# 16.2F: Microfinancing

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Microfinance is usually understood as the provision of financial services to micro-entrepreneurs and small businesses.

### LEARNING OBJECTIVES

Examine the use of microfinance and microcredit for industry, including the benefits and criticisms

### Key Points

• The modern use of the expression “microfinancing” has roots in the 1970s. At this time, organizations such as the Grameen Bank of Bangladesh, led by Muhammad Yunus, were starting to shape the modern microfinance industry.
• Microfinance is a broad category of services, one of which is microcredit. Microcredit is the provision of credit services to poor clients. Although microcredit is only one of the aspects of microfinance, conflation of the two terms is endemic in public discourse.
• An important source of detailed data on selected microfinance institutions is the MicroBanking Bulletin, which is published by Microfinance Information Exchange.
• Most criticisms of microfinance are actually just criticisms of microcredit. Other microfinance services, like savings, remittances, payments, and insurance, are rarely criticized. For example, many have criticized the high interest rates microfinance charges to borrowers.

### Key Terms

• microfinance: finance that is provided to unemployed or low-income people or groups
• microcredit: the practice of making very small loans, especially to poor people to promote self-employment; microlending
• Grameen Bank: The Grameen Bank, a microfinance organization and community development bank started in Bangladesh, makes small loans (known as microcredit or “grameencredit) to the impoverished without requiring collateral.

### Microfinance

In microfinance, financial services are provided to micro-entrepreneurs and small businesses, many of whom lack access to banking services because of the high transaction costs associated with serving these types of clients. There are two main mechanisms for delivering microfinance services. Relationship-based banking deals with individual entrepreneurs and individual businesses. In group-based models, several entrepreneurs unite to apply for loans and services as a group.

### Microcredit

Microfinance is a broad category of services that includes microcredit. Microcredit is the provision of credit services to poor clients. Although microcredit is only one type of microfinance, conflation of the two terms is endemic in public discourse. Critics often attack microcredit while referring to it indiscriminately as either ‘microcredit’ or ‘microfinance’. Due to the broad range of microfinance services, some argue that it is difficult to objectively assess its impact. Very few studies have tried to assess its full impact, although there have been several studies that examined particular cases.

### The History of Microfinance

The history of microfinance dates back to the middle of the 19th century, when Lysander Spooner, a theorist, argued that entrepreneurs and farmers could be raised out of poverty if they were given small credits. Independently of Spooner, around this time, Friedrich Wilhelm Raiffeisen established the first cooperative lending banks to support rural German farmers.

The modern use of the term “microfinancing” dates back to 1970s. At this time, organizations such as the Grameen Bank of Bangladesh, led by Muhammad Yunus, were beginning to shape the modern microfinance industry.

An important source of detailed data on microfinance institutions is the MicroBanking Bulletin, which is published by the Microfinance Information Exchange. At the end of 2009, this organization was tracking 1,084 microfinance initiatives that were serving 74 million borrowers ($38 billion in outstanding loans) and 67 million savers ($23 billion in deposits).

### Criticisms of Microfinance

Most criticisms of microfinance are actually just criticisms of microcredit. Other microfinance services, like savings, remittances, payments and insurance, are rarely criticized. For example, many people have criticized the high interest rates microfinance charges to borrowers. In 2006, in a sample of 704 microfinance institutions that voluntarily submitted reports to the MicroBanking Bulletin, the real average portfolio yield was 22.3% annually. That being said, the annual rates charged to clients were higher, because these rates included local inflation and the bad debt expenses of the microfinance institution. Recently, Muhammad Yunus has tried to react to this point. In his latest book, he argues that microfinance institutions should face penalties if they are found to be charging more than 15% above their long-term operating costs.

Community-based Savings Bank in Cambodia: This is a photograph of a community-based savings bank in Cambodia. There is a rich variety of financial institutions which serve micro-entrepreneurs and small businesses.