Understanding Microfinance and microcredit

Many microcredit lenders and industry associations say more borrowers manage to repay microcredit loans than other loans, sometimes because members of their communities encourage them to repay so as not to threaten future loans. The Grameen Foundation says 95-98 percent of borrowers repay their loans, although other groups record somewhat lower repayment rates.

Microfinance is the provision of financial services to people, generally the poor, who would otherwise not be able to access such services from commercial banks. Services can range from savings to insurance but the most common form is microcredit, which involves the lending of small amounts of money which large banks would not generally find commercially viable.

How does it work?
Lenders known in the industry as microfinance institutions (MFIs) extend small loans starting at just a few dollars to individuals.
The borrower makes small but regular repayments until the debt is repaid. Because of higher overheads in terms of time and expense per dollar loaned to arrange loans and collect repayments, interest levels tend to be significantly higher than those for conventional loans, ranging from 15-35 percent, according to the Grameen Foundation.

Aren’t those interest rates high?
Yes, compared to cheaper commercial loans available to big businesses or wealthy individuals. But they are often still far cheaper than going to loan sharks or money lenders, who the Grameen Foundation say regularly charge 120-300 percent on loans.

Many microcredit lenders and industry associations say more borrowers manage to repay microcredit loans than other loans, sometimes because members of their communities encourage them to repay so as not to threaten future loans. The Grameen Foundation says 95-98 percent of borrowers repay their loans, although other groups record somewhat lower repayment rates.

Where does the money come from?
Funds come from a number of sources. Some MFIs operate savings schemes, giving them access to funds in return for interest payments to savers. Foreign donors or non-governmental organisations provide funds on free or preferential terms to some lenders, and Germany has proposed creating a G8 microcredit fund for African entrepreneurs. Increasingly, commercial banks are entering the microcredit industry, either by setting up their own local lending operations or through third parties.

Who borrows?
Individuals in poor countries take out microcredit loans, often to fund investments in farming or small businesses such as local shops. Many microcredit lenders, especially non-governmental organisations and donor-funded operations, deliberately target women and the poorest people, generally those living beneath the absolute poverty threshold of $1 a day. At the end of 2005, a total of 3,133 institutions were lending to 113 million people, of whom nearly 82 million were classed as “poorest,” according to the Microcredit Summit Campaign, which aims to bring microcredit to 175 million of the world's poorest families by the end of 2015. The overwhelming majority, nearly 97 million, of borrowers were in Asia, with just over 7 million in Africa and under 4.5 million in Latin America.