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Some economists believe that microfinance is the key to economic recovery, whether from a devastating natural disaster or a global recession. But what exactly is microfinance? Essentially it’s the availability of financial services to micro and small businesses that are generally owned and operated by people from poor and low-income households. The financial services needed include traditional deposit accounts, insurance funds and microcredit (very small loans).

Microfinance has its roots with the pawnshops founded by Franciscan monks in the fifteenth century. Since its humble beginnings, microfinance has expanded to crowdfunding and peer-to-peer lending, and Nobel Prize winner Muhammad Yunus introduced the concept through Grameen Bank, which now serves over 7 million poor Bangladeshi women.

Why is microfinance so critical to economic development and recovery? Small businesses provide up to 80% of all jobs globally. On average, they provide 50% gross domestic product (GDP) of a high-income country and anywhere from 65% to 80% GDP of a developing nation. Despite these staggering statistics, micro and small businesses suffer from a lack of capital. Those owned by families living in poverty are especially un-served or underserved.

Globally there are 200-245 million small and medium enterprises (SMEs) that either do not have a loan but need one, or have a loan but find constraint with access to finance. 90% of these SME’s are micro businesses and the financial gap is even more urgent for women owned businesses. Therefore, necessary infrastructure must exist to support microfinance. Some obstacles include:

  • Insufficient donor subsidies
  • Poor regulation and supervision of microfinance institutions (MFIs)
  • Few MFIs meeting the needs for savings, remittances or insurance
  • Limited management capability in MFIs
  • Institutional inefficiencies
  • Lack of distribution of services to rural and agricultural entities

To address some of these issues, the Consultative Group to Assist the Poor (CGAP) established the following 10 Microfinance principles in 2004, which the Group of Eight (G8) has endorsed.

  1. Poor people need loans, savings, insurance and money transfer services
  2. Microfinance must be useful, helping raise income, build assets, cushion against external shocks
  3. Microfinance must pay for itself and not rely on donors or government
  4. Financing must be offered through permanent institutions
  5. Microfinance institutions (MFIs) must help integrate the poor into the mainstream financial system
  6. The job of government is to enable financial services not provide them
  7. Donor funds complement and build private capital, not compete with it
  8. Bottleneck is shortage of strong MFIs and managers
  9. Interest rate ceilings hurt poor people by preventing MFIs from covering their costs, which reduces access to credit
  10. MFIs must measure and disclose performance

In addition to CGAP’s microfinance principles, some developing countries have successfully surmounted obstacles to establishing an infrastructure that supports microfinance. The following lessons can be adopted by other developing countries that wish to establish microfinancing.

  • Focus on women business owners
  • Embrace the future – do not rely on tradition to guide development efforts
  • Establish a nationally supported business bureau database to which financial institutions contribute micro and SME data
  • Provide incentives for informal businesses to register and implement regulatory reforms

In summary, providing credit through microfinance strengthens and grows micro and small businesses, which leads to job creation and economic development. Improvements and sustainable solutions for global economic development and recovery are possible with the support of microfinance.

Based on the whitepaper by Sharon O’Connor-Clarke: Microfinance – An Aid to Nepal’s Post-Earthquake Recovery.

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