What is Microfinance

Microfinance are small loans extended to business people to help grow their business or tide over a financial crisis. Institutional lending can often be cumbersome with plenty of paperwork to be filed and a collateral is required for loan clearance. Microfinance on the other hand is easy to dispense, with minimum paperwork and keeps the client’s requirements and abilities in mind. Initially it was started in third-world countries to help the poor. Today, developed nations are also adopting microfinance to fund customers.

The objective of microfinance is financial inclusion. Customers who get turned down by banks often turn to unscrupulous usurers who trap them in a debt cycle. A modern day example is payday loans. Microfinance lending aims not at generating profit but at helping their customers by having a reasonable rate of interest. People who avail this microcredit thus now have access to finances that were unavailable to them before.

Microfinancers help the financially marginalized with capital and help them become independent. Borrowers do not have to provide a collateral but pay a slightly higher rate of interest because of the risk of default. In India for instance micro credit providers offer loans starting at 10% without collateral, but can go as high as 24%. Loan amounts are between Rs. 5000 and Rs. 10000, but it can be more. They come with a tenure of 6,12, 18, 24 and 36 months.

Microfinance’s scope includes microcredit, microsaving and microinsurance. Individuals can save money in a microfinancing bank at zero balance. Micro insurers offer customers insurance at lower rates of interest and lesser number of premiums. This is in keeping with the objective of including as many people under the insurance umbrella, so that they can benefit from it during an emergency or a calamity.

Microfinance thus helps small business people be independent without borrowing money from family or money lenders. It is also helpful for customers who cannot get a line of credit, checking accounts or loans from banks. Data reveals that a large percentage of borrowers are women in rural areas. Micro entrepreneurs use micro credit to jump start their business ideas and sustain themselves.

Like with all great ideas with noble objectives, there are downsides too. Often, borrowers use their micro credit simply for consumption or in loss making businesses. This leads to them incurring debt, since they cannot repay the loan. In some cases they take new loans to service the old ones and get on the debt train.

The solution for this is financial literacy, help with how to generate profits in business, helping micro entrepreneurs move up the value chain if possible and meetings where they can exchange ideas and their learnings.

The global microfinance industry was valued at 7 billion in 2020, and is expected to be $395 billion by the year 2027. The expected Compound Annual Growth Rate or CAGR is 13.8% in the time period ranging from 2020-2027. Banks will continue to be a growing segment in the microfinance sector with a CAGR of 15% while non-banks will have a CAGR of 13%. Currently, the microfinance segment is largely serviced by non-banks.