Microfinance – financial services supplied to low-income individuals and those who do not have access to typical banking services – has seen its share of media coverage grow over the past decade as stories of feel-good entrepreneurial success continue to emerge. It’s an intriguing concept: providing support to the less fortunate by granting them access to financial resources that can help enable their rise out of poverty and into self-sufficiency. With microcredit (a branch of of microfinance), low-income individuals are granted small loans to launch their own business, gaining valuable skills related to banking, finance, and management along the way.
How does it work?
In developing nations in particular, financial institutions do not provide services to low-income individuals. Banks incur expenses when managing a client account so opening near-zero balance accounts results in a net loss to the bank. Therefore, most improvised people are turned down. Additionally, low-income individuals looking for a loan are rejected as they have little to no collateral to put up, giving banks little recourse against a defaulting borrower.
Microfinance and microcredit organizations, on the other hand, offer financial services to individuals who would normally be turned down due to circumstances beyond their control. On loans, interest is charged, but only enough to cover the rate of default and processing fees. Say, for instance, that a Congolese woman is loaned $100 to buy cooking utensils so she can start a food preparation business. If the default rate on microloans is 1% and transaction fees are $4, then the Congolese woman will have to repay $5 in interest, or 5%, on the $100 loan. Some microlenders will charge additional interest in order to make a profit, but the more altruistic organizations are not-for-profit lenders.
As with any loan, there is a risk of principal loss, so only lend what you can afford to lose.
Who can I lend through?
Kiva is one of the better-known online microlending platforms. Founded in 2005, Kiva brings together lenders with low-income borrowers and local microfinance institutions to enable small-scale lending. According to Charity Navigator, a non-profit organization that ranks charities based on their use of finances and transparency, Kiva is one of the more reputable organizations in America, earning a perfect score on accountability & transparency.
Some other key stats on Kiva:
- Number of lenders - 1,042,035
- Total loans - $521,470,525
- Repayment rate - 99.01%
New father to a gravely ill baby boy, Erivan dos Santos was struggling to support his family and keep his bike repair shop in Brazil afloat. Money was scarce and sometimes there was not enough to put food on the table. But thanks to a loan of US$800 from Accion Microfinanças, he was able to buy merchandise and supplies in bulk making him more efficient at repairs and his business more profitable. Today, his business is thriving and his family is healthy and well.
Is microlending better than donating to traditional charities?
No - both have their value. Even though most traditional charities aren’t built around enabling self-sufficiency, the need for charitable donations is still very real and no less important. Disaster relief, food supplies, and medical aid are in high demand around the world and donations to those causes go a long way. For example, since the devastating earthquake in 2010 in Haiti, UNICEF vaccinated more than 3,000,000 children, including children who had never before been immunized.
Before donating to a charity, visit the Charity Navigator site to see how it stacks up.