting payments.
Why it’s Helpful
Identification and opportunity are the biggest reasons why many individuals have trouble accessing formal financial institutions. Banks will not lend to those with little or no assets and generally do not engage in lending small sized loans. Women, especially, benefit from this service as historically, they have been more likely to develop sustainable livelihoods, invest more in their health and education, and interact and benefit from markets. According to the 2019 Microfinance Barometer, women made up 80 percent of loans in 2018, with 65 percent living in rural areas.
Financial diaries of people living on under $2 a day also show that microfinance helps many families deal with emergencies, make essential purchases, and provides food in times of extreme hardship. These loans can be as small as $60, but for individuals that come from places of extreme poverty, this money can help start a snack stand, for example, which starts the cycle of being financially independent. Once this money is paid back, individuals can then take on larger loans to help expand their businesses. Another valuable aspect of microfinance is its reliability. People are able to receive a loan at a specific time then commit to making the small, regular payments to be eligible for a future loan. Additionally, Nobel Laureate economist Amartya Sen views microfinancing as an opportunity for greater freedom in navigating their financing lives.
There is also evidence that microfinance can play a broader positive role. Economists Emily Breza and Cynthia Kinnan studied what occurred in Andhra Pradesh India, when microfinance institutions were shut down in 2010. The results indicate that notable decreases in wages in rural areas were found, emphasizing that “microfinance, despite its small loan sizes, can have meaningful impacts on rural economies.”
Pushback
While some loans have decreased unemployment and increased earning power, some argue that microfinance only makes poverty worse. In South Africa, 94 percent of all microfinance loans are used to pay for basic necessities, with borrowers not generating new sources of income. While microfinance may be used for day-to-day needs and not business loans the way Yunus had envisioned, microfinance nonetheless helps support people even if it is just money for food on the table. As Jonathan Morduch writes:
“Evidence that microfinance loans are used to fund non-business needs (even if for education or health) is sometimes used to criticize microfinance, but that misses the point….poor families, like richer families, need broad financial tools. In fact, the poor may need them more urgently.”
Without the ability to generate new income, microfinance also faces criticism over borrowers being trapped in a debt cycle whereby they must take on more loans to pay off the previous loan. This can then lead to over-indebtedness and the likelihood of default. Another issue with lending to impoverished people is the cost associated with it. Since the loans offered usually average a few hundred dollars, the overhead costs are higher as a proportion of the loan. It is difficult to make the lending process profitable. Long-running debates over what level of interest rate is acceptable versus exploitative have surfaced. On average, institutions offer loans from 20 to 30 percent, although some rates are much higher. People, including Yunus, have, thus, argued that interest rates above a certain level turn predatory and end up trapping the poor in debt.
Final Thoughts
Some continue to argue that microfinance is not among the best options for accomplishing as much good as possible. This is not to say that microfinance does not provide any benefit at all, but nonprofit charity evaluators such as GiveWell expresses concern about potential harm to some microfinance borrowers. This being the case, research from the World Bank has shown that the vast majority of microfinance is subsidized through donors and investors providing capital at below-market rates, making it a cost-effective way to help those in need even if it is not the most transformative solution. Since its turning point in 2010, microfinance institutions have lent billions of dollars, with an average annual growth rate of 11.5 percent over the past five years, and borrowers increasing at a rate of 7 percent since 2012. This emphasizes the sheer magnitude and potential of this form of financing. Therefore, despite the pushbacks, microfinance is still a step in the right direction to help end the poverty cycle for individuals in struggling economies. Whether it be to start their own businesses or merely for food on the table in times of need, microfinance has positively impacted the lives of hundreds of millions of people around the world.
By Katherine Li