They were born mainly to help micro-enterprises and entrepreneurs with little money. They diversified over time and now encompass new socioeconomic aspects. So much so that some people see them as a way to end poverty. But there’s a debate about whether this is as true as it seems. What’s the deal with microfinance…?

Microfinance and its impact on society

To explain this phenomenon, microfinance deals with the provision of financial services. They have a long history in humanity and to tell the truth, it’s difficult to explain what they’re about. Mainly because experts don’t usually agree and tend to combine several meanings in one or vice versa. But now it’s more defined and can be explained without major problems.

Microfinance consists of providing “microloans” (small amounts of money) to people or entities that require them. It must be emphasized that this term shouldn’t be confused with microcredit. Which is about offering these microloans to poor entrepreneurs or small companies that lack resources. Microfinance instead covers many more aspects and from it derives other levels such as microcredit.

microfinance poverty
Microfinance is mainly granted to poor people in low-income countries. As for example India, where they have a lot of presence. Source: Research leap

It was in 1983 when it’s thought that microfinance was implemented for the first time. This happened in Bangladesh, through the Grameen Bank, which began offering micro-loans to poor people. Over the decades, microfinance began to be seen as an alternative to help developing countries. Worldwide, both in America and in Africa, Europe and Asia.

Unfortunately, microfinance has been the source of much scrutiny and criticism. Mainly because many question its usefulness to help people and reduce poverty. And there’s evidence of abuse and mismanagement by some financial institutions that offer them. They’ve created a whole debate around their presence in our society.

Risks, consequences and solutions

Late payment, high interest rates and other problems are often reported as negative results. Let’s cover the high interest rates first. They’re one of the reasons why microfinance is criticized. Or rather, microcredits. Which seem to “lend” themselves more to harm the less fortunate part of society. And the worst is that catastrophic results usually come out from this.

According to a press release from the BBC newspaper, microfinance was the cause of a wave of suicides in India. Critics say that more than helping, “microloans” drag poor families into debt. Which can end even in humiliation or suicide. And the previous report states that most people usually take several microloans at once.

microfinance india
As recently as in 2017, there have been protests in India of people demanding protection and regulation of microfinance. Which can turn against the borrowers. Source: sharone-microfinance.com

What happens with this, is that families or individuals in poverty cannot pay. They borrow more than they can offer as collateral and end up in ruin. Based on this situation, microfinance institutions (particularly in India) adjusted their interest rates so that they don’t exceed 10%. However, low interest rates aren’t ideal for these institutions either.

Norma Ortiz, PhD in Economics and Business Management, gave an interview to ESAN in 2011. She explained that this happens because people resort to informal lenders. Then they’re victims of indebtedness and threats from these informal lenders. Which makes them turn to microcredit financial institutions to pay these debts. But this also doesn’t help them get out of trouble.

microfinance in the world
According to an article in The Conversation, one way to protect people is to identify the modus operandi of informal lenders. Avoid them, and promote real initiatives. Source: The Conversation

As good advice, Ortiz explains that these situations can be avoided. Adding that over time, the wrong policies of these institutions can be changed to continue to benefit people. She says it would be wise to turn to trained loan officers. That must exhaust all the options to avoid that the clients fall behind in the payments. And preventing the last option is to take more drastic measures.

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Will microfinance continue to work…?