You might have heard the term microfinance many times. You might also have a rough idea as to what it is and why it is important. Most of us knows that the role of microfinance in economic development is to serve the needs of those who are economically marginalized. But do you know how it actually works? Or how did it all begin? and most importantly how will it shape in future?
In this blog we will try to give answers to all these questions one by one. But before that, let’s understand what microfinance is?
What is microfinance?
Microfinance which is sometimes also referred as microcredit is the banking services that are aimed at low-income or unemployed groups and individuals. The aim is to help those who don’t have the privilege to access financial services.
The banks or financial institutions that participate in this provide microloans that can range from something as small as $100 to something as big as $25,000.
Not only this, many banks also provide additional services like business education, savings accounts, and micro-insurance products. The prime objective of microfinance is to give the poverty-stricken people opportunities to become self-sufficient.
History of Microfinance
The seeds of microfinance were sown in the 70s in the rural areas of Bangladesh. However, there is evidence that there used to be informal borrowing and lending in the APAC region for centuries.
The first modem microfinance transaction involved Dr. Muhammad Yunus of University of Chittagong. Dr. Yunus saw village women who made bamboo stools trapped in a repressive debt cycle. He was surprised to find out that they needed only $27 dollars to get rid of this debt cycle. This incident led him to start the Grameen Bank Project.
Grameen bank is an organization of community development bank that provides small loans without requiring any collateral in exchange. This project began in Jobra and its nearby villages from 1976-1979.
During its initial years, the Grameen Bank was sponsored by the Bangladesh’s central bank and other nationalized banks. By the year 1983, the project became an independent bank via a government legislation.
In 2006, Dr. Yunus received the Nobel Peace Prize for his work in the Grameen Bank. The Grameen Bank also received several awards and international recognitions such as the world habitat award, congressional gold medal, US Presidential Medal of Freedom, etc.
It’s currently operational in over 2500 locations and has a workforce of more than 22,000 people. Grameen Bank has the net operating income which is about $120 million.
Grameen Bank was not the only microfinance program in the 70s. Shorebank was another community development bank that was founded in 1974 in Chicago.
The modern use of the expression “microfinancing” has its roots in Grameen bank. However, the history of microfinancing can be traced back in the 1800s, when Lysander Spooner, a theorist wrote about the benefits of small credits to farmers and entrepreneurs as a means to get people out of poverty. Moreover, Friedrich Wilhelm Raiffeisen, founded the very first cooperative lending banks that supported farmers of rural Germany.
Microfinance at present
Today there are more than 10,000 microfinance institutions worldwide. If we talk about the number of borrowers and savers, then the number goes up to more than 70 million. And the total loan portfolio amounts to an estimated $40 billion.
The impact of microfinance has been tremendous. More than 130 million people have been helped by it. (International Finance Corporation)
South Asia region has emerged as the top beneficiary of microfinance as it accounts for approx. 60% of global microfinance borrowers. If we convert this into number then we get over 83 million microfinance borrowers from South Asia.
However, this massive number is only a 5% of South Asia’s total population, which indicates a larger untapped market.
Another important stat about microfinance is that 80% of the first time borrowers are women near poverty. This stat is essential as the major intent behind microfinancing is to provide financial aid to those who otherwise can’t get access to credit. Moreover, there are also some microfinance lenders who encourage financial growth of women by primarily providing credit to them.
Global microfinancing is growing at a rapid pace and the total number of borrowers is expected to reach $180.4 billion by the year 2021. Similarly, the global loan portfolio is estimated to reach $146.8 billion in 2021.
As discussed earlier, the definition of microfinance has usually revolved around that of providing small amount of loans to the underprivileged. However, with time the definition has changed as it now includes many other financial services apart from just microcredit like insurance, payment solutions, savings accounts, etc. Today microfinance means to deliver financial solutions to everyone at an affordable rate.
The first thought that comes to our mind when we hear microfinance and FinTech is quite contrasting. For microfinance, the first thought is usually about small loans worth $200 to $ 500 for setting up small businesses.
On the other hand, for FinTech, the first thought is usually about the innovative and advanced technology in the world’s financial sector. So, what’s the common link between the two?
Surprisingly, both microfinance and FinTech are closer than they seem. Both have the common aim of improving the financial accessibility. Thus, by adopting FinTech, the MFIs (microfinancing institutions) can achieve their goals, quicker and more efficiently.
MFIs can utilize FinTech in several ways. Firstly, the MFIs can leverage the FinTech to make loan repayment and disbursement quicker and more efficient with the use of mobile wallets, mobile money, and loan management software.
Secondly, the data obtained from FinTech can be used to make loan decisions, analyse profiles, and improve communication. In both the above cases, FinTech can be used to improve the cost of doing business and speed for various MFIs.
Nowadays, we have numerous examples, where many microfinance businesses are benefiting by embracing FinTech.
For example, Tala, a US-based mobile technology company that was founded in 2011 aims to serve those who are unbanked. It has offices in countries like Tanzania, Kenya, Philippines, Mexico, and India. The company enables individuals to get personalised loans on the basis of alternate credit checks.
The mobile app that Tala uses collects all the cellphone data including text messages, call logs, and other behavioural data to construct a customer’s credit profile. This profile building exercise leads to instant loans that can range from $10 to $500.
Once completed, the loans can be approved and disbursed within minutes via mobile payment platforms. Not only that, Tala also helps its customers by building their credit profile by sharing their information with the local credit bureaus and hence enabling them to secure bigger loans in future.
Using a very similar approach, China’s MYbank uses non-traditional sources of data like payment transaction data and social network data to determine the ability of businesses to repay their loans.
Mybank backed by Alibaba is a great example of FinTech as it has loaned $290 billion to 16 million small companies in a span of over four years. This FinTech has emerged as a boon for small entrepreneurs as it provides loans with an average size of $1,500 and a default rate of one per cent.
If we talk about customizing loans to the needs of entrepreneurs then one name that comes up is of Grab Financial. It’s one of South Asia’s leading FinTech companies that have entered the lending space by offering a suite of financial services to its drivers which includes insurance, loans, and payments.
Grab’s motive behind building an alternate credit scoring system is to tailor its products as per the needs of its drivers across Southeast Asia.
Future of microfinance
The future of microfinance seems bright as it will continue to expand beyond the traditional institutions. New actors like distribution networks and mobile operators will assist in offering financial products and services at cheaper costs to underprivileged and isolated population.
The new technologies along with online banks will help to market these large scale offerings. Talking about the regulations, they will be more focused on the client rather than on institutions, products, or processes. In coming years, financial inclusion will become reality in most parts of the world which is currently excluded from financial services.
Not only this, the technological advances will also cause crucial structural changes in the microfinance sector.
The new technological innovations are not only offering more diverse services like insurance, credit, and savings products but also are offering low-cost payment infrastructure along with other services to poor people.
More innovations in the coming years will give rise to mobile banking software and services in the developing countries. Many niche actors such as agent network managers and small financial institutions will emerge and try to make their name among the small customers and big banks.
Moreover, there will be requirement of products that easy to market as banks won’t be able to train their agents of all the specificities and complexities.
An experiment that started in a small village of Bangladesh has become a huge revolution and is expected to become even bigger in the near future. We saw how microfinance played a crucial role in providing financial services to people who were devoid of banking or credit service.
We also saw how microfinance has become a big phenomenon, especially after the introduction of FinTech. At present, micro finance services are provided by using the cutting-edge technology. The present times are ideal for microfinance institutions and future is also seems promising.
With the technology developing at a rapid pace, we are on the brink of witnessing major FinTech services in the field of Microfinance. What would be those changes and how soon would we see them? Only time will tell.