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What Are Microfinance Institutions?

Eugene P.
Eugene P.

Microfinance institutions are banks, financial companies or organizations that focus on providing credit and other financial services to people who traditionally do not have access to it. The services provided range from small loans to savings accounts to grants for improvements to the local infrastructure. The primary recipients of the services of microfinance institutions are women and poor families from countries that are underdeveloped. Although interest rates for some of the loans can be exceptionally high, the rate of repayment among recipients is equally high. The loans that are given allow families and individuals to start businesses, buy food and establish workable credit.

One of the benefits of microfinance institutions is that they must be regulated in the countries where they operate. This means they are required to be a valid financial institution, non-governmental organization (NGO) or other licensed group. This helps to prevent those seeking the loans from usury practices. It also ties those getting the microfinance services to real banks so they can establish usable credit.

Man with a backpack
Man with a backpack

A successful aspect of microfinance institutions is the granting of small loans known as microcredit. Microcredit is assessed on a per-person basis and can give the small edge needed to raise a family out of poverty. The loans carry a high interest rate, but the default rate is exceptionally low.

The microcredit loans allow their recipients to start businesses and make a profit, buy food so they can continue to work, or invest money in other financial instruments. Once the loan is paid back, most institutions will grant a slightly larger loan, if desired. The loans can eventually be used to fund schools or build wells for clean drinking water, increasing the overall quality of life in an area.

Not all regions have equal access to microfinance institutions, though. An assessment of an area might result in there being too few resources, people or infrastructure to make repaying the loans possible. This is a decision that each institution makes based on its expected returns and the plans of the residents in the area.

Large commercial banks have entered into the microfinance market and could offer a solution. By employing their network of physical locations and relationships with entrepreneurs, the larger commercial institutions could help in bringing microfinancing to even more distant markets. The microfinance industry has proven to be profitable, gaining it commercial interest.

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