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Microfinance Information-- Pros, Cons, and Recommendations

Updated on October 20, 2009

Introduction: What is Microfinance?

Developing countries are riddled with societal problems—from excessive poverty, to corrupt governments, to insufficient education systems, and to poor health care, the road to development for these countries is long and hard. Climbing out of poverty is the first step toward development, yet is probably one of the hardest tasks for many individuals struggling in developing countries. Most of these people have little formal savings, no previous credit history, and no formal work experience. This leaves them hardly qualified for services from formal financial institutions. How can people start a business without a loan? How can people be prepared for unexpected crises without a savings account? This is where microfinance comes in. Microfinance, in its most simple definition, is providing financial services such as loans, savings accounts and insurance in a more informal way to poor people. Microfinance, in theory, should provide a solid foundation for entrepreneurship, self-sustainability and economic know-how. With these tools, people in developing countries can enjoy a much higher quality of life—but to what extent? Can microfinance pave the way toward sustainable, long term development in poor countries? Will lifting individuals out of poverty lead to overall growth? Some experts say yes and some say no, but my conclusion is that unless microfinance can begin to address the broader social problems within an area and really get to the heart of what is impeding development than sustained, overall development will not be achieved.

Microfinance: Recommendations for Success

First of all, microfinance donors should focus their support on (and encourage) MFIs who operate in countries who are making consistent efforts to improve regulation, institutions, and legal systems. If governments of developing countries are looking to lead their countries out of poverty, perhaps this might create incentives for governments to increase transparency and regulatory systems.

Secondly, MFIs need to rethink their target recipients. This is a more difficult way of handling microfinance. Yes, at first glance it may seem unfair to stop lending to poorest people who need it the most, but at a closer look it becomes clear that these people are not benefiting from their loans long term, or making business ventures that are sustainable. The more well off, who can still benefit from a microcredit loan to expand their business, buy more equipment, and employ more people, should be the main recipients of loans. These types of enterprises have the capacity for self-sustainability and revenues. Businesses under this category include (but is not limited to) those that have steady markets, some kind of office to operate out of, and room for expansion. More formal sector businesses such as these will create more growth and development than loans to informal sector businesses will.

Thirdly, using microfinance to increase access to public goods is an innovative and new way of improving quality of life for people. For instance, MFIs could offer low interest rates on village loans that will be used to build a well or a small school. While these loans would be larger and probably riskier, the condition of group lending makes it feasible. Arrangements could be made for urban districts interested in public good improvements. Default would cause the village or district to forego monies for future improvements. With this incentive, members of the group are keen on monitoring their fellow members and ensuring that everyone involved makes their repayments. While, such projects would certainly be more complicated than basic microfinance loans, perhaps that is the key to paving the way toward growth.

Microfinance Village Group

Microfinance and Economic Growth

See, economic growth requires many things—from relatively stable governments to alleviation of poverty to the creation of a formal business sector to access to clean water, education, and healthcare. What can microfinance do or change to promote long-term growth? First of all, there should be an emphasis placed on improving overall quality of life— Public goods are missing from many of the small villages and poor slums in which microcredit is extended. Lack of safe wells, paved roads, and so on, limits the growth that successful and entrepreneurial microcredit borrowers can experience. A focus on real businesses (which very possibly means not lending to the poorest of the poor, but lending to the better off who can create real enterprises and employ their less able neighbors) is necessary to create self-sustaining small companies, and to make the push toward a formal sector. Because MFIs have maintained their strong reputation and their ability to reach millions of people, they possess the necessary qualities to bring change.

While projects of this caliber may sound too lofty, it is absolutely necessary to consider using microfinance on a slightly larger, more innovative scale. There is no accessible data to say that these types of projects in conjunction with MFIs have been tested or tried, therefore it cannot be stated that microfinance used in other ways would not lead to more successful, and developed towns, villages and cities. Because microfinance is still a relatively new idea, MFIs are not eager to switch practices. But there are some changes that need to take place...

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    • profile image

      Kumail 

      6 years ago

      Pros: Poverty alleviation, provides subsistence to the the very poor.

      Cons: Poor people due to lack of education may not be able to efficiently allocate the borrowed money and hence a wastage in resources. Micro finance generally carry high level of interest rates.

    • profile image

      Meli 

      8 years ago

      does anyone actually know the pros and cons about microfinancing?

    • profile image

      gloria 

      8 years ago

      :)

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