The term of microfinance refers to the whole of the banking services put at the disposal of the poorest by specialized agencies. They can be services of loan, saving, insurance and transfer, microloan or other financial services thought up for low-income customers.

Microfinance finds its origins in the first farmer’s credit unions appeared with the XIXth century and knew its hour of glory with Muhammad Yunus’ works, Bangladeshi economist and businessman known as the incorporator of the first microloan company, the Grameen Bank, in 1977.

Since pioneer experiences as Professor Yunus’, microfinance area has evolved and is growing exponentially. There is nowadays a plurality of institutions, calling upon different legal status (foundations, savings and credit cooperative, public banks, limited companies…) whose operation running and purpose strongly vary. If MFI depend now on neo-liberal views tending to an institutionalization of microfinance programs – in other words to settle profitable microfinance institutions – some initiatives are the work of NGO like the French one ACTED (Aide à la Coopération Technique Et au Développement) concerned about remaining first and foremost in the service of the most destitute.

However for organizations like the World Bank or the United Nations, these institutions with social vocation are flimsy, because they are tributary of subsidies coming from the backers. However, one thing stays in common to all the MFI: development aid by the settlement of a “Bank of the poor”.

Why microfinance?

Microfinance is above all things an enterprise of development aid and consequently, takes place in the less developed and developing countries. In these countries, lots of very small activities (described as micro-activities) have developed to permit poor populations live on. They include trades very varied like door-to-door salesman, small craftsmen, newsstand, cabs, street peddler, bazaars... Beyond diversity, these subsistence economy activities take on common features.

• The invested capital is limited and comes almost exclusively from familial properties.
• These people are generally unskilled and badly-paid,
• They resort to a flexible schedules of work and often operate partially or completely in margin of the legislative and administrative rules.

The whole of these activities is confronted with the problem of the access to external sources of financing. Except this potential family contribution, the little contractors do not profit from any financial service of loan to allow the launching of their activity. Until 1950, the main alternative was having recourse to the unofficial economy. This much diversified financial sector gathers the whole of the financial transactions which are not regulated by a central monetary authority or a money market. These transactions generally concern the short term and are founded on personal relationships.

This keeping away from the classical financial circulations is owed to a difficulty in risk detection and to a lack of guarantees on customers’ side. One lends only to the wealthy.

On the contrary, microfinance offers the possibility of breaking this circle. Actually in countries where only hundred euros are enough to fight its way out of poverty, it’s easy to put at whole families’ disposal the means of their autonomy and subsistence. To overcome imperfections of the market, in the sixties, the governments of the South countries ruled low interest rates and settled public institutions of loan. In this way, they hoped to supplant informal sector, to raise economic effectiveness and to reduce inequalities. However, these state institutions failed in their mission and made way to a semi-formal financial sector, notably composed of NGO. Nowadays they are real institutions sent by the Mondial Bank or directly patched by NGO.

The microloans consented by MFI allow launching of activities to people who were born businessmen but they further also the creation of new jobs and have an influence on activity progress of developing countries. Poor populations showed that not only do they pay back their loan on time but they invest their raised incomes in the material well being of their family. They use also other financial services like insurance and savings in order to ensure their future.

In a nutshell, microfinance exists to give back the most underprivileged sections of the population their autonomy permitting them to take part in decision makings and to control them.

Microfinance: services and functioning

Microfinance is interested in local projects and tries to spin every thread of country or city networks. MFI loan little amounts to a group of village residents or to inhabitants of a same neighbourhood. Owing to the risk which does exist for institutions never being paid back, they had to find an alternative. From this, the idea of joint guarantee was born: microloans are often granted to a group (self-help groups), not to one single man: if one of the members doesn’t discharge for his repayment duties, the whole group is penalized and deadlocked. It’s the only kind of guarantee for the money-lenders.

One of the essential features of microloan is its heavy interest rate (sometimes almost 30%). Criticized aspect but justified in many ways. First and foremost, we have to emphasize that it’s their only possibility of acces to loan but also the opportunity of eluding an informal money market often dominated by gangs and mafias. The usurers, who they used to borrow from, grant loans with rate close to 1% a day or 100% by month, so microloans are still very attractive. These heavy interest rates are due to the costs of an important workforce (necessary to select and follow customers through great distances) or to the cost for institutions refinancing, reinforced by important inflation rates. At least, needs of computer equipments and other goods (office equipment, cars, software…) often imported, come and swell functioning costs. There is also psychological, social and technical care of which charges are counted in functioning sector. However, in well-managed MFI, payment rates of lent amounts are next to 95%; therefore rates are not so dissuasive.

Microfinance also put on poor countries’ disposal long-term services like savings accounts which allow defending financial goods from stealing and squandering.

Lastly, insurance takes part of services of MFI. It allows the business to settle strongly and to protect themselves from unexpected events (bad weather for productions, unexpected outcomes…)

Effects of microfinance on developing countries

Today, microfinance is a system known the whole world over and is considered as a main development tool. There are 500 million people who benefit by it especially in Asia and Pacific. Its success is so great that 2005 was declared year of microfinance. Thanks to this recent approach of finance, a real micro economy is beginning to expend in every underdeveloped and developing country. Million traditional or trading activities employments generating could be created with this kind of finance.

Microloan permitted development of local and national activities, and jobs expansion particularly women jobs. Indeed, the majority of microloans are agreed to women who can do now the trade of their know-how. So microfinance reasserts the value of women’s condition.

Spin offs are positive for the whole family and the whole community. In certain places, there is an increase of standard of living. Other roundabout effect: the development of education which comes and strengthens bounds between poor people and bank systems. It’s true, it’s in lender’s interest to have formed and informed customers in order to establish good relationships of confidence. Because of this, the “Bank of poor” sometimes settles education programs.

Reporting to concrete results: in less than 10 years, one third of Grameen Bank’s customers managed to fight their way out of poverty, and a second third got to a level next to poverty line. On a second hand loans permitted families to plan their future on a long term, as far as education is concerned for example. Inequalities between men and women had been reduced also.

However, if microfinance can improve most destitute’ life, impact measurement isn’t easy to do. No econometric study has given yet rise to a broad consensus. There are many examples of individual success but it may be difficult to generalize the effectiveness of microfinance.