The terms microfinance and microcredit came into use during the 1970s and are often credited to Muhammad Yunus, a Bangladeshi economist and the founder of Grameen Bank, an early microfinance institution (MFI).
Ever since the concept of currency was introduced some 2,500 years ago, rich and poor people alike have wanted to earn, save, spend, borrow, loan, transfer, and invest it. Microfinance is a modern term for a concept that has been evolving from the time we began using money.
What is Microfinance?
I began researching microfinance by pulling my Webster’s New World College Dictionary Fourth Edition off the shelf and looking up microfinance. I discovered it does not contain the word microfinance but did find:
- Micro – small, very small, or on a small scale
- Finance – the money resources, income, etc. of a nation, organization, or person; the managing or science of managing money matters, credit, etc.; to supply money, credit, or capital to or for; to obtain money, credit or capital for
Next, I searched online. There does not appear to be an “official” definition of microfinance, however, there is some common ground among most definitions:
- Small – money amounts are small
- Poor – clients are poor, many are women
- Lack of Access – clients do not have access to “traditional” banking services.
- Loans – there is a lot of focus on loaning money (microcredit, microlending), especially to people who want to start or already own a microenterprise or small business.
- Financial Services – while not universal, in addition to credit, microfinance sometimes includes savings, payment transfers, insurance, and other financial services.
Based on the above findings, a simple definition might be:
Microfinance is the provision of financial services, involving small amounts of money, to poor clients who do not have access to banking services.
A microfinance institution (MFI) is a financial organization that provides microfinance services.
Saving and Borrowing Money before Microfinancing
Before microfinancing came on the scene, poor people borrowed and saved money in a variety of ways. Some of these methods continue to exist today and are used by the millions of people who are still without access to banking or microfinance services. A few examples are listed below.
Moneylenders have been providing quick access to cash at high interest rates for thousands of years. If the borrower encounters a problem with repaying the loan, moneylenders may or may not be flexible about repayment. High interest rates make it difficult for poor borrowers to pay off loans and get out of debt.
The term “loan shark” refers to a moneylender who charges exorbitantly high interest rates and preys on the poor and people in difficult situations.
Pawnbroking is an old profession. A pawnbroker offers loans to people who secure the loan by bringing in and leaving their personal property as collateral. If the borrower does not repay the loan, plus interest, within the agreed upon timeframe, the pawnbroker may sell the borrower’s personal property to recover the cost of the loan.
Keeping savings safe and readily available is an age old problem. Stashing money under a mattress, in a strongbox, on one’s person, at a family member’s house, or buried in the yard are methods that have been around for many years. In these scenarios, the money might not necessarily be safe. In addition, because the money is readily available, savers may find it difficult to refuse a family member or friend asking for a loan.
Savings collectors collect small savings amounts from a number of people at their homes, workplace, or in the marketplace. For a fee, the collector safeguards the money and returns it to the depositor upon request. Some collectors use the deposits to make small, short-term loans. The saver must rely on the honesty of the collector and their ability to keep the saver’s money safe.
Before the introduction of microfinancing services, poor people had few choices for borrowing and saving money. The limited options available were often fraught with high cost, risk, and uncertainty.
High transaction costs associated with loaning small amounts of money and administering small deposits contributed to the banking industry’s lack of interest in providing financial services to poor people. In addition, there seems to have been a belief that poor people were unreliable borrowers which negatively influenced potential lenders.
A future post will explore the shift in thinking about banking services for the poor and look at microfinance institutions and organizations.