Micro Finance is a way of lending money to those in need in developing countries. Rather than going to a bank, the borrower applies to be listed on-line. Often their needs are modest – just a few hundred dollars to purchase a new industrial sewing machine for making shoes, or to equip and furnish a restaurant.
Not a New Idea
The concept of micro finance has been around for a long time. Self Help Groups have been a growing feature in the developing world, where it is often women who get together to form a fund as a safety net or to pay for schooling.
However the new face of micro finance is to be found on the internet where today’s technology allows borrowers and lenders to be brought together with ease. Another feature of micro finance is the use of internet banking to facilitate speedy and secure payments
How Micro Finance Works
Once the borrower is listed with an organisation, individuals can offer to contribute towards the sum requested – Kiva, for example, suggests a minimum loan of $25. Eventually, when enough individuals have offered to lend and the requested amount is achieved, the loan is paid out to the borrower.
The borrower repays the loan in instalments and this is either refunded to the lender in small amounts across the board to all of the conbtributors, or the whole sum may need to be repaid before each lender receives a full payment. There is a very low rate of default amongst micro finance borrowers – around 2 – 3 per cent.
Keeping the Money Active
At that stage there are two options; either to withdraw the original sum of loaned cash with or without interest, or to reloan it to another borrower. In practice most lenders keep their money in the pot. According to Mads Kjaer founder of MyC4 less than 0.5% of the €5 million invested so far has been withdrawn.
To Take Interest or Not?
Many lenders are involved in micro lending from purely altruistic motives; a small loan isn’t going to harm one’s finances but can mean a lot to the borrower in the developing world where the dollar stretches much further in terms of what it can purchase.
However there are also microfinance companies that will charge interest; in some cases as much as 40 per cent APR once fees have been added. This is a benefit for the lender and for the organization that manages the loan and may incentivize more people to become lenders, but may create ethical issues for others.
One very successful micro finance company asks for a donation towards the administration costs to be paid by the lender, not the borrower.
Criticism of Micro Finance
Micro Finance has been criticized as it offers governments a way of opting out of their own responsibilities in terms of social and business development. It remains to be seen what will happen to micro finance in view of the current credit crunch.