Microfinance is a basis of financial services for entrepreneurs and small businesses deficient in contact with banking and associated services. The two key systems for the release of financial services to such customers include ‘relationship-based banking’ for individual entrepreneurs and small businesses along with ‘group-based models’ where several entrepreneurs come together to apply for loans and other services as a group.
Similar to banking operation traditions, microfinance entities are supposed to charge their lender’s interests on loans. In most cases the so-called interest rates are lower than those charged by normal banks, As per the World Bank estimates, more than 500 million people have improved their economic conditions via microfinance-related entities.
History Of Microfinance
The history of microfinance can be traced back to the middle of the 1800s. During the 1800s, the benefits of small credits to entrepreneurs and farmers was written by Lysander Spooner, the theorist, as a way to get people out of poverty. Later, the first cooperative lending bank was founded independently by Friedrich Wilhelm Raiffeisen to support the farmers in rural Germany.
The term “microfinancing” was first used in the 1970s during the development of Grameen Bank of Bangladesh, which was founded by the microfinance pioneer, Muhammad Yunus. In 1976, Yunus institutionalized the approaches of microfinance, along with the foundation of Grameen Bank in Bangladesh. Since, in the developing countries, a large number of people still depends largely on subsistence farming or basic food trade for their livelihood, therefore, smallholder agriculture in these developing countries has been supported by the significant resources.
The modern use of the expression “microfinancing” has roots in the 1970s when Grameen Bank of Bangladesh, founded by microfinance pioneer Muhammad Yunus, was starting and shaping the modern industry of microfinancing. The approach of microfinance was institutionalized by Yunus in 1976, with the foundation of Grameen Bank in Bangladesh.[10] Another pioneer in this sector is Pakistani social scientist Akhtar Hameed Khan.
Since people in the developing world still largely depend on subsistence farming or basic food trade for their livelihood, significant resources have gone into supporting smallholder agriculture in developing countries.
In developing economies, and particularly in rural areas, many activities that would be classified in the developed world as financial are not monetized: that is, money is not used to carry them out.This is often the case when people need the services money can provide but do not have dispensable funds required for those services. This forces them to revert to other means of acquiring the funds. In their book, The Poor and Their Money, Stuart Rutherford and Sukhwinder Arora cite several types of needs:
Lifecycle Needs: such as weddings, funerals, childbirth, education, home building, holidays, festivals, widowhood and old age
Personal Emergencies: such as sickness, injury, unemployment, theft, harassment or death
Disasters: such as wildfires, floods, cyclones and man-made events like war or bulldozing of dwellings
Investment Opportunities: expanding a business, buying land or equipment, improving housing, securing a job, etc.
People find creative and often collaborative ways to meet these needs, primarily through creating and exchanging different forms of non-cash value. Common substitutes for cash vary from country to country, but typically include livestock, grains, jewelry and precious metals. As Marguerite S. Robinson describes in his book, The Micro Finance Revolution: Sustainable Finance for the Poor, the 1980s demonstrated that “micro finance could provide large-scale outreach profitably”, and in the 1990s, “micro finance began to develop as an industry”.In the 2000s, the microfinance industry’s objective was to satisfy the unmet demand on a much larger scale, and to play a role in reducing poverty. While much progress has been made in developing a viable, commercial microfinance sector in the last few decades, several issues remain that need to be addressed before the industry will be able to satisfy massive worldwide demand. The obstacles or challenges in building a sound commercial microfinance industry include:
Inappropriate donor subsidies
Poor regulation and supervision of deposit-taking microfinance institutions (MFIs)
Few MFIs that meet the needs for savings, remittances or insurance
Limited management capacity in MFIs
Institutional inefficiencies
Need for more dissemination and adoption of rural, agricultural microfinance methodologies
Members’ lack of collateral to secure a loan
Microfinance is the proper tool to reduce income inequality, allowing citizens from lower socio-economical classes to participate in the economy. Moreover, its involvement has shown to lead to a downward trend in income inequality.