Microfinance has defined the methodology that employs effective collateral substitutes to deliver and recover short-term working capital loans to microentrepreneurs.
- The emergence of microfinance was a result of the poor performance of government programs set up in the 1960s and 1970s to provide subsidized credit to poor farmers and small entrepreneurs in developing countries.
- In the 1970s, it took the initiative of a rare breed of an economics professor Professor Yunus of the University of Chittagong, who was touched by the plight of the poor in the neighbourhood of his elite university campus, to ‘discover’ what the shylocks the world over knew all along that the poor can also repay loans.
- The professor’s ‘discovery’ was a result of his decision to start an experiment of giving small loans (microcredit) to poor village women, who did not let him down by repaying the money they borrowed from him.
- As a result of the success of Professor Mohammed Yunus’s experiment in Bangladesh, microfinance has since the 1970s evolved as an economic development tool, which is used to address poverty in developing countries.
- The term, microfinance, is used to refer to the provision of financial services of saving, advancing credit, providing insurance and facilitating payment for utilities to the low-income earners, including the self-employed (Ledgerwood, 1999).
- In addition to financial intermediation, many microfinance institutions (MFI) provide social intermediation services, which include facilitating the formation of groups, whose members come together for purposes of accessing credit, training their members in enterprise development, and financial literacy and management capabilities.
- Thus, microfinance is not just financial intermediation (banking), but also social intermediation as a development tool.
- Microfinance institutions (MFIs) can be non-government organizations (NGOs), saving and credit unions, government banks or non-bank financial institutions (NBFIs).
- On the other hand, microfinance clients are, in most cases, self-employed, low-income entrepreneurs in both urban areas (artisans, kiosk owners, small scale traders, mobile street vendors or hairdressers etc.) and rural areas (blacksmiths, pottery artisans or small-scale farmers) in the formal and informal sectors.
- Before the emergence of microfinance, the low-income entrepreneurs in the informal sector were served by private money lenders (shylocks), pawnbrokers and rotating savings and credit associations (ROSCAs).
- Originally governments and donor agencies in developing countries set up credit cooperative unions styled on the Raiffeisen model, which was developed in Germany in the 1850s to provide agricultural credit to poor farmers.
- The focus of these credit cooperative unions was to mobilize savings in rural areas in an attempt to teach poor farmers how to save (Ledgerwood, 1999).
- Although well-intentioned, and designed for economic development, many of these credit cooperatives were perceived either as social welfare programs or political party programs designed to advance the political agendas of political leaders.
- As a result, most programs accumulated large loan losses, partly because the programs were mired in corruption, nepotism and gross inefficiency leading to the collapse of most institutions that were set up to serve this noble cause.
- It is the dismal performance of government-sponsored credit programs that led to the emergence of microfinance as a market-based approach to address the problem of financial intermediation to serve the poor.
- In Asia, Professor Mohammed Yunus of Bangladesh led the way with a pilot project to lend to the poor villagers, particularly women.
- Contrary to general belief, Professor Yunus’s pilot project established that poor people can borrow and pay interest rates high enough to cover transaction costs plus a reasonable profit.