dihard:

Microfinance is a movement to provide poor households permanent access to financial services. It is the act of lending small loans to poor or low-income people who normally don’t qualify for traditional banking credit to help them start or grow their small business.

While there are many ways the loans are structured, the business model relies purely on community and relationships. While in Chile, I met with a microfinance institution (MFI) and was given the run-down on how one business model actually works. And I was blown away! See below..

A group, usually between 5 and 10 neighbors in a small rural community, gathers and appoints a loan manager within the group. That loan manager receives the loan from the MFI and distributes the money to the group members. The individuals then then use the money to invest in supplies for her business. These loans are repaid weekly in this scenario, though repayment schedule varies.

If anyone in the group does not pay back her loan, the rest of the group must make up the difference that week. The group will not be awarded further credit unless it delivers total repayment. Thus, if one person does not repay, she affects the business and lives of her neighbors. It is peer pressure and reliance upon one another that allows the model to work.

I say ‘her’ because most MFI’s target women. The women, they have found, are the most likely to give money back to the family. Additionally, access to financial services also helps to improve the status of women within the family and the community. In some areas with strong microfinance programs, there have even been reports of declining levels of violence against women. Economists actually found that the reason microfinance even works is because in these rural areas there is a a market for male labor, but not for female labor. Credit, therefore, is a catalyst for women to become economically productive when they otherwise would not be. Without this factor, microfinance doesn’t make economic sense.

Muhammad Yunnus began the movement in 1976 after a devastating flood in Bangladesh. He loaned $27 to 42 women in a village in Bangladesh who made small items and furniture. Each woman made a profit of 2 cents on the loan. By 2007 his Grameen Bank (village bank) had issued $6.38 billion to 7.4 million borrowers. Yunnus won the Nobel Peace Prize in 2006.

There are now thousands of MFI’s, including big banks who were initially not interested in making small loans to the poor because of the high default risk. They now recognize the viable business model. Microfinance has also grown to include not just credit, but insurance and fund transfer services.

Many believe microfinance is the force that will single-handedly defeat poverty. Some believe otherwise, citing the lack of measurement of macro effects, the evidence that some women give all of the money to their husbands, and the lack of efficiency of the model with the poorest of the poor.

It could certainly be a driving force in defeating poverty. That is if all microfinance institutions were socially driven. However, recent reports of extremely high interest rates, questionable tactics to ensure repayment, and soaring profits indicate they may not all be so. Case in point, CompartamosBanco, a Mexican lender to the poor whose interest rates are at least 79%, went public last year, listing its shares for over $1 billion. In the company’s Letter to Our Peers, it explains that by pursuing profits it will be able to lend to many more people more quickly than if it were to act as a charity. Yunnus, on the other hand, believes a MFI that charges more than 15% above their operating costs should face penalties.

OMG! CAN WE PLEASE RECRUIT HER TO SLIDE NOW OR WHAT!?  I am more excited for SLIDE than ever after reading this!