You are probably familiar with the term ‘microfinance’, but what about its meaning? There are hundreds of microfinance charities all around the world and they provide a financial lifeline for people who can’t get credit elsewhere, so having an understanding of them is crucial to understanding what forms a significant part of the economy in some places.
Microfinance is a relatively simple concept, working on similar principles to credit unions. This means that all of its profits are put towards future loans and developments, allowing microloan charities to benefit as many people as possible. These charities can be funded in a range of ways: some are quite closely tied to the mainstream financial system, meaning that there is a sort of ‘top down’ approach to the distribution of funds.
However, many other microfinance charities and groups are member-funded. This can take a couple of different forms. One way of funding these groups is for people to donate money that is then lent to people requesting loans. For instance, people in the UK could donate money to help small businesses in Africa. The loan can then be paid back to them or they can put it towards more business ventures. The groups can also be funded locally, where small unions are set up in a particular area – the aim is that they can eventually become self-funding as more people receive and then pay back their loans.
Some people question the idea of charging interest on these loans, especially as the money is going to people who are very poor. Not all institutions charge interest. However, for those that do, the interest serves a couple of purposes. One is that it helps to formalise the loans process, which means that the people receiving the money are more likely to feel that they are valued clients – as opposed to receiving charity, to which some people might be opposed and others might see as providing less incentive to pay back the money.
Another reason for charging interest on microfinance loans is that it helps to fund local unions and the charities that run these schemes, as well as offering the potential for more money to be made available for loans in the future. This means that even though much of the microfinance industry operates outside of what we might consider ‘mainstream’ financial institutions, it still upholds strict and robust economic principles – it’s main difference is that it is willing to lend money to people who ordinarily would not be able to get credit elsewhere and so plays a valuable role in the world of finance.
Guest post of behalf of World Vision Micro-loans Charity
Incoming search terms:
- how does microfinance operate
- how does microfinance work
- how does Microfinance work out?
- interest on microfinance loans
