The percentage of the world population living on less than $1 a day fell from 40% to 21% during the decade spanning 1980-90. In China, the GDP per inhabitant has increased fivefold since 1981 and the percentage of people living in a state of extreme poverty has declined from 64 to 17%.

In the next ten years, the total number of inhabitants of the globe living on less than a dollar a day will drop from 1.3 billion to 913 million.

In spite of these seemingly encouraging figures, in sub-Saharian Africa, the number of people living in extreme poverty keeps on growing and is expected to reach 400 million in 2015. If the current trend persists, 40 years from now more than half of the world’s population, or approximately 4 billion individuals, will have to survive on less than two dollars a day.

The loans to the 66.6 million microfinance clients who are among the poorest of the poor have a direct repercussion on a total of 333 million people, or the equivalent of the populations of the U.K., France, Germany, Italy, Spain, the Netherlands, Switzerland and Norway combined.

The UN declaration of an International Year of Microcredit in 2005 as part of the Millennium Development Project for reducing poverty worldwide was a strong indication of the importance of the sector’s actions and impact.

It has been proven that microcredit has a positive impact on the level of profits, investments and  access to macroeconomic markets. On the level of households, microcredit has a positive impact on consumer spending. And on the individual level, microcredit has resulted in greater regard for spouses and children.(Study conducted by PlaNet Finance in Morocco in 2004)

Microfinance institutions are in permanent contact with their clients and have the means to facilitate the distribution of services that enhance the value of microfinance by associating them with the promotion of good practices in matters of health, education and the environment.

• Microfinance Institutions (MFI) are the organizations that offer microfinance services and products to the populations concerned. There are many different types: savings and credit cooperatives, NGO, programmes established by international organisations, legally-recognized microfinance institutions, microfinance banks...
• Commercial Banks back microfinance operations either indirectly, by providing existing MFI with financial support or by acquring an interest in a company, or directly, by creating a subsidiary or a microfinance product/service offering (downscaling).
• Microfinance Investment Vehicles (MIV) participate in the financing of the sector. There are over 75 of these worldwide.
• Governments and Local Authorities are involved in the development of microfinance, through the defining of relevant legal frameworks and national sustainable development strategies with a microfinance section, and through the support of Central Banks, government departments and local authorities.
• Insurance Companies insure the MFI and their portfolios and distribute microinsurance products via MFI networks.

HOW MICROFINANCE WORKS

Lending methodology:

The two major lending models are joint (or grouped) microloans and individual contracts.

Individual contracts are the type of loans that most resemble traditional loans: a person receives a certain amount of money and must repay it within a relatively short period of time (a few weeks or a few months) taking the interest into account. The amount accorded for these types of loans is generally higher than that for joint loans.

Joint microloans are granted to a group of people who are jointly responsible for repaying the loan. Individual failures to pay (due to illness or a “bad week”) are avoided and group pressure serves as a strong incentive in ensuring responsible behavior.

Interest rates

The very principle of microfinance, which consists in moving away from the idea of aid by providing individuals with the opportunity of self-financing, implies the application of interest rates to loans.

As the loans are for small amounts and must be paid back rapidly (often on a weekly basis), the sums to be repaid are affordable for clients, especially given the productivity of their income-generating activities: “a study conducted in the Dominican Republic, Colombia and Chile showed, for example, that even a monthly interest rate of 6% represented only 0.4− to 3.4 % of a microentrepreneur’s operating costs (…) Research conducted in India, Kenya and the Philippines showed that the average annual rate of the return on investment in microenterprises ranges from 117 to 847 %.”

The interest rates of microfinance institutions are high as MFI grant many more small loans than traditional banks do, using a rigorous methodology that results in higher operating and processing costs.

The interest rates cover: the cost of the money to be reimbursed, the costs associated with risk of non-reimbursement and expenses relating to the microcredit administrative and processing tasks (time spent selecting and accompanying clients, the processing of requests for financing, payment collection…).  It is estimated that operating costs represent 25% of the average amount of a MFI portfolio; whereas in India, for example, commercial banks post operating costs of approximately 5 to 7% of their outstanding loans.

On the other hand, although microcredits cost substantially more than “traditional” loans, MFI loan officers appear to be far more productive: in viable MFI, a loan officer manages an average of 359 microborrowers, according to the Microfinance Information Exchange (MIX).

Interest rates depend on the:

• Local rules and regulations concerning the ceiling fixed on interest rates;
• Expenses related to microfinance activities;
• Type of institution (not-for-profit or profit-oriented) MFI);
• Technologies or innovations that allow the MFI to enhance productivity and reduce operating costs.