Microfinance Basics

Microfinance
Microfinance is the provision of financial services such as loans, savings and insurance products, to the poor. It is regarded as an effective poverty reduction tool as it provides the capital low-income entrepreneurs need to grow their businesses and thereby raise their standard of living.

Key Participants in the Microfinance Industry
Microfinance Institutions
Microfinance institutions (MFIs) provide financial services to the poor. There are a wide variety of providers who differ in their legal structure, size, clientele, sustainability and lending methodology. MFIs are most frequently classified by their legal status as some function as NGOs, while others function as banks, cooperative or non-regulated financial institutions.

Clients:
The clients of MFIs are low-income entrepreneurs who are not served by mainstream financial institutions, usually because of their lack of assets to pledge as collateral. The client group served by a MFI is determined by its mission as some institutions only serve women, while others serve on a particular income segment.

Microfinance Investment Vehicles
Microfinance Investment Vehicles (MIV) are a relatively new addition to the universe of microfinance. They raise capital, usually from investors in the developed world, and invest in MFIs. Thus, they serve as an intermediary between investors who do not have the expertise to invest in the microfinance industry and MFIs, who do not have the expertise and are usually too small to pursue investors. The number of MIVs has grown dramatically in the last few years as has the portfolio they control. By the end of 2005 the combined portfolios of MIVs nearly doubled, reaching US$ 1 billion.

Profitability of MFIs
Conventional wisdom dictates MFIs would be unprofitable institutions as the loans they provide are small and their clients unable to repay. Thus, losses and overheads would be high while yields would be low. However, MFIs have proved otherwise by training loan officers to understand clients’ ability and willingness to repay, using unique underwriting techniques that maintain portfolio quality and accurate accounting systems that recognize arrears and detect fraud. Leading MFIs are typically better at maintaining a higher portfolio quality than their commercial bank peers in many countries.