Microfinance – A Solution to End Poverty and to Create Inclusive Growth?


To the wide majority of people in the industrialized world, traditional banking services appeal to us as a basic human right – something we just have, we do not even think about and basically take for granted. However, more than 2 billion people do not have any access to transactions accounts according to Douglas Pearce, the World Bank’s leader of the initiative “Universal Financial Access 2020”, in 2016. Furthermore, an additional billion people on top does not have access to financial lending services that are a cornerstone for the growth of small and micro enterprises (SMEs).

These people are often forced to comply with the terms and rules of payday loan companies that charge interest rates in ranges of 200% to a staggering 1500%. More substantially, in many rural areas in Africa, Asia and Latin America, the only way to obtain credit is through loan sharks that usually aim to charge interest rates at such high levels that they create definite economic dependence in order to captivate people in the cycle of poverty.

Yet, access to capital at fair rates is crucial. In many developing countries the main driver of poverty is a high level of unemployment combined with a relatively low level of education and little political and general security. These factors restrict the production work of larger corporations and associated jobs that such a country may be able to attract and therefore facilitating entrepreneurial activity in SMEs is the core solution for inclusive and sustainable economic growth in these countries.

From this situation, one major question arises: how can one organize lending services for financial inclusion if traditional banks are certain that these services cannot be run profitably due to high operating costs and high default risks? The business model that arose from this market opportunity is today known as microfinance and one of its front-runners from the 1970s onwards was Muhammad Yunus, the founder of Grameen Bank in Bangladesh.

The business model consists of four pillars: first, the banking services come to the rural people, not the other way around. Since many people that are being served have lived all their life in poverty, it is very important that the services are brought to them because they lack the self-esteem and confidence to go to a bank. Second, the credit officers from the bank try to serve as many people as possible and therefore rural communities form centers of 20 to 70 people. These centers have weekly center meetings with their credit officer and five members form a group together to support each other on the way to cross the poverty line. Third, to reduce default risk, when a member asks for credit, not only the credit officer has to agree but also all group members have to confirm that they believe the member has the ability to profitably run his entrepreneurial income-generating activity. Fourth, the organizational structure is set up as flat as possible to reduce operational costs.

In Bangladesh, Grameen Bank runs its operations profitably at an interest rate of 20% on a declining basis for income-generating loans – hence 10% interest on a flat rate since the loans are maturing within one year. Grameen Bank currently serves 9 million people with their financial services and already over 6 million members or former members have crossed the poverty line since its beginning in 1976.

Due to this success, the system has been replicated in many countries in Africa, Asia and Latin America. However, Grameen Bank in Bangladesh carries a major advantage in setting up its organization due to a relatively high safety level in rural areas and especially because the country is extremely densely populated. Globally, the average interest rate for microfinance loans is equal to about 37%.

Critics therefore have argued that microcredits can effectively lead to a debt trap. For certain, the system is not perfect. Yet, to recap: the alternative for the vast majority of microcredit borrowers is no income-generating activity, hence unemployment or, even worse, they are in the hands of credit sharks or payday loan companies that charge much higher rates while many people are able to successfully start and grow a profitable small business at the microfinance interest rates.

Besides, many microfinance institutions are on the run to professionalize and redesign their business models in order to lower default risk and increase operational efficiency to ultimately reduce costs and consequently to lower interest rates. Digitalization is a cornerstone in the decrease of operational costs. IT Systems can majorly facilitate the center meetings. Also, IT-based risk management tools (that are ethically designed in a way that they do not discriminate for example by level of poverty, level of education or number of dependents) can then further decrease the individual credit default risk.

To take away, the concept of microfinance is a great model to facilitate access to capital to the “unbankable” half of the world’s population. Yet, it still needs further innovation in order to lower interest rates, which would allow for better and faster socioeconomic development. However, microfinance is already part of the world’s efforts to end poverty and by serving the very poor and by giving them economic opportunities it contributes to inclusive growth and the growth of SMEs.

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