With the increased focus on social responsibility and the rising awareness of its importance for the civilizations around us, many financial institutions are wondering how they can support communities where access to banking isn't easily available. As a result, microfinancing has become a topic of much interest recently. But what exactly is microfinancing, and is it really an effective way of supporting underprivileged populations?
Microfinance refers to the financial services provided to low-income individuals that are typically excluded from traditional banking. It provides resources and access to capital for the financially underserved, like those who are unable to get checking accounts, lines of credit, or loans from traditional banks. According to the Council on Foreign Relations, “in 2018, there were around 140 million microfinance borrowers worldwide (80 percent of whom were women), accounting for a total of $124 billion in loans”. Gavin Poore, a Florida high schooler who is president of his school's finance club that has a microfinance initiative, states that microfinancing can uplift many individuals in poverty to a certain extent, providing women and those in rural areas a small loan to sustain a business idea. However, despite microfinancing being around since the 1980s, there hasn't been much improvement in global poverty rates in the regions where a lot of microfinance activity occurs.
A financial advisor, who prefers to remain anonymous, suggests that "the best way to reduce poverty is to create significant job opportunities in small and mid-size enterprises, not micro-enterprises.” Just like any borrowing in finance, microfinance can lead to micro debt. Microcredit loans rely on high-interest rates to meet operation costs. The Center of Global Development shared that, for example, “the largest microfinance bank in Latin America, with over 2.5 million subscribers, Banco Compartamos, has charged nearly 200% per year on its loan products”. For an individual in poverty, the benefits of microfinance can't always alleviate the difficulties.
Regardless, because microfinance targets the poor and economically disadvantaged, it provides these individuals with new financial opportunities to generate income. While there are no doubt things to beware of in the microfinance industry, there are still many benefits microfinancing can provide if used cautiously.