“Microfinance” refers to a range of financial services provided to poor clients who are typically unserved or underserved by other financial institutions. Microfinance institutions (MFIs) provide loans, savings, insurance, and money transfers to micro-entrepreneurs to support productive activities, build assets, stabilize consumption, and protect against risks.
The most common microfinance product is microcredit, which is a small, collateral-free loan used to grow small businesses called microenterprises. A key feature of microcredit is that the lending decision is not based on the client’s available collateral, which may be limited. Rather it is based on the ability of the client’s microenterprise to effectively apply the loan to increase revenue, and in turn, repay the loan. MFIs deliver microcredit through three lending methodologies: village banking, solidarity groups, and individual loans.
Microfinance is important because without it, micro-entrepreneurs – the majority of whom are self-employed women living in urban areas – would lack sufficient working capital to grow their businesses and improve their standard of living. Without access to services like savings and insurance, micro-entrepreneurs are limited in their abilities to smooth consumption or withstand major life events.
While various forms of microfinance activities have been around for centuries, the modern microfinance movement can be traced back to the work of ACCION in Brazil and Grameen Bank in Bangladesh. During the 1970s and 1980s, these two pioneering organizations were among the first to establish successful, scalable models for modern microfinance.
In the early days, microfinance institutions typically began as small, non-governmental organizations (NGOs) that only offered microcredit and were funded by governments, public institutions, or foundations. Today, in addition to traditional public funding sources, MFIs are also funded by investments from microfinance funds (also called microfinance investment vehicles, or MIVs), institutional investors, local commercial banks, and foundations.
Today, there are nearly 2,000 MFIs serving over 92 million clients with $70 billion in assets (as reported to the Mix Market). As the size and number of MFIs continues to grow, so does the diversity of MFIs which now range from socially-driven NGOs to mainstream international banks. In mature microfinance markets such as Latin America and South Asia, many successful MFIs that began as NGOs have transformed into for-profit financial institutions, which allows them to provide microfinance services independently of donor funding.
As MFIs in mature microfinance markets became more sophisticated, their product offerings expanded beyond microcredit to include savings, insurance, and money transfers. Less-developed markets such as those in Africa generally have a more limited range of products. The success of MFIs in mature markets has also allowed them to secure funding from commercial sources such as local banks and international capital markets, as well as through client deposits.
While the growth and development of the microfinance industry is impressive, the unmet need of financial access for the poor is enormous. Microfinance must continue to grow in order to meet this demand. However, the volume of MFI funding needed is too high to be met solely by NGOs and publicly-funded international institutions, as it was in the early years of the industry. Therefore, growth can only occur by increasing the participation of mainstream capital markets – specifically, by increasing private investment.
The key to increasing private funding sources for microfinance is to create greater transparency in the microfinance investment industry as a whole. MicroRate seeks to create transparency and help develop the microfinance industry by producing MFI rating reports. MFIs use these reports as an internal management tool, as well as to attract investment. In recent years, MicroRate has also been evaluating the funds that invest in these MFIs, called microfinance investment vehicles (MIVs).