Poverty in the Developing World
Historical Perspective
How Microfinance Works
Uses of MFI Loans
Impact on Women
Impact of Microfinance
Microfinance involves the provision of very small or “micro” loans and other financial services to the world’s poor. Viewed by many as having great potential to alleviate poverty worldwide, microfinance is based on the principle that the greatest weapon against poverty is the poor themselves. Microfinance is not about handouts. It involves providing credit and other financial services to poor entrepreneurs so that they can work their own way out of poverty, thereby creating self-esteem rather than dependence. Microfinance leverages the energy, passion and entrepreneurial spirit of the poor to allow them to help themselves and their families.
Poverty in the Developing World
Three billion people — half the world’s population — live on less than $2 per day, unable to meet their basic human needs. A subset, approximately 1.2 billion people, or 240 million families, live in “absolute poverty”, on less than the equivalent of US $1 per day. Malnutrition, lack of health care, substandard housing and illiteracy breed desperation, disease and daily suffering. Poverty traps future generations in a vicious cycle without hope or opportunity. In an increasingly globalized world, no one is immune to these problems.
Most of the world’s poor are self-employed. Each day, without the security of formal jobs, they eke out livings, whether it is by raising chickens, selling produce in markets or weaving baskets. Despite working from dawn to dusk, there is no money left over to improve their quality of life or expand their businesses. All they earn goes toward basic survival.
Focusing on income-producing solutions for the working poor is a powerful way to alleviate the pain of poverty for an entire family.
Over thirty years ago, social innovators in developing countries realized that providing credit to the poor, who do not have collateral, are typically not literate, and are living in rural areas where banks seldom exist, would revolutionize the struggle to lift families out of poverty. Initially, governments, multilateral organizations and non-profit organizations began to experiment with credit programs for the poor. Based on the success of the “microcredit” programs, the first microfinance institutions (MFIs) were set up in the 1970s to lend money at fair market interest rates to poor people who could offer no collateral. Not only did the borrowers expand their businesses and increase their incomes, but their high repayment rates demonstrated that the working poor are capable of transforming their own lives given the chance. This model of lending disproved all conventional thinking. Microfinance was born.
Though most MFIs were originally organized as non-profit or non-governmental organizations, some began to transform into for-profit entities or regulated financial institutions. Today, MFIs serve over 80 million poor clients in developing countries, of whom 55 million live on less than $1 a day.
Microfinance products such as savings accounts, microcredit loans (usually $50 to $150), and health insurance empower the poor to lift themselves out of poverty. Through microfinance, they can secure better nutrition, education, healthcare and housing for their families. Microfinance has helped millions in developing countries raise their standards of living and protect themselves from economic setbacks. The tragedy is that the vast majority of the world’s poorest people still lack access to these basic financial services.
Many microfinance institutions (MFIs) utilize social collateral in the form of peer groups to ensure loan repayment. Borrowers take out loans in groups of five to eight individuals. If a borrower defaults on her loan, the entire group typically is penalized and sometimes barred altogether from taking further loans. This peer pressure encourages borrowers to repay loans in full and on time, resulting in the higher than 95 percent repayment rates among well run programs. Among the few who default, the most common reason is an illness in the family, which disrupts their lives, rendering them unable to continue their business and repay their loans. The second most frequent reason is natural disaster or unanticipated crisis.
Microcredit loan cycles are usually shorter than traditional commercial loans – typically six months to a year with payments plus interest, due weekly. Shorter loan cycles and weekly payments help the borrowers stay current and not become overwhelmed by large payments.
Clearly the transaction-intense nature of weekly payment collections, often in rural areas, is more expensive than running a bank branch that provides large loans to economically secure borrowers in a metropolitan area. As a result, MFIs must charge interest rates that may sound high – often 30 percent to 70 percent annually – in order to cover their costs. These interest rates are still significantly lower than the 300 percent to 3,000 percent annual rates the borrowers were previously paying money lenders and are typical of the local credit card interest rates.
Borrowers tend to use funds for basic industries such as agribusiness (e.g. buying a cow or chicken); cottage industry (e.g. basket weaving); basic services (e.g. opening a hair salon); or commerce (e.g. opening a small store). Funds from micro-loans are used as an initial investment or working capital for the microenterprise. Two examples help illustrate typical entrepreneurs who borrow from MFIs:
1. For a woman living in rural villages, a trip to the market for necessities can be a major undertaking. She must walk several miles to the bus, go into a city, buy her products and carry them home. This often takes a half day or more. A microfinance entrepreneur can use her loan to buy inventory and set up a local village store: now all of the villagers benefit because they can buy products locally.
2. Pasteurized cheese commands twice the price of unpasteurized cheese. A woman making cheese for a living can use her microfinance loan to buy a $35 thermometer. With a thermometer she can pasteurize her cheese and double her profits.
As the microenterprise is often the largest source of income and employment for a poor family, the ability to borrow at a better interest rate than that offered by money-lenders allows the entrepreneur to generate greater profit to invest in her family and business.
Of the 55 million poorest clients serviced by MFIs today, 83% are women. MFIs generally lend primarily to women for many reasons. Men often have access to other work, whether a steady job or migrant/seasonal labor. More importantly, many MFIs have found that women are more likely to repay their loans on time, and that women tend to use the profits from their entrepreneurial ventures to support of their families by securing healthcare, food, clothing, education and housing.
It is also important to understand that the women of the world represent a vastly disproportionate percentage of the world’s poorest individuals. In most families in these countries, the men eat first, the children eat next, and the women eat whatever is left. In many countries women are treated as second class citizens. Women are often not allowed to handle money, or leave the house without a male escort.
The social impacts of microfinance on women are significant. Many find themselves for the first time earning more money than their husbands, which allows the women a level of equality within the family and community previously unavailable to them. Giving women a chance to be entrepreneurs creates a powerful catalyst towards greater social equality. Studies show poor women who secure micro-loans experience significantly lower domestic violence rates.
It is difficult to quantify the success of microfinance and its impact on people’s lives. Studies have shown that among the poorest in Bangladesh, those with credit from MFIs have a higher likelihood of rising above the poverty line than those without access to credit. Studies also show that households involved with microfinance are able to provide their families with improved nutrition, to afford solid roofs over their heads, and to allow children to attend school. Loan officers holding weekly borrower meetings provide information about healthcare, family planning, and self esteem in addition to entrepreneurship training.
The microfinance industry is having a powerful impact on the lives of those living in poverty. In addition to helping families emerge from poverty, it is helping them reach balance in gender equality, garner better education for themselves and their children, and move towards a better life for the next generation.