Start-Ups

10 things to know about how microfinancing is using tech to empower global entrepreneurs

Mobile technology, the internet, and globalization are powerful tools in eradicating poverty through microfinance loans, which have funded half a billion people and counting.
 
Kiva
A loan of $725 allowed Rosalinda Matea to create a business making sashes for women in her community in Guatemala.
 Image: Kiva
 Ten percent of the world has access to traditional banking, according to the Gates Foundation. And traditional banks often refuse to finance low-income or unemployed entrepreneurs, no matter how viable their ideas are.

Now, enabled by the spread of mobile technology and wireless internet access, microfinancing organizations are attempting to eradicate this problem through small loans given to impoverished people who need the finances to become self-sufficient.

In the past 30 years, microfinance loans have brought banking to more than half a billion people, and that number is growing even more rapidly today. Startups, nonprofits, big companies—they're all jumping on the opportunity to alleviate poverty throughout the world with microfinancing. Here are 10 things you should know about microfinance, because of the significant impacts it's having on startups and entrepreneurs around the globe.

1. Microfinancing was pioneered by Muhammad Yunus in Bangladesh

"We have to get out of this mindset that the rich will do the business and the poor will have the charity." —Muhammad Yunus

In 1974, Yunus founded the Grameen Bank in Bangladesh and pioneered microfinance and microcredit in order to promote self-sustaining social business. The Grameen Bank began by giving loans to poor Bangladeshi women to fund their small businesses. The bank extends its loans at a maximum interest rate of 20 percent, and Yunus advocates that it should never be much higher than that. Yunus won the Nobel Peace Prize in 2006 for his global impact and work to improve economic development through microfinancing and has since been a major proponent and leader of eradicating poverty through social business.

2. Kiva is the most well-known microfinancing organization

The San Francisco-based nonprofit has provided loans to low-income entrepreneurs in more than 70 countries since 2005. Microfinance institutions, businesses, schools, and nonprofits—what the agency calls "field partners"—post qualified local entrepreneurs on the site, with personal stories about what they want to fund and use their own interest rates, which average 35 percent. Kiva Zip enables lenders to make direct loans to entrepreneurs in Kenya and the U.S. through PayPal.

More than 600,000 loans have been made through Kiva, totaling almost $500 million with a 99 percent payback rate. More than 80 percent of those loans were made to women.

3. Microfinance interest rates vary widely around the world

The average global microfinance interest rate in 2008 was about 35 percent, according to research by CGAP. More recently, several organizations and websites have quoted it closer to 37 percent. Data shows Mexico recently reported rates as high as 74 percent, and many other countries pay close to that as well. High rates have been criticized since the early microfinance movement in the 70s.

Why are they so high? The institutions' administrative and transaction costs for many small loans is much more than if a bank offered one large loan sum. Transportation costs for loan officers are also factored in. Borrowers pay these rates because it's the only way to receive money and they are still much cheaper than moneylenders and banks. However, that doesn't mean that the high rates are unavoidable. Microfinance institutions have come under much scrutiny recently because of the high rates. One answer is legislative rate caps, which many countries are starting to introduce—including 17 countriess in Sub-Saharan Africa.

4. Technology is making microfinancing accessible

Nearly one-quarter of the global population lives below $1.25 a day, according the World Bank. Seventy percent of South Asian households do not have a deposit or loan account. In the Middle East, it's 58 percent. In Sub-Saharan Africa, that number reaches 88 percent. Compare that to the West, where it's just the opposite: 89 percent of people have bank accounts.

Zidisha
Microfinancing allowed a Kenyan man to build a cyber cafe.
 Image: Zidisha

Mobile technology and wireless internet make all the difference when it comes to microfinancing by using devices as banking channels and payment systems. The accessibility of mobile phones around the world is quickly growing, especially in the last four years. In Kenya, which has become the poster child for mobile payment systems, 68 percent of people said they used a mobile phone to send or receive money. Organizations like Zidisha and Kiva have leveraged the success of mobile technology to spread microfinance banking.

5. Interest rates can be lowered relatively easily

By eliminating intermediaries and allowing borrowers to directly speak to lenders about funding through the web, Zidisha has lowered the interest rate to borrowers throughout Africa and other developing nations to under 10 percent. There is also a 5 percent service fee, which covers messaging costs and and transfer fees. The loans are repaid in monthly installments after he/she finds a lender to support the business venture listed on the website. There are other benefits to this model as well, including opening the dialogue between lenders and borrowers.

"Of course we have had international communication for a long time, but it's not normally done across such vast differences in circumstance," said Julia Kurnia, founder of Zidisha. "Connecting people in this way, this seamlessly, has never been done before."

In general, lower interest rates improve access, and microfinance institutions can be operated much more efficiently than they are by better utilizing technology such as mobile payments and direct lending. Granted, Zidisha is a virtual company, operating on a lean budget with Kurnia taking on most of the costs herself. But it's a novel model that's using technology to disrupt the finance industry.

6. The average microfinance payback rate is 97 percent

That's according to the Microfinance Information Exchange, a microfinance business information provider. Individual institutions such as Accion and Kiva report anywhere from 95 to 100 percent as their average loan repayment rate. What seems like a small loan to lenders can go very far for low-income entrepreneurs by giving them a launching pad to build a sustainable business. The average microfinance loan for Kiva is about $400.

7. Empowering women through microfinance will improve economies

Many microfinance programs target women, and for good reason. Studies have shown that women are the change agents in families; when they have resources, they use them to benefit their children. According to the World Bank, countries that invest in the social and economic status of women have lower poverty rates. Just one extra year of secondary schooling for girls results in wage increases up to 20 percent.

8. Microfinance is not just for business loans

Most borrowers ask for loan capital to start or expand a business, but that's not the only reason. Almost 90 percent of people in developing countries said they use banks to store money for personal use, aaccording to a survey from the World Bank and the Gates Foundation. The most common reason for taking out a loan is for family emergencies. That's closely followed by school fees and home construction. Kiva stated that some people use the microsavings to start an account for their cash earnings. Other microfinance loans are specifically for housing costs or school fees, which are very expensive in developing countries.

9. The global microfinance market is expected to grow 16.6% by 2016

From 2012 to 2016, the compound annual growth rate (CAGR) of the global microfinance will rise at a rate of 16.6 percent, according to TechNavio analysts. Much of this growth is due to finding untapped markets around the world and the appearance of more credit bureaus for microfinance institutions. Still, the main vendors of microfinance loans are Compartamos Banco in Mexico, Grameen Bank in Bangladesh, and SKS Microfinance and Bandhan Financial Services Pvt. Ltd. in India.

10. There are several different models of microfinancing

  • Collective repayment: The Grameen Bank model originally used group-lending, or microcredit, in which small groups of community members were bound to borrowers by a moral guarantee in lieu of the collateral required by traditional banks. This model of social responsibility worked well in Bangladesh, and many countries localize the model to fit their ethics and needs.

  • Micro-banks and microfinance institutions: For-profit models include rural micro-banks that vary depending on the community and location. One example is India's ICICI Bank, which has subsidiaries in Europe and Asia that provide microcredit and microfinance loans. Micro-banks also exist in the U.S., and have a hard time competing here because of major competition. But in developing countries, they can fare well as the only option. Other microfinance institutions include schools, nonprofits, and agencies.

  • Peer-to-peer lending: Nonprofit organizations like Zidisha and Kiva are examples of peer-to-peer lending. Zidisha is a database of borrowers that lenders speak with directly. No one censors the information or requests. Kiva, on the other hand, uses microfinance institutions on the ground to take care of the loan requests, though they have just launched the Zip model, which is more direct. They also censor and edit borrowers' descriptions on the website for clarity.

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About

Lyndsey Gilpin is a Staff Writer for TechRepublic. She writes about the people behind some of tech's most creative innovations and in-depth features on innovation and sustainability.

2 comments
Hugh Sinclair
Hugh Sinclair

In response to the 10 things you should know about microfinance, here are 10 concerns with this article:


1. Yunus did not invent microfinance, it has been around for centuries. Roodman's history chapter in his book "Due Diligence" is a good start.


2. Kiva is certainly well-known in the US, but in the rest of the world most clients are unaware from where their loans originate, as the capital passes through intermediating banks.


3. A principal reason why interest rates are so high is that shareholders of private microfinance banks enjoy making substantial profit. Banco Compartamos in Mexico, or SKS in India, are the classic examples of such profiteering.


4. In addition to technological advances for distributing microfinance, cloud-based back-office systems are emerging, which offer substantial cost savings to banks, which can hopefully be passed on to the poor via reduced interest rates.


5. Although interest rates could be lowered relatively easily, according to the Economist average interest rates have increased by 5% from 2004 to 2011. So much for competition driving interest rates down!


6. Repayment rates are generally good, but simply repaying a loan does not mean the client is less poor as a result, particularly when interest rates are so high.


7. Microfinance tends to target female clients, but this is not always beneficial. The vast majority of clients who committed suicide in Andhra Pradesh under extreme pressure from the microfinance banks were also women. Credit is a double-edged sword.


8. An undisclosed amount of microfinance is used not for a business, emergencies, school fees or construction, but for simple consumption.


9. Growth of the sector is inevitable, but so is over-indebtedness and non-performing loans. Peru is currently facing severe challenges in both regards, and the #1 bank in Peru was recent sold following the near collapse of its main shareholder.


10. Two major additional sources of microfinance not mentioned in the article are savings and loan co-operatives, and credit unions.

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