What is Microfinance?

Teen in store

When talking about helping developing countries, people throw around the term microfinance. You might be wondering (and too afraid to ask), what is it?

Susan Davis, President & CEO of BRAC USA, devotes her career to alleviating poverty by empowering the poor. We relied on her to tell us what it means, how much someone could give, and just why it might be better than simply sending a boatload of clothes to Africa.

DS: In the most basic terms, what is microfinancing?

Davis: In many countries, underprivileged young people who want to start a small business can access capital through a microfinance institution. Microfinance entails providing financial services to those people who cannot access financial services through big banks and other large financial institutions due to geographical limitations, lack of credit score and other barriers.

DS: Who does microfinancing help?


Davis:  A lot of research suggests that the overall benefits of microfinance increase when a woman receives a micro-loan. She will tend to use the profits from her business for the benefit of her family, not just for herself. She will invest in her family, often investing in education for her children or siblings. She is likely to save as opposed to spending money on recreational activities. We tend to see this less with male borrowers. A short video made by the http://girleffect.org/  explains the benefits of investing in girls.

DS: How do developing countries lose out when Americans simply donate shoes or clothes? Are these programs a bad thing to have? 

Davis: An old proverb says if you give someone a fish, she can only eat once but when you teach her how to fish, she can eat for a lifetime.  Solutions that address poverty’s root causes, and enable communities to become self-sufficient are more sustainable. Solutions that bring about change in society are more powerful than a onetime donation of a “pair of shoes”. What will happen when that person outgrows the shoes? 

DS: “Microfinance” isn’t necessarily showing up in our news feed. What success has it shown in getting people out of poverty? 

Davis: Microfinance is not a [simple cure] for poverty–alleviation but a very effective tool in helping people to create their own jobs when there are no jobs available. BRAC’s experience has shown that Microfinance as a poverty alleviation tool is most effective when combined with other services such as programs in education and healthcare.

DS: What are the challenges of microfinancing? 

Davis: Microfinance institutions (MFI’s) that operate solely for the profit motive can tarnish the reputation of an effective poverty-alleviation tool. In many countries, for profit microfinance companies charge excessive interest rates and loan money to vulnerable people without conducting due-diligence on the person’s ability to pay.

DS: What is microcredit?

Davis: Microcredit is the practice of making small business loans to micro-entrepreneurs. To get a loan from a bank, one must have collateral or an asset against which the bank will make a loan. Most poor people do not have an asset (like a home or a car) against which they can borrow money from a bank. Unlike big banks, MFI’s will make small business loans to the poor which provides working capital for their business. 

A financial system approach to microfinance entails the cooperation of all sectors of society to create an environment in which poor people can realize the maximum benefits from micro-finance.

DS: What is the smallest microfinance donation you've ever heard of? Anything under 100 dollars? 50? 

Davis: No donation is too small. The need for microfinance on a global scale is immense so every donation counts. What might seem like small microfinance donation in the U.S. might be large enough for a woman in Africa to buy a cow with which she might eventually be able to start a dairy farm.  

DS: What areas of the world are most in need of microfinance? 

Davis: Microfinance is more prevalent in developing countries where poor people do not have access to financial services. There are a lot of microfinance program in Asia and South America but the there is still a large number of people in the world that need access to microfinance services. Africa also needs more microfinance institutions. Over the last few years, many microfinance institutions have also cropped up in the United States to address growing poverty. 

DS: What are the most common businesses established or sustained through microfinancing? 

Davis: Running a roadside tea-stall or a snack shop, raising a cow or chickens, a small tailoring shop are all typical examples of micro-enterprises, small businesses supported through micro-credit. Any small business that can successfully address the needs of the community has the potential of being a business sustained through micro-finance.  Our experience has shown that this varies from country to country. 

DS: Can you offer an anecdote of someone who was micro-financed and it ended up helping not just them but their community? 

Davis: In Bangladesh, Shahida Begum, a woman borrowed 50USD to start a small tailoring business 12 years ago from BRAC. She repaid that loan successfully within a year and since has taken out bigger loans that she has also paid back. Twelve years later, Shahida has managed to grow her business substantially and now employs twelve women from her community. Shahida’s employees earn enough to send their children to school and to get an education. Shahida’s access to small loans coupled with her entrepreneurial ability not only changed her own life but the lives of others in her community. 

DS: What is a common misunderstanding or misconception about microfinancing those in developing nations? 

Davis: One of the misconceptions about Microfinance is that poor people default on their loans and will not pay back just because they are poor. This is simply not true. Microfinance repayment rates have been very high traditionally. In BRAC’s case, the repayment rate is over 98%.

The success of microfinance has also created big expectations of what it can achieve.  As I have mentioned before, microfinance should not be seen as the silver-bullet solution to defeating poverty.  Poverty has complex multi-faceted causes, and therefore one should not expect one method (microfinance only) to root out poverty. It is, however, a transformative tool when coupled with other solutions.