Microfinance Overview
Introduction to Microfinance
Microfinance provides financial services to low-income individuals lacking access to the formal banking sector. The first microfinance institutions (MFIs) were non-profit organizations with a social mission to alleviate poverty by helping the poor develop vocational and business management skills, and by giving them small, uncollateralized loans for working capital. From this modest yet revolutionary beginning in South Asia and Latin America in the 1970’s, microfinance now encompasses 10,000 charitable organizations and regulated financial institutions across the globe, which offer a burgeoning array of credit, savings, housing finance, remittance, and insurance products to the base of the pyramid. According to the Consultative Group to Assist the Poor (CGAP), in 2007 the total estimated number of microfinance customers was $100 million.
Microfinance clients are predominantly engaged in income-generating activities in the informal economy in emerging countries, as a means to self-reliance in the face of high, systemic unemployment. They are street and market vendors, small-scale farmers, cottage industry participants such as weavers, and in some cases medium-enterprise business owners not eligible for loans from mainstream banks. Globally, clients number over 100 million including both borrowers and savers. Many MFIs target women borrowers since research shows that they devote a larger percentage of income to improving the family’s dwelling, nutrition and health care, and to keeping children in school.
Microborrowers may access loans either through a group lending model or through individual loans. In the first instance, the joint liability of all group members to repay a defaulted loan provides “moral collateral” in the absence of a material guarantee. This solidarity system has proven extremely successful in generating high loan repayment rates. Loans can be as small as $100 per borrower (higher in dollarized economies), tenors are short (six to 18 months) and loan repayments rates are 95-98% across the industry. Under the individual loan model, the borrower has sole liability and provides some type of collateral. Such borrowers usually manage more stable microenterprises and may be creating jobs for others in the community, an important social benefit. However, repayment rates in this lending model are lower at 80-90%.
Microfinance lending has high operating costs which are covered by elevated interest rates. These vary according to country and effective rates can top 100% in some markets, but the average is around 30% on an annualized basis. While astronomical by mainstream lending standards, MFI rates are cheaper than those offered by informal moneylenders, which can reach 30% per month. Borrowers are able repay MFI loans because the incremental income from a small amount of capital in their labor-intensive businesses outpaces the interest burden.
Here are some key statistics on the microfinance industry:
Microfinance Fast Facts
- Total estimated microfinance loans outstanding: $35 billion (CGAP)
- Total estimated microfinance customers: 154 million (MicroCredit Summit)
- Total estimated potential customers: 1.5 billion (CGAP)
- Total number of microfinance institutions eligible for commercial funding: 250 (CGAP)
- Total estimated investment by microfinance investment funds (MIVs): $13 billion (IAMFI)
- Estimated compound annual growth rate of MIV investment: 79% (CGAP, 2004-2008)
- Number of MIVs: 109 (IAMFI)
- Percent debt deals: 67% (IAMFI)
- Percent equity deals: 30% (IAMFI)
- Percent guarantees: 3% (IAMFI)
- Microfinance funding gap to meet demand: $265 billion (CGAP)
More information about the microfinance industry is available in the Microfinance Overview section of IAMFI’s Current Research page.
To learn more about the organizations active in the industry, visit IAMFI’s Industry Links page.
Microfinance Institutions
Although there are many different types of microfinance institutions, they are generally defined as organizations that provide financial services to the poor. Microfinance institutions (MFIs) may differ in their legal structure, mission, methodology, and the products and services they offer. One feature they all hold in common is the goal of meeting the banking needs of those who are too poor to fit the profile of traditional bank clients.
The MFI landscape is complex, encompassing a broad range of legal structures, lending methodologies and product offerings. MFIs which are regulated, and therefore investable, comprise credit unions, co-operatives, other non-bank financial entities, microfinance banks, and commercial banks moving down-market. A major difference between these is ownership, which may consist of members, the government, socially-minded shareholders, or profit-seeking shareholders. The type of ownership is important because it often dictates the approach, priorities, and specific projects undertaken by an MFI.
MFIs are also commonly divided into those that are regulated and those that are not regulated. Regulated institutions meet an extensive set of requirements that allow them to offer financial services such as savings and insurance. Additionally, only regulated MFIs are considered ‘investable,’ or eligible to receive profit-seeking investments. Non-regulated MFIs are not monitored for compliance with these requirements, and are therefore legally unable to perform these functions. Some non-regulated MFIs choose to undergo the process of formalization, an increasingly strong trend which is reshaping the microfinance industry today.
To learn more about MFIs, visit the Industry Landscape Microfinance Institutions page.
More information about MFIs is available in the MFIs section of IAMFI’s Current Research page.
Microfinance Funders
Funding for microfinance comes from local and international sources. Depositors, government agencies, charitable organizations and the private sector provide local currency funding. In Asia and Latin America, several larger MFIs have successfully issued bonds and access local bank loans. Deposits provide an inexpensive, stable source of funding for MFIs. According to CGAP CEO Elizabeth Littlefield, "Savings are often overlooked as the main, growing, and ultimately most important, form of funding for microfinance institutions. Deposits are not only the cheapest way for an MFI to fund itself, but they also provide a valuable service for clients." Evidence shows that savings – not loans – alleviate poverty by providing families with a safety net in the event of an illness, natural disaster, or economic crisis. Clients of regulated, deposit-taking MFIs therefore benefit doubly from secure, liquid savings products that augment the capital base for loans. This is the basis of a fundamental argument in favor of MFI transformation from a non-profit to a for-profit business model, as legal constraints prohibit non-regulated institutions from accepting deposits.
However, foreign capital has fueled microfinance’s double-digit growth. In 2008 alone the industry received $11 billion in private sector funding. These investors include socially responsible individuals in Europe and the United States, the private sector branches of governments which support development in emerging nations (known as development financial institutions or DFIs), and private sector institutions such as banks, insurance companies, pension funds, endowments, foundations undertaking mission-related investment, hedge funds, and the family offices of ultra-high net worth individuals.
Increasingly, socially responsible individuals in Europe and the United States are pursuing microfinance investing as a way to align values and finances. The latest figures indicate that total investment in the microfinance sector has expanded to around US$35 billion. However, industry experts estimate that an additional US$265 billion is needed to provide financial services to the world’s 1.5 billion working poor.
DFIs’ investment in microfinance is dictated by their official mission to foster sustainable private-sector development and investment in emerging countries. In the late 1990s, DFIs began introducing a more commercial approach to the primarily donor-funded industry, with quasi-commercial loans, equity and guarantees to MFIs capable of scale and profitability. They played a crucial role in supporting the growth of what are now some of the most successful MFIs. In assuming financial risks at a time when microfinance was less proven as a sector, they paved the way for commercial investment.
Private sector investors entered the microfinance market in earnest beginning in 2005, and raised concern over competition and “crowding out” by DFIs, which typically offer below-market interest rates and more flexible terms to MFIs. Ideally, DFIs will continue to seed countries and lower-tier MFIs that are still unproven, and in doing so entice more private capital into the sector. As an example, DFIs are increasingly investing in frontier African countries and also providing first loss guarantees in co-investments with commercial investors.
As of December 2008, private sector funding growth outpaced DFI sources. According to CGAP, DFIs’ outstanding microfinance portfolio grew by 24% in 2008, still strong but much lower than the 2007 growth rate of 60%. DFI investment accounted for nearly 45% of total committed funding of $14.8 billion in 2008. Five DFIs held three fourths of all DFI-related investments: German KfW, EBRD, IFC, Spanish AECI-ICO and Dutch FMO.
The long-term view of Raimar Dieckmann, Senior Economist at Deutsche Bank Research, is that private sector individual and institutional investment in microfinance will grow significantly to US$20 billion by 2015, up from a base of $640 million in 2004.
‘Who is Funding Microfinance? Results of CGAP's 2009 Microfinance Funders' Survey
However, only about 250 MFIs currently possess strong enough balance sheets to be eligible for investment, and financing is concentrated in this top segment. According to the most recent data from CGAP, in 2007 10 MFIs received 60% of MIV investment (one of these is a holding company of 22 MFIs). In its January 2009 report, Microfinance – Testing its Resilience to the Global Financial Crisis, Fitch Ratings corroborates the concentration of microfinance activity by estimating that the 100 largest MFIs represent 80% of sector assets.
To learn more about the funding of microfinance visit the Industry Landscape Microfinance Investment page.
To learn more about MIVs visit the Industry Landscape Microfinance Investment Vehicles page and IAMFI’s Microfinance Investment Database.
More information on the funding of microfinance is available in the Microfinance Investing and MIVs sections of IAMFI’s Current Research page.
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