Top 10 things to know about microfinance
By James Allman-Gulino, KF11 Uganda
For the regular visitors to the Kiva Fellows blog, I’m sure you have a good idea of how microfinance works and how Kiva fits in to the bigger picture. However, newer visitors may be less familiar with some of the basic characteristics of the field. With that in mind, I’ve created a “top 10” list of (hopefully) helpful facts about microfinance and Kiva’s operations:
1. Microfinance delivers financial services to poor individuals
Microfinance specifically offers services to those who don’t have adequate credit or who are otherwise “unbanked”, meaning they do not have access the services of a traditional financial institution like a bank. This may be because they lack the assets needed to get a loan, are deemed too poor to merit targeting, or live in a remote area where there are no financial institutions. Microfinance institutions (MFIs), however, adapt their services to cater to these populations and get them financial credit; MFIs also typically have an explicitly “social” goal of helping these people lift themselves out of poverty. Microfinance exists all over the world (including in the United States), but is focused on the developing world due to poorer populations and lesser penetration of traditional banks.
2. Microfinance includes more than business loans
As you can see if you browse around Kiva, most microfinance takes the form of business loans, where an entrepreneur asks for an amount of loan capital to start or expand a productive business. This is the prototypical image of microfinance that many people have. However, not all people are successful entrepreneurs just because they can get credit! Microfinance comes in many other forms as well. For instance, microsavings can afford poor individuals a secure place to keep their cash earnings, and actually earn interest on their savings. Other microfinance loan products might be specifically designed for housing (in a format like a traditional mortgage, just on a much smaller scale), or to pay for children’s school fees. This range of services helps provide clients with the products most needed to pay for (or save for) important things in their lives.
3. Kiva works through partnerships
Kiva works exclusively through Field Partners. These are the MFIs on the ground in developing countries that actually give out and administer the loans you see on Kiva. If Kiva was the organization actually taking pictures of borrowers, giving out loans, collecting repayments, and authoring journal updates in countries stretching from Mexico to the Philippines, I think we’d need a few million employees. Instead we work with MFIs in these countries to do these tasks, then provide them with interest-free loan capital every month that comes from your contributions on the website. For a handy diagram of how this works, see below or click here.
4. Microfinance is not “the answer” to poverty
With the rise in popularity of the Grameen Bank in the 1990s, microfinance became a familiar concept to people all over the world and a newly favored strategy for poverty alleviation. This lead some organizations and analysts to rosily portray it as a wholesale answer to poverty in the developing world. However, microfinance is not a be-all, end-all “poverty solution.” As I alluded to in an earlier blog post, entrepreneurs in developing countries still have to deal with a multitude of problems that reinforce persistent poverty, such as poor public infrastructure, lack of health services, gender and social inequity, and unrepresentative governments. These problems might prevent entrepreneurs from getting their products to market, require them to spend all their profits on medicines, or otherwise inhibit the beneficial effects of microfinance. Microfinance is, however, an excellent means to provide populations in the developing world with a means to develop their own enterprises and solutions to local poverty.
5. Microfinance empowers borrowers
This leads me to my next point – microfinance is empowering for borrowers. It enables them to create homegrown solutions that address poverty in its own environment, instead of being told what to do by an outside entity that pays for a poverty intervention (usually an aid agency). In this way microfinance not only obviates the problem of aid dependency that plagues many well-intentioned programs in the developing world, but also gives borrowers the pride of responding to poverty themselves instead of depending on the assistance of outsiders. Microfinance is also socially empowering for the disadvantaged target groups it often serves (women, refugees, minority ethnic groups) by giving them a means to become financially independent.
6. Kiva is a “peer-to-peer” microfinance model
This is the best part about Kiva! When you make a loan on Kiva, it is a direct connection to an individual entrepreneur in another country. It is not donation that gets put into a huge pool without you ever knowing exactly where it goes; it is a loan, and if the borrower that you funded doesn’t repay their loan, then you won’t get back your money. This (hopefully) gives you an incentive to really look into what businesses you fund, and lend ones you think will return your investment. It’s also a great way to learn a little bit about some other countries around the world, and what the lives of entrepreneurs there are like. It also works in the other direction – working with an MFI that’s on Kiva gives borrowers a neat connection to people overseas, and the much-appreciated (I can attest to this) knowledge that lenders an ocean away are genuinely interested in their business.
7. Microfinance borrowers are charged interest
I believe most Kiva users know this fact, but it’s still worth clarifying. Funds raised on Kiva are “interest-free” capital, in that Kiva transfers the funds to MFIs at 0% interest, unlike commercial capital which would probably cost the MFI 8-12% in interest. The MFIs, however, still charge their borrowers interest. This interest rate will be whatever the MFI charges on their loan product(s). These rates will vary from institution to institution, but are likely to be somewhere north of 20% annually.
8. Microfinance operating costs are high
As a follow-up to the last fact, why are MFIs still charging their borrowers interest if they’re getting funds at 0%? The reason is that microfinance is expensive. When borrowers live in very rural locations, it’s costly for loan officers to commute there; when borrowers don’t have assets to put up as collateral for a loan, it’s risky for the MFI to loan to them in case they default; and so on. The point is, the operations of an MFI that allow it to pursue a social goal like lending to remote/poor/disadvantaged populations also end up costing a lot of money (note for accounting types: this is why MFIs’ Operating Expense Ratios are so much higher than normal institutions). The difference between the Kiva funds’ 0% and the interest rate to borrowers helps pay for these costs. There have been a lot of excellent discussions by Kiva Fellows on this topic: see this post by KF9 Eva Wu, another by KF9 Meg Gray, or simply search “interest rates” on the Kiva Fellows blog.
9. Microfinance still has room to grow
Microfinance has in fact become so prevalent that some analysts have deemed the microfinance market as approaching “saturation” because of the depth of financial services now available to poorer populations. This is undoubtedly a fair issue to raise, since the popularity of microfinance as a poverty intervention has led to a large proliferation of MFIs (for instance, even financial institutions in Kampala that really are traditional banks now advertise themselves as MFIs). With such an expansion of credit for the developing world, MFIs will need to be better monitored in the future to ensure they are practicing responsible lending. But this expansion of services certainly doesn’t mean the market is saturated. An oft-cited 2004 paper by CGAP (an arm of the World Bank dedicated to microfinance) hypothesizes that “alternative financial institutions” still fail to reach 2/3 of the world’s unbanked population, and that the number of potential microfinance clients worldwide is as high as 3 billion. So there’s still room to grow!
10. Microfinance makes a real difference in the lives of the poor
I’ve been in Uganda about 4 months now, and have met with many different borrowers of both BRAC Uganda and MCDT SACCO. These borrowers are certainly not free from poverty now just because they’ve gotten microfinance loans. But the loans have made a real difference in the borrowers’ lives. Women living in internally displaced persons (IDP) camps in Northern Uganda spoke to me about the sense of community they got from group borrowing when they were separated from their families; a poultry farmer I met in a Kampala slum (who is pictured below) went from having a few chicks to a massive indoor installation that produced eggs and broiler chickens for her whole neighborhood; adolescent women in BRAC Uganda’s ELA program had started productive hairdressing enterprises, despite being all of 17 years old. Stories like these are commonplace in microfinance – having new access to capital, whether for a business or otherwise, can have a big impact on borrowers’ lives. So keep this in mind when you contribute to borrowers on Kiva!