What is Microfinance?
The concept of microfinance was originally founded Muhammad Yunus a Bangladeshi social entrepreneur, banker and economist who was awarded the Nobel Peace Prize in 2006.
Microfinance is the provision of financial services for people living in poverty who don’t have access to traditional financial services. Besides loans, microfinance can include other services such as savings, money transfer and insurance and allows low-income earners to finance income-generating activities and protect against risks.
The principle of microfinance is based around the ideology ‘give a man a fish, feed him for a day….teach a man to fish feed him for a lifetime’. In most countries where microfinance is offered there are usually very limited ‘salaried’ opportunities, so many ‘micro-entrepreneurs’ set up small businesses from home. These are usually very different from the type of entrepreneurs that spring to mind in the western world. The 'borrower' may be running a small shop from their house, selling goods at the local market or providing services such as hairdressing or tailoring services.
Who is microfinance aimed at?
Microfinance is aimed at individuals who were previously considered “unbankable” by larger banking institutions. These are individuals who are possibly dealing in small amounts of money each day, living in hard-to-access areas, without credit histories or who don’t meet “traditional requirements” within the banking sector. For example, in many parts of the world, women are not allowed to own property. Since banks often require collateral for loans, women are often excluded because they don’t have access to collateral against which to secure the loans.
When is it not suitable?
It’s widely accepted by socially driven microfinance institutions that microloans specifically are not appropriate in situations where they propagate a cycle of debt or dependence. For example, if a client is taking a loan to pay off another loan, this is (ethically speaking) considered very bad practice and is something Deki works with our Field Partners to avoid. Also in times of famine or natural disaster microfinance is also considered unsuitable.
The loans given by Deki are very small. How can such small amounts of money make a difference to people’s lives?
A few hundred pounds may seem like a small amount, but loans of this size can make a huge difference to people running small businesses in developing countries. In countries like South Sudan and Malawi, staff and overheads are much cheaper than in Europe. This means that entrepreneurs there can accomplish more with less money. Read some successful stories.
Studies have shown that a loan given to an entrepreneur in the developing world can be worth almost 60 times what it would be worth in a developed country. This means a loan of £500 could be worth as much to a small business owner in Uganda as a loan of £30,000 to a business in the UK.
Successful businesses affect whole communities. They generate employment, bringing new money and boosting the local economy. This helps people to feed their families, access better healthcare, and send their children to school.
Why can’t commercial banks offer these services to people living in poverty?
People in developing countries often don’t have bank accounts or credit histories. This makes it hard to apply for loans from traditional banks. They may also lack legal documents and don’t have verifiable sources of income or have become a refugee.
In most cases, credit bureaus and banks are unable to assess creditworthiness without correct documentation, regardless of whether applicants have good business plans or already run successful businesses.
In the UK, credit bureaus can access information on 84.6% of the adult population. For people with bad credit this might not be a good thing, but for the majority it makes life easier, helping them access credit and other essential banking services. In regions of the developing world, this infrastructure does not exist, making banking services difficult to access.
This does not mean that these people are not creditworthy. The growth of microfinance has shown that many poor people have good business ideas and entrepreneurial spirit, making them extremely capable of repaying loans.
Why do microfinance institutions charge interest on loans to people already living in poverty?
Deki charges no commission or interest on loans. Most of our field partners, small microfinance institutions, charge interest on the loans. They do this to generate the running costs they need to deliver the loans and the associated supporting services, such as business , social and economic training with the loan.
Historically the interest rates of some microfinance institutions have been criticised for being higher than those of commercial banks. Several factors explain this. Firstly, it is generally more expensive to administer smaller loans, and since most microfinance clients do not have regular salaries or collateral, the process of evaluating applications is particularly difficult. Secondly, costs associated with delivering loans in hard-to-reach rural areas, accompanied with training and support must be considered. Thirdly, though repayment rates can be very good micro lending involves more risk than the lending commercial banks engage in.
What sort of interest rates are Deki’s field partners charging?
None of our field partners are driven by maximising profit, and any profit is reinvested towards delivering more loans and high quality training. This enables them to grow and develop to better serve their clients. Deki works very closely with field partners to ensure that costs, and therefore interest rates, are kept to a minimum. The aim is for them within 10 years to become fully sustainable and for Deki to withdraw loan capital completely.