what are microfinance institutions and are they good or bad?

Question

I’ve been googleing but I’m trying to pull myself out of a rabbit hole. I don’t see these institutions prominent in my country – where are they? And the pros and cons of them seem to be in theory? Like there aren’t news stories accompanying them

In: 1

Answer 1

Microfinance starts from the idea that poor people, particularly those in poor countries, want to be entrepreneurial. They need small amounts of money to start businesses, expand them or make them more efficient, and can get big returns from small investments. Even households could save money through small investments (like a more efficient stove).

Mainstream financial institutions aren’t interested in loaning such small amounts to people with few assets and no credit history. Small local lenders tend to be effectively loan sharks, charging very high interest and operating in very questionably ways. So it’s hard for these people to get the finance they want.

That’s where microfinance banks came in, specialising in this kind of small loan to poor people.

It was a big idea in development circles in the 2000s. There were lots of stories of great business successes, high repayment rates, and a development initiative that didn’t need subsidies.

Unfortunately it turned out there were lots of problems. The posterchild for the movement, Grameen Bank, was shown to be hiding subsidies. Interest rates were often as high as loan sharks would charge. Loans ended up being used not for investment but for consumption. And many business success stories turned out only to apply to the first mover.

So, for example, the first business in a town to get a mobile phone might be really successful and have no trouble repaying a loan. But the second and third would be less successful, and before long competition would push down profits, making high-interest loans impossible to pay off.

I’m not quite sure what state microfinance is in now. It’s still going, but I think it’s contracted a lot and doesn’t get the same hype. I’d guess some lenders and governments are accepting the need for subsidies, while also being more selective about who they lend money to.