If you aren’t familiar with microfinance, the term can seem a little cryptic. In this guide we’ll help demystify what microfinance is, where it is used, and how it helps.
What is microfinance?
Microfinance is a term used to describe a suite of financial services made available to individuals, entrepreneurs, and small businesses who don’t have access to traditional banking. Often, this lack of access is correlated with poverty and systemic inequality. Over 1.7 billion people around the world—more than 31 percent of adults—are considered “unbanked,” meaning they have few options to manage their finances. Some of the reasons that people don’t have access to finance include:
Lack of access to a nearby bank branch (where the United States has over 30 bank branches per 100,000 people, many countries have less than 10)
Lack of access to a mobile phone or internet service
Minimum balance fees or a minimum opening balance
Distrust of the banking system, typically due to a lack of transparency regarding fees
No access to a government-issued ID, which is required to open a bank account
Socioeconomic factors like gender inequality, wealth inequality or lack of education
Systemic or structural factors like unstable governments, conflicts, refugee status, or racism
Lack of assets to serve as collateral
Microfinance services aim to increase access to financial products like loans, savings accounts, insurance, and fund transfers, providing opportunities for growth and stability.
What is a microloan?
“Microlending” or “microcredit” deals specifically with the practice of extending credit and/or loans to people who lack access to traditional financial services. Microloans are designed for individuals not served by traditional banks and are generally offered by specialized financial services providers often called Microfinance Institutions (MFIs). The “micro” part refers to the amount of money lent to these individuals, which is usually anywhere from a few hundred to a few thousand dollars. Microloans aim to provide enough money to make a difference to an individual’s life, while still being manageable to pay back. While the sum may be small, the impact can be big, allowing people to grow businesses, expand farms, and fund educational pursuits. Often this provides a sustainable way for loan recipients to grow their income. Kiva funds microloans by allowing individual lenders to contribute small amounts. Through Kiva’s online platform, with as little as $25 you can contribute to loans that help people access finance for starting or running a business, getting an education, or making sustainable swaps in their lives.
How did microfinance start?
Microfinance began with the aim of eradicating poverty. Bangladeshi innovator Dr. Muhummad Yunus was one of the initial founders of the movement in the 1970s. Dr. Yunus found himself interacting with destitute basketweavers who were trapped by unfair and predatory lending situations when trying to purchase raw materials for their wares. He made a few small personal loans that allowed the women to buy more materials and sell more baskets, enabling them to pay back the loans easily. Dr. Yunus went on to found the Grameen Bank in 1983 on the principle that credit is a fundamental right, spurring similar lending models in more than 100 countries. He won the Nobel Peace Prize in 2006 and continues to promote the concept of microlending through his service with the UN Foundation. Alongside the creation of the Grameen Bank, there were two other movements that led to this method of individual lending around the same time. In the 1980s, a restructuring of the rural credit system of Indonesia’s national bank led to its transformation into a dedicated MFI, with a network of designated village posts to address a wide variety of financial needs. The maximum loan began at USD$1000 and loans were made available to “any creditworthy customer for any kind of productive enterprise.” Simultaneously in Peru, a small pawn shop in the northern city of Piura had been the only available source of loans for local entrepreneurs. It was transformed into the Municipal Savings and Loan Bank, and focused mostly on providing people a place to put their savings, then expanded its lending capacities as its portfolio grew. The model spread across Peru to 12 locations, then quickly throughout South and Central America. In the mid-1990s, this credit methodology jumped continents to former Soviet states after the Soviet Union fell, and the original Peruvian model is now deployed in some form in all corners of the globe. Building off the success of these pioneers, Kiva was founded in 2005 with a mission to expand financial access and help underserved communities thrive. By leveraging the internet and a crowdfunded lending model, Kiva allows anyone, for as little as $25, to become a lender and participate in the economic innovation of microfinance.
What is the goal of microfinance?
While the eradication of global poverty remains a primary ambition, microfinance also aims to improve financial inclusion—to provide access to services that enable economic agency and financial freedom for all.
What are the benefits of microfinance?
Microfinance expands access to financial services and extends credit to those who would otherwise have limited options. Some of the benefits this can provide include:
Increase household wealth.
For the more than 97 million people on the planet living on less than USD$2 a day, having the means to invest in raw materials, better seeds for farming, or a college degree can compound into a more successful future.
Create opportunities for others.
A loan used to launch a small business can help improve the economic health of a community by providing new job opportunities.
Promote better health and education.
Families who utilize microfinance are less likely to pull their children from school for economic reasons and have more resources available to pay for healthcare.
Help close the gender gap.
Over 80 percent of Kiva microloans go to women, funding businesses, enterprises and education in countries where social norms do not support gender equality.
Provide a sustainable way to help low-income populations.
While charitable giving can be a way to help those with financial difficulties, it requires a constantly replenished pool of financial resources. With a repayment rate of 96.4 percent, microlending through Kiva provides a sustainable flow of cash which can be lent again to additional individuals once it has been repaid.
Through Kiva microloans, approximately USD$1.8 billion has been deployed to nearly 4.5 million borrowers in 94 countries so far.
What are examples of how microfinance is used?
Microfinance in the form of microloans can take many forms. For example, Peter, a maize farmer in Kenya, borrowed USD$125 through Kiva, facilitated by Kiva’s Field Partner Apollo Agriculture, which helps small farmers maximize their profits. With the loan, Peter was able to purchase and plant higher quality seeds, leading to an increased harvest and higher earnings—which he will then reinvest in his farm for another growing season. An example of how a larger microloan works to create a positive impact on an entire community can be found in Catherine’s story. As the owner of a cereal company in northern Rwanda, she purchases raw grains from 3,500 small farmers across the region and processes them to sell to wholesalers and in her small supermarket. A loan of USD$35,475 bought a new commercial truck to collect more grains from more farmers, enabling her to expand her business in southern Uganda and hire more employees. Other examples of microfinance include savings accounts like those that Kiva Field Partner Xacbank sets up for students in Mongolia.
Does microfinance work?
While Dr. Yunus’ vision of microfinance alleviating global poverty is far from realized, the microfinance movement appears to have had a positive effect on financial inclusion. From institutional lenders to Kiva’s crowdsourced loans, microfinance has offered millions of people in impoverished communities loans and services aimed to improve their livelihood. Critics of microfinance cite that high interest rates and predatory lending practices can trap already vulnerable people in debt. Kiva remains vigilant in circumventing unethical applications of such lenders, vetting its Field Partners by a rigorous process to ensure interest rates are not unreasonably high. Kiva conducts due diligence and regular audits, choosing only to partner with organizations committed to responsible and fair lending practices. Kiva and its Field Partners often conduct studies to assess the impact of loans on borrowers. Positive impact can mean more money, of course: Rural farmers in East Africa who received microloans through the One Acre Fund have shown to increase their incomes 40-50 percent compared to a control group, and an external study of borrowers with another Field Partner, BRAC, reported that 92 percent earned more money after engaging with BRAC.
Positive impact can also mean better quality of life: In Madagascar, 92 percent of customers of Boabab+, a provider of off-grid solar energy systems, reported that they feel safer in their homes because of the increased light, and that children have been able to study 75 percent more in these households. In Kenya, a study conducted of borrowers who took a loan to buy a BURN cookstove not only experienced a safe, efficient energy source but saved $USD120 annually. The impact of microfinance and its ability to improve the livelihoods of borrowers depends on how loans are designed and who the borrowers are. Studies show that if microfinance is designed around customer needs and circumstances, then it can be transformative. For example, a study in India showed that when microloan borrowers were given a two-month grace period before they had to start repaying their loans, they saw a 41 percent increase in weekly profits compared to a control group.
Microfinance takes investment
Microfinance isn’t a perfect or singular solution. Alongside microloans, Kiva works on innovative programs like Kiva Capital and Kiva Labs, designed to address systemic issues that create the need for microfinance in the first place, and to create more pathways to financial inclusion in developing countries. The good news is that with fewer people living in extreme poverty than ever before, continued effort can help bring more individuals economic agency. “The global poverty rate is now lower than it has ever been in recorded history. This is one of the greatest human achievements of our time,” says World Bank President Jim Yong Kim. “But…we need much more investment, particularly in building human capital, to help promote the inclusive growth it will take to reach the remaining poor.” Microlending on Kiva allows anyone to participate in that inclusion. Ready to try it out? Make a loan today.