FAQs

Many of the microfinance web sites that we list in our Learn More section have helpful collections of Frequently Asked Questions.  We have selected a few for you here, drawing from the websites of CGAP, World Relief, Opportunity Internationaland Hope International.

 

What is microfinance? The term “microfinance” refers to the practice of providing financial services to people in impoverished countries who have no collateral, credit history, or access to traditional lending services.  These services can include credit, insurance, and a place to deposit savings and can make the difference between economic opportunity and crushing poverty.

 

Do the poor really repay loans? Remarkably, repayment rates among microfinance borrowers are often higher than those of more wealthy borrowers, with repayment rates of 95% and higher very common.  It is likely that to factors drive this high repayment rate:  the social sanction of non-repayment from other members of the solidarity group is very high, and secondly, access to future credit is so valuable to a borrower and they are reluctant to lose this privilege by failing to repay.

 

What is a solidarity group? A solidarity group is a group of approximately 5-15 individuals who are held jointly liable for one another’s loans.  Often other members of the group assess the ability of a borrower to repay the loan before the loan is approved.  This group liability takes the place of collateral in microfinance lending, and is often called social collateral.

 

How does microfinance help the poor? Microfinance helps the poor lift themselves out of poverty by providing the means to:

• Finance micro-enterprises – access to credit allows clients to take advantage of economic opportunities.
• Reduce vulnerability to economic shocks – clients can smooth their consumption and survive unexpected events without selling income-generating assets through savings and credit services.
• Invest in the future – clients can expand their businesses, start new businesses, improve their homes, and educate their children.

Wouldn’t the poor be helped more if they received grants rather than loans? If MFIs gave out grants, whatever funding they had would be used up very quickly, only assisting a handful of people.

• By requiring repayment and revolving the loans to more people, MFIs are able to use their limited funds to serve a much larger population.
• This allows the MFI to remain as a more permanent institution and serve a community for a much greater period of time.
• Providing loans also promotes dignity rather than dependency. Microfinance is about empowering the poor to bring themselves out of poverty rather than seeing them as recipients of charity.  MFIs provide a hand up, not a hand out, to the poor.

Why do MFIs charge poor people interest? Even if clients repay all of their loans, MFIs would only get back the loan fund that they originally started out with and would not be able to cover the numerous costs required in running and MFI. These operating costs include staff salaries, overhead costs, and transportation costs, just to name a few. In addition, interest revenue can go to expanding a loan fund so that the MFI can reach even more poor people. If MFIs didn’t charge interest, they would have to pay their operating costs out of their loan portfolio or from donor grants which is not a sustainable situation.

 

How high are interest rates charged to microfinance clients? Interest rates that cover the costs of providing a loan to microfinance clients can be 30% to 50% or higher.  In 2006 the median interest rate was 30%.  Is this exploitative?  See an interview with Richard Rosenberg of CGAP here.

 

Why do MFIs charge such high interest rates? The costs involved in administering small loans are higher than for normal bank lending, which is one reason traditional banks have not serve the needs of the poor in the past.  See more at CGAP . . .

 

Is there a trade-off between profitability and reaching poorer clients? Microfinance can be profitable, but reaching marginalized people or seeking to also achieve other social objectives may require a subsidy.  See more at CGAP . . .

 

How great is the need for microcredit? More than 1.3 billion people in the world are trying to survive on less than $1 a day. This leaves them without the means to adequately feed, clothe, or shelter their families.  According to a 2006 report (The State of the Microcredit Summit Campaign Report), microfinance institutions served 113 million families during the previous year – but more than 500 million families who could definitely have benefited had no access to the services.  Neither did an additional 300 million who might have derived benefit.  Estimates suggest that only one out of every eight people who could benefit from microfinance has the ability to access it.

 

What is savings-led microfinance? Savings-led microfinance uses the savings of the poor to finance loans.  Often the need of the poor to save is greater than the need to borrow.  In one model, groups are established and meet on a regular basis; the group members decide together on an amount to save per month or week. They pool their agreed-upon savings and keep it in a lock box or bank account. Members can then apply for loans from the group’s pooled savings. They agree upon an interest rate. This provides the rural poor with access to savings and credit.

 

Aren’t microfinance clients too poor to save? Throughout much of the world, bank accounts are scarce – a privilege reserved for the rich.  Though it may seem hard to imagine that the poor would have a great need for savings services, they actually so value the ability to save that in some circumstances they will pay for the privilege. Saving money in a safe place protects it from being quickly depleted as personal or community needs arise or even getting lost or physically deteriorating. Savings allow the poor to hedge against extraordinary events, such as weddings, funerals, or natural disasters.

 

What are typical sources of funds for MFIs? External funding for MFIs typically comes from 3 main sources: grants, equity, and debt.

1. Grants – this has been the most common form of funding to begin a MFI; governments, development organizations, foundations, and private donors all contribute capital to cover a MFI’s operating expenses and loan fund.
2. Equity – this is becoming more popular and is seen by many as the future of microfinance; MFIs that are attractive enough to draw commercial investment can use equity financing to improve operations, enhance service quality, expand the products and services offered, utilize newer technologies, and grow the loan portfolio so they can serve many more poor people more effectively.
3. Debt – a growing number of MFIs have the financial resources and stability to successfully borrow on international capital markets, allowing them to grow more rapidly.

Can microfinance be profitable? Yes, many MFIs generate a positive return on assets.

Some of the top performing MFIs actually generate a return comparable to that of the commercial banking sector.

Many people see the future of the microfinance field moving toward commercial sources of funding, which would be attracted by these profits.

• Advocates of this trend argue that commercial funding will bring much larger amounts of sustained funding (as opposed to grants and government subsidies) which will enable MFIs to provide financial services to many more poor people for a longer period of time.
• Critics worry that excessive attention on profits to attract commercial investment will lead MFIs away from the less profitable poor clients that originally motivated the field of microfinance – this is often referred to as “mission drift”.