Microfinance and its world-changing potential

Microfinance and its world-changing potential

1. What is microfinance?

“This is not charity. This is business: business with a social objective, which is to help people get out of poverty.” – Muhammad Yunus, 2006 Nobel Peace Prize Winner

In Zambia, microfinance helped Sanford (centre, yellow shirt) cultivate more of his land. He turned a profit, fed his family and covered school costs, then repaid the loan. The next year he borrowed twice as much, earning enough money to build a new house. Photo: Agatha Mali

2. Why is microfinance needed when banks already exist?

3. How did microfinance originate?

4. How does microfinance help the poor?

“Microfinance stands as one of the most promising and cost-effective tools in the fight against global poverty.” – Jonathan Morduch

5. How does microfinance empower women?

6. Who offers microfinance services?

7. What are the criticisms of microfinance?

8. How can I help through microfinance?

Microfinance offers key financial services to some of the world’s poorest and most vulnerable people. Millions of women and men are not viewed as valuable clients by traditional banks and consequently, lack access to services.In 2018 alone, the global microfinance industry helped 139.9 million clients through savings, loans, insurance and transfers. Microfinance empowered the poor with financial tools, more choices and greater capacity to change their lives.Many Canadians take this kind of financial inclusion for granted. We assume we can access useful and affordable financial products that meet our needs. But around the world, an estimated 1.7 billion adults don’t even have access to a bank account.That’s where microfinance steps in – not just to help families become self-sustaining, but as a key driver of social change, including women’s empowerment. It’s perhaps not surprising that some 80 per cent of microfinance clients are women.In this article, you’ll learn how microfinance is transforming lives for the world’s most vulnerable people – especially women and children.Microfinance is a term used to describe a range of financial services, such as savings, loans, insurance and money transfers. It helps some the world’s poorest and most vulnerable people achieve brighter futures. The main goal is providing equal access to financial services to help people become self-supporting. Another goal is social change, including women’s economic empowerment.Women and men who have traditionally been excluded from the formal financial system can benefit greatly from microfinance. It offers poor and low-income people the power to make everyday decisions many of us take for granted. Things like:• how to buy equipment like a sewing machine or a masonry tool kit to start a small business• how to repair a broken roof• how to pay for a child’s clothing and schoolbooks• where to get the funds for a family emergency such as funeral or medical expensesMicrofinance clients are hard workers with dreams for brighter futures. They want to give their children better lives than they had. Many want to hire workers and improve their communities. To get there, the poor need and deserve access to basic financial services. Things like:• small loans• savings accounts• insurance• mechanisms for money transfersIn Myanmar, Thin Thin’s flower business is rapidly expanding, thanks to her hard work and microfinance loans. Next, she strives to drill a borehole for clean drinking water and irrigation. Stable income in families means brighter lives for children. Photo: World Vision MyanmarMicrofinance programs come with a vision for transformation. Many programs offer training, in skills like financial literacy, and support services such as business coaching. With the help of microfinance, people everywhere can gain the power to:a small businessto provide jobs for other workersfor larger items like machinerytheir crops against threats like droughtnecessities and opportunities for their childrenfunds to suppliers or family members who live far awaymarkets beyond their immediate community“People … were poor not because they were stupid or lazy. They worked all day long, doing complex physical tasks. They were poor because the financial institution in the country did not help them widen their economic base.” –Muhammad Yunus, 2006 Nobel Peace Prize WinnerImagine you are a single mother in a remote community in Nepal. You are known for your sewing skills and want to start a small tailoring business. Your dream is to expand and hire other women. But you have no credit rating and no collateral to borrow against.Even if the closest bank would offer you an account, it’s three days’ walk away. Banking services are too expensive for you. You can’t read, rendering simple documents impossible to navigate. And you may not trust the bank to have your interests at heart.These are common barriers facing many in the developing world, especially in remote areas. It’s not surprising that 65 per cent of microfinance borrowers reside in rural regions where traditional banking and lending is difficult or impossible.Microfinance services are critical in the developing world, where 1.7 billion adults remain “unbanked” . Without a bank in their corner, these people have no access to an account through which to save, borrow and send money. Nearly half of people without a bank account live in just seven economies Microfinance fills the large gap historically left by traditional banks, allowing people everywhere to live out their potential. Even clients with no existing credit rating can leverage their income and follow their dreams.Microfinance has existed in various forms for centuries. But the popularity of modern-day microfinance surged upward in the 1990s and 2000s.In 2006, Bangladesh’s Grameen Bank, founded by Muhammad Yunus, won the Nobel Peace Prize for work on microfinance. Yunus believed passionately that credit is a fundamental human right. He became known as “Banker to the Poor”.Yunus established the Grameen Bank in 1983, with a goal of helping poor people move beyond poverty. They could do this, he theorized, by receiving access to loans on terms manageable to them. He believed in teaching the poor some basic yet solid financial principles.Replicas of the Grameen Bank model now operate in more than 100 countries around the world. What started as Yunus’ personal loans of small amounts to impoverished basket-weavers created a world-wide movement.Thanks to Yunus, a new model of micro-lending has emerged. Loan officers judge people’s credit worthiness, not by the collateral most do not have – but by what they expect to earn.Earlier microfinanceModern-day microfinance stands on the shoulders of its forbears around the world, smaller groups in Asia, South America and Europe. In the early 1700s, for example, the Irish Loan Fund system was founded to provide loans to poor farmers with no collateral.In the 1880s, larger and more formal savings and credit institutions began to appear in Europe. Their main clients were the poor, both rural and urban. By the early 1900s, variations on these models began appearing in Latin America.Modern microfinanceNowadays, many proponents of microfinance are championing entire financial systems that work for the poor – not just the traditional micro-loans of decades ago. Microfinance is available even here in Canada , to those with low income who don’t qualify for services with their banks.Globally, with the development of inexpensive smartphones, telecom providers have been motivated to enter many remote regions. Today, up to 95 per cent of the world’s people live in areas with mobile network coverage. Access to a Smartphone serves as a gateway to multiple services, tools, and technologies.Many agree that microfinance is a valuable tool to help the poor, whether they are expanding a small business or surviving a food crisis. Microfinance can help people in need by:With a small loan, a savings account and some basic training, many farmers, fishers or entrepreneurs begin turning a profit. They can put money away, gaining interest. Many pay off their micro-loans quickly. As their income increases, borrowers can even hire another worker or two.For decades, microfinance institutions have been a key driver for women’s empowerment. In 2018, 80 per cent of microfinance borrowers were women. Empowering women yields undeniable returns, for everyone in the community.Around the world, families have traditionally turned to “loan sharks” or payday lending institutions when they’ve needed cash for business ventures, necessities or debt. Such lenders often have exorbitantly high interest rates. They can trap borrowers in a strangle-hold of debt.Through microfinance, borrowers can establish both collateral and a credit rating. When the time comes to expand the company and hire more workers, many business-owners are then ready for a bank loan.With microfinance, families can rebound when emergencies strike. Consider a drought, in which farmers lose their crops and can’t purchase seed for the following year. With crop insurance, business loans and a savings account, they are better equipped to feed their families through the winter and plant again next year.“Give a man a fish, he’ll eat for a day. Give a woman microcredit, she, her husband, her children, and her extended family will eat for a lifetime.” – BonoWithout financial inclusion, women lack the stepping stones to change their lives and those of their children. Yet globally, men are more likely than women to have access to traditional bank accounts – about 30 per cent more likely , in Bangladesh, Pakistan and Turkey.That’s where microfinance steps in. Many microfinance organizations have found that women tend to pay back loans more effectively than men. Women have dreams and ambitions, for themselves, for their businesses and for their families.At the Grameen Bank, the world’s largest microfinance institution, more than 90 per cent of loan clients are women . Many microfinance organizations make a point of partnering with female clients. This offers a great potential to bring about social change.Microfinance empowers women by increasing their decision-making power and improving their overall economic status. For many, confidence increases. They start believing in their right to enter other spheres of society.A 2017 study found that providing women with microfinance services could greatly impact gender equality in that country. Just a 15 per cent increase in female clients could reduce gender inequality by as much as half, the study said.These interventions are much needed. Though women comprise 70 per cent of the world’s farmers, they’re less likely to have a bank account than men. Women in rural areas face challenges when trying to become financially independent for some of the following reasons:Girls are often encouraged to leave school before completion, for work, marriage or the care of younger siblings.Once girls and women are busy with a home and children, they have less capacity to navigate complex banking systems, especially if illiterate.In many places, laws favour men, even if the property was originally in a woman’s family. This leaves a woman without assets to pledge for bank loans.Women have traditionally been viewed as incapable of starting and managing a successful business.Microfinance is not a “magic bullet” for women’s empowerment. Some critics say it simply increases a woman’s already-heavy work burden. She must now run a business, on top of all her other, unpaid work.“Microfinance recognizes that poor people are remarkable reservoirs of energy and knowledge, posing an untapped opportunity to create markets, bring people in from the margins and give them the tools with which to help themselves.” – Kofi Annan, former Secretary General of the United NationsMicrofinance institutions (MFIs) are organizations which offer microfinance services to individual or group applicants. Over the past ten years, they have lent hundreds of billions of dollars with an average annual growth rate of 11.5 per cent.Microfinance institutions and programs come in various forms. Some organizations, World Vision, for example, are not formal MFIs, but do offer services which increase financial inclusion. Here are some examples:• Microfinance companies: The original Grameen Bank is still among the largest and most influential MFIs in the world today. Others include KIVA, BRAC, Bank Rayat Indonesia and 51 Give in Beijing.• Aid agencies: Non-profit organizations like World Vision promote financial inclusion through community based savings and loans groups. Community members decide together on the rules and terms for saving and borrowing. VisionFund , World Vision’s microfinance services arm, offers financial services – including insurance – in a more formal way.• Banks and governments: Increasingly, governments, banks and credit card companies are supporting microfinance and financial inclusion. Here are the 30 members of CGAP – the Consultative Group to Assist the Poor. Global Affairs Canada is among them.Most MFIs are not-for-profit, focusing on helping the poor and propelling development and social change. But increasingly, some are looking to provide a solid financial return for their investors. In this way, even major banks like Citigroup Inc. are offering microfinancing.This has not been without its challenges, as explored in the Stanford Social Innovation Review Some critics fear that microfinance lending can allow the rich to make money off the poor. The concern is that the borrowers receive loans they can’t afford to pay back easily. As a result, they accumulate interest over long periods of time.Microfinance through non-profit NGOs like World Vision eliminates that concern for many, as no one turns a profit except the borrower.Other critics fear that microfinance is not as effective as many had hoped back in the 1970s. They do note, however, that the model offers a step in the right direction, especially when executed properly. Combining microfinance with other programs, like education and agricultural support, can further increase its efficacy.World Vision sees microfinance as one tool among many, as Canadians partner with the poor to create brighter futures. It is not a magic bullet and was never designed to be. Microfinance does, however, give people struggling with poverty access to financial services the rest of us benefit from.You can help families start businesses , through a donation to the World Vision Gift Catalogue. Your gift will provide a microloan or equipment and training so families can launch small businesses such as sewing, farming, dairy production, baking or weaving.As loans are repaid, your gift will be re-loaned to help other families. Parents living in poverty have the skills, ideas and will to work. With the help of Canadian donors, they will at last have the funds needed to launch those dreams.

Making Microfinance More Effective

For the 2.5 billion people who live on less than $2 per day, shocks such as illness, crop failures, livestock deaths, farming-equipment breakdowns and even wedding or funeral expenses can be enough to tip them, their families, or even an entire community below the poverty line. A major challenge for international development efforts is determining which financial tools provide durable buffers against such setbacks.

While meeting this challenge is a clear priority for policy makers and donors, it is also a major profit opportunity for commercial players who can solve market failures and create real value. Personal savings, insurance, credit, cash transfers from family and friends and other financing mechanisms offer promising opportunities to create security and steady employment but they require a nuanced understanding of product design and the local market conditions in order to be effective.

We recently conducted a literature review of rigorous academic studies of financial service innovations among the very poor to find out what services and products would unlock the most value for those at the bottom of the pyramid. Our findings are captured in a working paper which we summarize below.

Traditional microcredit hasn’t lived up to expectations, but we are learning how to improve it. The Grameen model of microfinance gained a great deal of attention in the international development field after early data showed that it was associated with high repayment and low default. This model makes small loans, usually to women, without requiring collateral. However, seven randomized evaluations from around the world show that this type of ”one size fits all” microcredit product did not increase the average incomes or consumption of households. Expanded access to microloans did lead some entrepreneurs to increase business investments, but rarely to increased profits. Only one study found that microloans increased women’s decision-making power.

Recent evidence suggests that relatively simple tweaks to microcredit products—including flexible repayment periods, grace periods, individual-liability contracts, or the use of technology—may change their impact on poverty and financial institutions’ bottom line.

Savings accounts are effective safety nets—especially if they apply insights from behavioral sciences. People don’t need to borrow money during a personal crisis if they have their own savings. One study showed that just eliminating the costs associated with opening a savings account in Kenya significantly increased uptake, overall savings, and investment levels among market vendors. However, while replication studies in Uganda, Malawi, and Chile also found that removing account opening costs increased savings, this was partially offset by a reduction in informal savings and there were no observed impacts on business investment or income. In Nepal, offering female-headed households a no-fee basic account with deposit collection service tellers came to their home) led to high uptake and usage and real improvements in welfare. Households responded better to health shocks and spent 20 percent more on education and 15 percent more on meat and fish.

Often, the beneficial impacts of savings accounts can be enhanced by features that help people overcome behavioral biases by, for instance, fortifying willpower. So-called “commitment savings” products have lock-up periods, fees, or other penalties for early withdrawal that “commit” the client to a savings goal. These types of features increased decision-making power for women in the Philippines, with even larger effects for women who started out with below-median decision-making power. In Kenya, a simple “Safe Box” that allowed users to save for preventive or emergency health in a metal box to which they had a key increased achievement of health savings goals by 14 percentage points.

Insurance is highly valuable to protect against shocks but is difficult to scale. In Ghana, farmers who received rainfall index insurance cultivated more land and spent 13 percent more on fertilizer and labor than those who received just cash, implying that uninsured risk — not lack of access to capital — is a primary constraint on investment by farmers. In India, when farmers were given rainfall index insurance, six percent more farmers focused production towards higher-return, higher-risk cash crops.

However, despite the potential of insurance products to provide a “risk floor” for farmers and encourage higher-productivity investments and behavior, uptake at market prices is extremely low and commercial offerings have not found a profitable delivery model. Micro-insurance is not at scale anywhere except when heavily subsidized by government, a market we hope technology may change in the future.

Digital financial services let people help each other. Digital payments—for instance, by mobile phone or app—can significantly strengthen people’s financial resilience by enabling an informal risk-sharing network through loans or gifts from friends and relatives. In Kenya, users of mobile-based money-transfer service M-PESA maintained their consumption and spending in the face of economic shocks; non-users of M-PESA had to reduce consumption by 7 percent when facing these shocks. During these hard times, users were more likely to receive domestic remittances—more money from a larger number of people. These improvements in risk-sharing led to higher savings, higher consumption and changes in occupation for user households.

Digital platforms have the potential to change financial services in three ways. First, they may reduce financial institutions’ costs. Second, they can increase the reach of financial products, as traditional brick and mortar channels make it difficult to deliver financial products to people in remote areas. And third, digital platforms can facilitate innovation in product and service design. For example, digital platforms can be configured to improve the customer experience by offering sub-accounts or labeling accounts, and they can provide bank managers with real-time information and other decision aids that can help banks provide better service to clients. Yet there are potential downsides for the bank and the client, since digital products are accessed and disbursed digitally without any face-to-face interaction. Financial institutions must adjust how they analyze client risk, collect payments, optimally cross-sell products without getting to know customers in person. Lack of customer contact could drive up default rates, if not dealt with properly. Ultimately, digital finance may alter client behavior dramatically—for better or worse—with instant access to financial products and information, new user interfaces, and other accompanying changes. Researchers are now studying how digital financial products should be optimally designed to address these potential risks.

We believe that understanding the underlying market failures is the key to designing effective financial products and interventions. Economic theory suggests that we only fully tap the potential of financial markets when information flows freely and symmetrically, when participants choose rationally, when property rights are enforceable, and when transaction costs and barriers to entry are low. In developing economies, market failures and distortions are so strong that all five conditions often fail at once. For instance, lack of information about credit-worthiness—as well as lack of consistent screening ability among lenders—hinders the efficacy of loan programs; traditional bank accounts often are not profitable without high transaction costs that can deter poor borrowers such as long wait times, poor service, high withdrawal fees and high required minimum balances; women often do not have control over their own property; many rural markets are served by monopoly providers, and so on.

Understanding the roots of these market failures—and the evidence on the efficacy of existing financing interventions— will allow the next generation of financial services to better serve the world’s poor. To do so, donors, governments, and private sector players will have to answer some challenging questions: Can we find new technology-based models for digital credit that will succeed where microcredit has failed? Is there a viable way to scale insurance for small farmers? How can we encourage the delivery of well-designed saving products? Can financial products be used to empower women consumers and entrepreneurs?

With the advent of fintech, there is now an active community of scholars, donors, practitioners and technologists working together to find answers to these questions. With continued effort and innovation, we can continue to develop the right financial tools to support the world’s poorest households in resisting shocks and seizing opportunities to climb out of poverty.

Microfinance and Women: The Micro-Mystique

Women, as it turns out, are an excellent risk. Worldwide, microfinance loans serve almost 20 million people living in poverty. 74% of these clients are women. At the Grameen Bank, the world’s largest microfinance institution, more than 90% of loan clients are women. It is true that women tend to make their payments more reliably than men. But more importantly, a loan in the hands of a woman has a better chance to change not just her life, but to improve her children’s opportunities and her society’s prosperity. Why is the combination of microfinance and women so potent?

For one thing, women are ambitious, for themselves and for their families. As they lift themselves out of poverty, they carry their families to a better life. Once they get a leg up, women are more likely to spend their earnings on medical care and education for their children.

Women who provide for themselves and their families are empowered. They have more choices and influence in bargaining. They have a greater sense of self-worth and increased confidence in their abilities. Women who succeed economically also believe in their right to make decisions about their own lives.

Furthermore, the improved condition of a few women benefits the larger society. Studies show that low status for women obstructs a country’s to economic development. Microfinance offers women the chance to enter the public sphere as businesswomen, expanding their roles beyond housewife to breadwinner.

As women participate in the economy, they also become more involved socially and politically. Within their communities they may advocate for changes that will better their own lives and those of other girls and women. Even the power of example is important. More families will pay for their girls to attend school if they see women putting their education to use.

Of course, the social status of women in various cultures can hinder their efforts to start a business. Many women are overburdened with rearing children, cooking, cleaning, and managing the household. Many societies and families expect any business undertakings to take a backseat to domestic duties. Some cultural traditions or religious practices frown on women working outside the home and earning an income. In some cases, women have resorted to participating in microfinance secretly. In others, though, there has been an effort to educate women about their rights and in involving men so that the microfinance process seems less alien.

A woman’s efforts to earn money can also highlight the fact that her husband or father is failing to provide for the family. Some people worry that this could lead to an increase in domestic violence. More often, however, the opposite has been true. People have discovered that women’s participation in microfinance has led to an overall decrease in domestic violence in their household as the strains of poverty are lifted. In fact, the dynamic in many families appears to improve as men benefit from the household’s increased prosperity.

Perhaps the biggest obstacle women face is a lack of education. Illiteracy and deficient math and accounting skills are common among women living in poverty. This can harm their business’s competitive edge.

Organizations such as the United Nations, the World Bank, and others see education as the key to more opportunities for girls and women across the board. Educated girls tend to delay marriage and motherhood. They are also more likely to seek medical care for themselves and their children. They are more apt to encourage their own children to stay in school longer.

For women using microfinance, education broadens their business skills. Women who master reading, writing, and basic math are in a better position to work for themselves. Many microfinance institutions provide business training, information access, technology development, as well as policy and advocacy.

What is truly exciting about women and microfinance is the positive loop. As women prosper, they invest in their sons’ and daughters’ education and health, and elevate the status of women in their communities. When it comes to microfinance, women seem to have a magic touch.

Authors: Heather Clydesdale and Kajal Shah