What it is
Microcredit is a set of principles, distinguished from general financing or credit, which seeks to serve the micro-entrepreneur for employment generation, trust building, and to help with capital raising during initiation and difficult times.
It is a tool for socioeconomic development. It can encompass anything that involves granting access to poor people any of the typical financial services the average person in the Western world has access to. It is anything that is an alternative to the informal moneylenders and collectors typically used, or to replace charities that grant loans and grants, or that brings money into places typically occupied by the informal economy. Microfinance is something that gives \"poor people a 'hand up', not a 'hand out'\" by expanding available financial services, increasing the number of financial institutions available to the poor, as well as increasing the capacity and diversity of those institutions. It is important to not confuse microfinance and charity, charity is better suited for situations such as war zones and natural disasters,
where it is unlikely for people to be able to generate the cash flow required to repay loans. Below are the ten factors of microfinance set forth at a G8 summit on June 10, 2004:
- Poor people need not just loans, but also opportunities for savings, insurance, and money transfers.
- Microfinance must allow poor households to raise income, build up assets, and/or protect themselves from external conditions
- Microfinance must be able to pay for itself because subsidies from donors and governments are scarce and uncertain.
- Microfinance is a part of building permanent local institutions.
- Microfinance means integrating the financial needs of poor people into the mainstream financial system of the country
- The government must allow for microfinance systems, not provide them
- Donor funds should be a complement to private capital, not in competition with it
- Donors should focus primarily on building capacity to help create stronger institutions, which are the main piece of the puzzle currently lacking
- Microfinance systems should not have interest rate ceilings because they will either limit who institutions loan to or prevent them from covering costs.
- Microfinance institutions should measure and disclose their financial and social performance.
Why it is Important
The poor need the same financial services the average person in the Western World does, but they just use informal services that are not as reliable. For example, people save by investing in assets such as gold, jewelry, domestic animals, building materials, and other things that can be easily exchanged for cash. Crops can be saved, money can be buried or hidden, they can use informal savings groups, which contribute a small amount of money on a certain time basis and rotate the rewarding of the pot or may allow borrowing from the pot. There are limitations, however; the assets are not always easily divisible when a small amount of money is needed, they may be subject to fluctuations in commodity prices, destruction by natural forces or sabotage. There is also the risk of thieving/fraud, especially in the case of savings groups. As an alternative, neighbors, family, or local cash collectors can be used, but they are risky and may not be widely available options, plus
they are also subject to possibly thieving and fraud. One may ask why banking is not an option for many of these people; the
primary reasons are
outlined below:
This list is compiled from 2 sources, how do we want to dual site? - The poor may not have any savings to open an account with, especially if there are minimums.
- The poor often don't have collateral to secure a loan with, either because they actually don't have any, or just don't have proof of any assets they do have.
- There is no credit record because of self-employment and the lack of financial services available in the past.
- Someone who is illiterate can't complete the necessary paperwork.
In short, financial institutions as they have existed are
meant to help maintain assets, not help create assets. The reason banks tend to not help the poor is because of a combination of risk and the fact that they can make more money by giving out a few large loans than a number of smaller ones. Providing financial services to a few well-off people is much
easier and cheaper than a
huge population of poor people. Instead, the poor tend to borrow money from local moneylenders, whose interest rates can be very high. According to an analysis of 28 studies from 14 countries,
76% of moneylender rates exceed 10% a month, including 22% that exceed 100% a month. It is an accepted idea that the development of a nation's economy is very dependent on the development of a healthy national financial system, which has often focused on developing a commercial banking sector. While this is important, also important is the development of a banking sector
capable of providing financial services for the majority of a nation's population.