Microfinance is the provision of financial services for people living in poverty who don’t have access to traditional financial services. Besides loans, microfinance includes other services such as savings, money transfer and insurance and allows low-income earners to finance income-generating activities and protect against risks.
Microfinance is aimed at individuals who were previously considered “unbankable” by larger banking institutions. These are individuals who are possibly dealing in small amounts of money each day, living in hard-to-access areas, without credit histories or who don’t meet “traditional requirements” within the banking sector. For example, in many parts of the world, women are not allowed to own property. Since banks often require collateral for loans, women are often excluded because they don’t have access to collateral against which to secure the loans.
It’s widely accepted by socially driven microfinance institutions that microloans specifically are not appropriate in situations where they propagate a cycle of debt or dependence. For example, if a client is taking a loan to pay off another loan, this is (ethically speaking) considered very bad practice and is something Deki works with our Field Partners to avoid.
People in developing countries often don’t have bank accounts or credit histories. This makes it hard to apply for loans from traditional banks. They may also lack legal documents enabling them to use their home as collateral. In many cases our entrepreneurs are self-employed and don’t have verifiable sources of income.
In most cases, credit bureaus and banks are unable to assess creditworthiness without correct documentation, regardless of whether applicants have good business plans or already run successful businesses.
This does not mean that these people are not creditworthy. The growth of microfinance has shown that many poor people have good business ideas and entrepreneurial spirit, making them extremely capable of repaying loans.
Deki charges no commission or interest on loans. Most of our field partners, small microfinance institutions, charge interest on the loans. They have running costs they need to cover to stay operational and they offer supporting services such as business advice and training with the microloan.
The interest rates of microfinance institutions are often higher than those of commercial banks. Several factors explain this. Firstly, it is generally more expensive to administer smaller loans, and since most microfinance clients do not have regular salaries or collateral, the process of evaluating applications is particularly difficult and time-consuming. Secondly, costs associated with serving clients who are based in hard-to-reach rural areas and need training and support must be considered. Thirdly, though repayment rates can be very good micro lending involves more risk than the lending commercial banks engage in. You can help.