Microfinance institutions provide many functions for some of the poorest people on the planet. At the most basic level, they provide access to cheap capital which they loan out so that people can have an opportunity to start a business, expand an existing business or buy product in bulk so they can improve their profit margins as well as their lives.
History of Microfinance Institutions
The history of the modern microfinance institution can be traced back to Bangladesh in 1976 when Professor Muhammad Yunus launched a research project in his local community. He was talking to the rural poor surrounding the University of Chittagong, the college where he taught economics, and found that they did not lack the skills to participate in the business environment, but merely the capital. When he asked one of the people he was talking to how much she needed, the answer was absurdly low. Reaching into his pocket, he took out the amount of money that was needed. Handing it over with no collateral requirement, Professor Yunus made a verbal contract to be repaid over 52 weeks with interest that was much lower than what the local predatory lenders charged.
The Basics of Microfinance
Microfinance institutions exist to alleviate poverty. They do so by making loans with relatively low interest rates to people who are not able to access more traditional forms of financing. Requiring no collateral, the organizations rely upon several different mechanisms to guarantee repayment.
Lending to Groups
Lending to groups is the most common way a microfinance institution ensures that they will be repaid. They require that a person who is seeking a loan band together with several other people who are also seeking credit and make each member of the group guarantee the loans made to the other members. Through peer pressure and cooperation among the group members, there exists a rate of repayment that is higher than that of more traditional commercial banks.
In addition to lending to groups, microfinance institutions will also provide some basic education on running a business and managing money. Quite often they will mandate that the borrowing group must complete the education before they are able to receive their first loan.
Microfinance institutions also emphasize lending to women. Part of the intent is to promote gender equality, but also it is based on research that shows lending to women is better for the broader community. The research determined that the profits a woman made as a result of the loan were more frequently invested back into her family. Women were more likely than men to use the proceeds to pay for an education for her children, make improvements to the home or buy better quality food for the family.
Not Just Credit
Microfinance organizations don’t only provide money, they also provide access to ideas, technology and new business ventures for their members. One of the best examples is the introduction of cellphones to rural villages in Bangladesh. Communication between families in different villages and among suppliers and markets in different areas were very difficult. Days were often wasted traveling back and forth to get information. To fill the need, Yunus’s Grameen Bank leased a cellphone to one woman in each village. the women made money by charging a small fee for use of the phone. This allowed the women to make a living and made communication easier among villages. Introducing cellphones is just one of many examples of non-lending efforts made by microfinance institutions to improve the lives of their community’s impoverished citizens.