Micro finance is a general term to describe the financial services procured by individuals and businesses that do not have access to typical banking services. This is because they typically have no credit history and many are not employed in the formal sector, so there is no record of employment. Moreover, they are unable to provide collateral. Yet, low to middle income earners, like everyone else, need access to a diverse range of financial services to help run their businesses, manage risks and plan for a more stable future. The idea is that low to middle income earners should be capable of improving their living conditions through access to financial services.
A micro finance institution (MFI) is an organization that provides financial services — loans, savings, sometimes insurance — to the demographic locked out of the banking system. An MFI can operate as a nonprofit such as a non-governmental organization (NGO), a credit cooperative, a non-bank financial institution (NBFI), or even a formal, regulated bank.
MFIs differ in size and reach; some serve a few thousand clients in their immediate geographical area, while others serve hundreds of thousands, even millions, in a larger geographical region through numerous branches. Many MFIs offer services beyond loans and savings, including education on business and financial issues and social services focused on health and children.
Many times, people have questioned whether micro finance really helps in reducing poverty. Poverty is a very complicated issue and many different approaches and tools are being used to attempt to reduce and eventually eradicate it. Micro finance is one tool that seeks to address the poverty problem. Microfinance is not the ultimate answer, and may not always be an appropriate tool, but it goes a long way in providing the “un-bankable” portion of the population a gateway to opportunity.
The way people use their loans varies with the economic activities of the different sections of the population. This is the reason why there is a range of loan packages categorized as different products depending on the loan amount required and more importantly the purpose of the loan. Examples of packages are, asset financing, business loans, school fees financing, and the like.
Some argue that micro credit interest rates are high to a fault. Like other financial institutions, MFI’s charge an interest rate for the loans they give their clients. This a way for the MFI to be self-sustaining so that it can be a stable, long term provider of finances in its area of operations. A self-sustaining MFI is critical to the health of the sector it serves, for the risk it takes on, and for it to continue to provide micro finance services to its clients. However, because managing many small loans has higher administration costs for any institution than managing larger loans, an MFI typically needs to charge higher interest rates to cover their costs.
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