Microfinance (2024)

A type of financial services offered to individuals of lower socioeconomic backgrounds or those who lack access to traditional financial services

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What is Microfinance?

Microfinance is a term for financial services that are offered to individuals of lower socioeconomic backgrounds or those who lack access to traditional financial services. Microfinance includes a number of services, such as savings accounts, checking accounts, fund transfers, microinsurance, and microcredit.

Microfinance (1)

Microfinance originally started with microcredit, which is the practice of providing extremely small loans to those who do not have a steady source of income, collateral, or any credit history. It also aims to support and kickstart entrepreneurs who do not have the financial backing to begin a small business or capitalize on an idea.

The objective of microfinance is similar to that of microcredit; its goal is to provide financial services to help encourage entrepreneurs in impoverished nations to act on their ideas and obtain the financial tools available to do so and to eventually become self-sustainable. A few more of its overarching goals include to promote economic development, decrease unemployment, and boost small businesses.

Additionally, some microfinance institutions provide financial and business education in order to best position their clients for starting up a small business or to act efficiently as an entrepreneur.

Microfinance Models

Two models outline how microfinance is operated:

  1. Banking for individual entrepreneurs and small businesses revolved around relationship-based banking.
  2. Services for a group, where multiple individuals come together to form a group to collectively apply for a loan.

When applying for microcredit, individuals may not get a large loan – loans range from $10 to $2,000 – thus, they may decide to come together and form a group to qualify for a larger loan.

History of Microfinance

Upon the creation of microcredit by Bangladeshi social entrepreneur Muhammad Yunus in 1983, microfinance was simultaneously created. In 1983, Yunus established Grameen Bank in Bangladesh. The goal of Grameen Bank was to initially provide small loans to entrepreneurs.

Yunus’ vision for microcredit was inspired when he witnessed women who made bamboo stools in Bangladesh making two cents a day. He decided that if the women were able to fall back on a loan, they would be able to improve their margins and gain a more substantial profit. After issuing them a loan of $27, following the group model, the women were able to repay the loan and keep their business running.

Microfinance’s aspect of a savings account can also tie into microcredit; creditors may choose to include a loan covenant. The loan covenant states that the borrower must set aside a portion of profits in a savings account with the financial institution to be held as collateral until the loan is paid. Thus, it provides some protection for creditors, and if the loan is repaid, the borrower would’ve earned savings interest on the money that was deposited in the savings account.

In 2006, Yunus received the Nobel Peace Prize for his efforts with Grameen Bank. The bank currently oversees i2,500 operational locations and employs about 22,000 individuals. Furthermore, there are currently 10,000 microfinance institutions.

Pros and Cons of Microfinance

Many argue that microfinance is very beneficial, as it provides financial opportunities for those in impoverished nations or those with lower socioeconomic backgrounds. Another benefit of microfinance is that it encourages people to be financially independent and provides them financial resiliency to be able to cover any large unforeseen expenses.

Additionally, microfinance helps to provide financial services to those in remote locations where traditional financial institutions do not have operations. It also provides education. Finally, microfinance can encourage entrepreneurial activity and business development in poverty-stricken areas.

Some downsides of microfinance include claims that it can take advantage of those in tough economic situations, a situation similar to loan sharks. Some microfinance loans may include interest that can be as high as 30% or even higher. Furthermore, according to several studies, recipients of microfinance loans did not realize an improvement in their annual net income.

Additional Resources

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Microfinance (2024)


How effective is microfinance? ›

“Microcredit is not an effective way to reduce poverty,” observes Aneel Karnani of the Ross School of Business at Michigan University in the US. “The best way to reduce poverty is to create significant job opportunities suited for the poor.

What is a famous quote about microfinance? ›

  • "Give a man a fish, he'll eat for a day. ...
  • "I know of no more encouraging fact than the unquestionable ability of man to elevate his life by conscious endeavor. " ...
  • "The key to ending extreme poverty is to enable the poorest of the poor to get their foot on the ladder of development.

What problem does microfinance solve? ›

Microfinance is one of the ways of fighting poverty in rural areas, the place where most of the world's poorest people live. It provides funds, insurance, savings and other ancillary financial services within the reach of the poor.

Why did microfinance fail? ›

In fact, Jason Hickel of the London School of Economics points out that in South Africa, microfinance has failed because 94% of the loans people recieve are used to pay for basic needs rather than generating a profit to pay off the loans and sustain themselves.

Is microfinance good or bad? ›

Microfinance isn't perfect, and many of the concerns voiced about the industry are legitimate. It is, however, one of the more effective tools the world has for improving financial inclusion, which in turn can help to bring people out of poverty and assist in reaching the UN's Sustainable Development Goals.

What are the weaknesses of microfinance? ›

Microfinance can cause low-income people to become excessively indebted. Borrowers might take out several loans from several microfinance organizations, which could put them in a debt cycle and make it impossible for them to repay the debt.

What is the biggest benefit of microfinance? ›

There are several benefits of microfinance.
  • Providing immediate funds.
  • Access to credit.
  • Better rates for Loan Repayment.
  • Provides for those who go unnoticed.
  • An opportunity to receive education.
  • Possibility of future investments increases.
  • Creation of Real Jobs.
  • Significant Economic Gains.

What is the main challenge with microfinance? ›

Microfinance institutions have low transaction volume; however, the cost of those transactions are fixed and are high; this causes a significant challenge to all the institutions. The mainstream banks have laid deep roots in the market, and it has been evolving with the need of the times.

What is an example of a successful microfinance? ›

Here are the five largest and most influential MFIs today.
  • Pacific Community Ventures. Pacific Community Ventures was founded in 1998 and provides microfinance loans to small businesses in California. ...
  • CDC Small Business Finance Corp. Founded in 1978, CDC Small Business Finance Corp. ...
  • BRAC USA. ...
  • Grameen America Inc. ...
  • Kiva.

Is microfinance still a thing? ›

For many Americans, if they've heard of microfinance at all, it's because they or a friend or family member have lent through the platform. As of 2023, according to a Kiva spokesperson, 2.4 million people from more than 190 countries have done so, ultimately reaching more than 5 million borrowers in 95 countries.

Does microfinance reduce poverty? ›

By providing them with access to credit and training, microfinance can empower women and increase their economic and social status. Poverty reduction: Microfinance has been shown to help reduce poverty by increasing incomes and creating jobs, particularly in rural areas.

What are the benefits of microfinance? ›

Benefits of Microfinance

Most importantly, it provides economic resilience, helping individuals and business owners work effectively and alleviate poverty. Business owners can use these loans to run and expand their businesses and accumulate capital for future needs.

What are the advantages of microfinance? ›

There are several benefits of microfinance.
  • Providing immediate funds.
  • Access to credit.
  • Better rates for Loan Repayment.
  • Provides for those who go unnoticed.
  • An opportunity to receive education.
  • Possibility of future investments increases.
  • Creation of Real Jobs.
  • Significant Economic Gains.

What are the positive effects of microfinance? ›

Microfinance provides tools that the poor can use to manage their finances better. Micro-credit specifically can improve customer liquidity, financial resilience, and occupation choices.

What is the impact of microfinance? ›

Microfinance has a positive and significant effect on income and expenditure. However, the effect is regressive which implies that poorer households do not feel as much the effects of the intervention as compared to the richer households.

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