Microfinance loans
can lift millions out of poverty.
According to CGAP (Consultive Group to Assist the Poor), an independent policy and research center, "microfinance is the supply of loans, savings, and other basic financial services to the poor." With amounts ranging from 100 to 1,000 USD, microfinance institutions often employ the "group lending" strategy as a means of accountability to ensure that present loans are paid back before future loans are issued to others in the lending circle.
Principles
At a G8 Summit in June 2004, the Group of Eight Leaders endorsed general principles regarding microfinance, which included focusing on capacity building within the communities of the beneficiaries, developing permanent local institutions and maintaining organizational transparency. These principles encourage ethical practices and provide the framework for ensuring the long-term sustainability of microfinance.
Importance
Microfinance loans provide an option to people who are not eligible to receive traditional loans, such as those who are unemployed, possess few assets for collateral or lack a credit record to access services through the formal financial sector.
Lending Institutions
Institutions with the capacity to distribute loans and other services to poor or low-income clients refer to themselves as "microfinance institutions" (MFIs). Examples of potential MFIs include credit unions, nongovernmental organizations (NGOs), large commercial banks and cooperatives.
Effects on Poverty Reduction
According to the Kiva website, microfinance had a significant impact on the community in Lombok, Indonesia, where the average income of loan recipients "increased by 112%, and 90% of households graduated out of poverty." By providing aspiring entrepreneurs with the start-up funds to build their businesses, households are able to meet basic needs and afford education for their children, thus lifting many out of poverty.
Criticism
Many experts have criticized the high interest rates that MFIs charge to loan recipients, which averaged 22.3% annually for a sample of 704 institutions in a study conducted by the MicroBanking Bulletin in 2006. Kiva, an organization connecting MFIs to lenders, explains that high interest rates are necessary in microcredit to cover the cost of the loan and account for high operational costs, loan defaults and financial costs.
