Microfinance: a way out of poverty

Microcredit, or microfinance, is banking the unbankables, bringing credit, savings and other essential financial services within the reach of millions of people who are too poor to be served by regular banks, in most cases because they are unable to offer sufficient collateral. In general, banks are for people with money, not for people without.” (Gert van Maanen, Microcredit: Sound Business or Development Instrument, Oikocredit , 2004)

The history of microfinance can be tracked back to the middle of the 1800s when the theorist Lysander Spooner had researched the benefits from transferring small amounts of credit to people as a way out of poverty. In this way, people were able to start their own business or to extend their agricultural works by borrowing a small amount of money.

The modern wave of organisations occupied with microcredit started back in the 1970s with a lot of similar banks mushrooming across the world. The first Organization was the Shorebank, which was a microfinance and community development bank founded in 1974 in Chicago. This was followed by the Grameen Bank of Bangladesh in 1976 which essentially started and shaped the modern industry of microfinancing. Until today, many others have been founded and these kind of banking activities appear to have a big impact on the reduction of poverty.

But how does it actually work? In general, normal bank operations suit large transactions because they are more profitable. However this means millions of people are not able to borrow from the bank system because, as we mentioned before, they are not able to offer sufficient collaterals and so a vicious cycle of poverty is generated. Microfinance institutions target less affluent people like farmers and poor entrepreneurs, even beggars, by lending very small amounts of money with lower transaction costs.

The main goal of microfinance institutions is to provide loans as small as $75 which is re-paid over several months or even a year. Most of the time, programs point to innovations like ‘group-lending’ contracts in order for each member to give incentives to his/her neighbouring participant to repay his share because if he does not do it, the other members of the group will have to cover the balance.

Additionally, these organisations promote the participation of women. Women are less likely to default on their loans and therefore they will be able to support themselves independent of men in a manner which should encourage sustainable growth of enterprise and eventual self-sufficiency.

Yet there are a lot of arguments based upon the efficiency of microfinance to alleviate poverty around the world. It is true that microcredit has helped around 150 million poor people to finance their efforts and, at least temporarily, increased the quality of their everyday life. But due to its higher interest rates, which can be as much as 35% per annum, and its effort to avoid subsidising risky people and activities, it seems, in practice, not to be accessible to all.

Written by Dorothy Vaitsi