Microfinance: Meaning, Types, Features, Pros & Cons and History


Meaning Of Microfinance

Microfinance is a term for financial services offered to unemployed or low-income peoples or groups who lack access to conventional banking and related services. It is also called as microcredit that includes provision of basic financial services such as saving accounts, loan and insurances for peoples having lower earnings but are economically active. In many instances, microfinance represent the provision of small amount loans for micro-entrepreneurs. The motive of microfinance is to provide people with reasonable small business loans in safe manner and as per the ethical lending practices. An amount of micro loan can start from as small amount as $100 and ranges up to highest limit of $25000.

Microfinance plays important role in removing poverty and building better economy around the world. Around two third of world population have no accessibility to conventional financial market. The low-income earners do not have any collateral security and therefore carries no chance of getting loan, have no money to save or invest in future. Women are especially regarded as non-credit worthy by banking institutions. For all such peoples when willing to put their ideas into reality or want to overcome poverty, the only alternative available to them for raising capital is local moneylenders who charges very high rate of interest that can even be several times 100% a month. This is where microfinance came to rescue peoples from lower socioeconomic backgrounds via offering them financial services without any heavy collateral security. 

Types of Microfinance  

Following products are included within microfinance: –

Microloans- Microfinance loans are very crucial product as they are provided to borrowers in absence of any collateral security. These loans have end result of enabling its group of recipients to outgrow smaller loans and get ready for conventional bank loans. 

Microsavings- The microfinance provides facility of microsaving accounts where small entrepreneurs can operate a saving account with no requirement of minimum balance. Such accounts assist people in inculcating financial discipline among them and develop an interest of doing savings for future.   

Microinsurance- It is type of insurance provided to individuals who take microloans. Microinsurance plans carries lower amount of premiums as compared to traditional policies of insurance. 

Features of Microfinance

Various features of microfinance are as described in points given below: – 

  • Microfinance serves the need of borrowers belonging to either low-income group or are unemployed.
  • The amount of loan provided under microfinance are generally of smaller amount (i.e., micro loans) starting with $100.
  • There is no requirement of any collateral security for availing loan services unlike the traditional banking institutions who mandatorily needs some kind of collateral for approving loans. 
  • Loans provided under microfinance are usually paid back at higher frequencies. 
  • Microfinance provides loan with tenure of short durations.
  • Generation of income is purpose of most microfinance loans. 
  • Microfinance charges higher rate of interest than levied by banks as processing of smaller loans require more expenses. Majority of microfinance loans reside in rural areas that raises the cost of operations. 

Steps For Getting Approval To Microfinancing

The approval is up to large extent dependent upon lender, but few things that can increase the chance of loan approval are as follows: – 

Proper business plan

A proper business plan depicts that a person is serious about his business and working hard to make it success. Lenders want to work with people who have proper plan and takes everything in systematic manner thereby carrying more chances of getting success. Each successful plan of business comprises of company’s introduction, overview, mission statement, marketing plan, operations plan, marketing and industry analysis.   

Have decent credit

A good credit makes an outstanding impression on lender, even though the individual does not have enough money at present. Proper reviewing of report should be done such that it does not include any of the false information. In case, if any wrong details are found by lender, then it would result in disputes accordingly. Also, it should be noted that individual is entitled for only one free report every year.    

Sealing the dealing with personal guarantee or collateral

Inclusion of personal guarantee in report act as a legal promise for repaying loan. Lenders get assurance via collateral security such as borrower’s house that can be used by them in case of repayment default by individuals. If person is very confident about his/her business success, then offering these two things (collateral and decent credit) will make chances of his/her loan approval high.      

Put into some of your own money

The personal investment made by business owner along with microfinance loan into their company shows good image of borrower to lenders. It gives them a proof that person will take every step to make sure that his business will success.  

Microfinance Channels

There are mainly two channels of microfinance: –

SHG- Bank Linkage Programme (SBLP)

SHG refers to self-group that is famous for Bank linkage programme. This microfinance channel was started in year 1992 by NABARD and inspires financially weak women’s to form up a group of 10-15 members. The members contribute their individual savings in group at regular intervals and these savings are then utilized to grant small loans to group members. At later stages, the SHGs are too offered bank loans that can be used for financing future income generating activities. The SHG model have become very popular as well as successful, and now they have even start getting support from distinct NGOs and institutions such as SIDBI and NABARD.   

Micro finance institutions (MFIs)

Microfinance institutions have their primary operation as microfinancing. They lend via concept of joint liability group (JLG) that is simply an informal group consisting of 5-10 members seeking loan either jointly or individually. There are several microfinance institutions of distinct size and legal forms providing range of microfinance services. 

Pros of Microfinance

The benefits of microfinance are as follows: –

Collateral-free loans- The first and foremost advantage of microfinance is no requirement of collateral security for seeking financial credit. Majority of the microfinance companies does not take any collateral from borrowers for approving them loans. In addition to this, there is minimum paperwork hassle-free processing involved in microfinance making it very good option for quick fundraising. 

Quick disbursal of loan- The state of financial crisis is totally unpredictable that can arise at any point of time without intimating anyone. Microfinance companies allow people to get quick loan for meeting their financial urgency timely. Thanks to these companies as they offer secured and collateral-free credit to individuals in their demanding situation for fulfilling their fund requirements.  

Offers extensive portfolio of loans- Microfinance companies offer an extensive portfolio of loan services to borrowers. It is not only limited to providing emergency credit but also has potential of disbursing housing loans, working capital loan and business loans with very less formalities and processing. 

Economic growth- The microfinance companies raise investment that also raises the production of goods as well as services. With increase in production, it eventually results in raising the economic growth of nation. 

Social wellbeing- It offers credit facilities to people who are poor and have weak socioeconomic background. These people get loan easily via microfinance companies that helps them in availing better health facilities, education and family wellbeing, etc. 

Women empowerment- Microfinance plays an effective role in empowerment of poor women that are not considered credit worthy by traditional financial institutions. They offer women’s financial credit for starting their own business and become self-sufficient thereby helping them in growing both economically as well as socially. 

Employment creation- These companies provide capital to individuals who have business ideas and want to put them into reality. When people set up their business units, they provide employment to other peoples as well. Therefore, microfinance companies are indirectly helping lots of people in earning some income. 

Cons of Microfinance

There are distinct disadvantages of microfinance companies as well, that are: – 

Harsh Repayment Method- The microfinance companies may adopt a harsh repayment approach in absence of legit working protocol and compliances. This approach will not be preferred by peoples who are facing financial crisis. Also, as these companies work under strict compliances, therefore they may even manipulate their customers for repayment unethically. 

High rate of interest- Another major drawback with microfinance companies is that they are unable to provide lower interest rate loans. They do not operate on traditional banks approach, where funds accumulation is quite easy. Also, microfinance companies need to borrow funds from traditional banks for appropriate execution and allocate some part it for management of risk. Therefore, the operating cost of each transaction becomes quite high for them despite of having high volume of transactions every day.  

Small Loan Amount- Microfinance companies provide a small loan amount to borrowers unlike the mainstream financial banks offering big loans. The disbursement of large loan amount is impossible in their case as they don’t ask for collateral security against the credit. 

History Of Microfinance

Microfinance was created simultaneously by Bangladeshi social entrepreneur Mohammad Yunus, upon the creation of microcredit in 1983. Yunus established Grameen bank in Bangladesh in year 1983, whose main goal was to offer small loans to entrepreneurs initially.     

Vision of Yusuf for microcredit was inspired when he saw women making bamboo stools in Bangladesh and earning two cents a day. He thought that if women’s get loan, then they would be able to raise their margin and earn profit more substantially. When loan was issued to them of $27 following the group model, women were able to repay them and keeping their business still running. 

The saving account aspect of microfinance can also be tie into microcredit; creditors may choose to opt for loan covenant. Loan covenant defines that borrower must set aside a profit’s portion in saving account with financial institution that act as collateral till the time loan repayment is done. This way, it offers some protection for creditors, and if loan is repaid then saving account interest on money that was deposited in account would be earned by the borrower. 

Yunus was awarded with Nobel Peace Prize in 2006, for his Grameen bank efforts. The bank currently employs around 22,000 personnel’s and have i2,500 operational sites. In addition to this, there are 10,000 microfinance institutions at present.