Starting with the basics: What is microfinance?
As CGAP defines microfinance, it is the provision of financial services to low-income people. It is an initiative for low-income households to have permanent access to high-quality and affordable financial services to finance their businesses, build assets, stabilize consumption and protect against risks.
The term initially was associated with microcredit, but now it includes a range of financial products, such as savings, insurance, payments and remittances. Microfinance institutions are constantly evolving and improving their understanding of the financial needs of their target clients in order to tailor their products and methodologies accordingly.
Who are the typical clients?
Low-income individuals and families, which are often self-employed in the informal economy and don’t have access to banks and other formal financial institutions, are the main targets for microfinance institutions.
It is quite common for the target audience to be running small stores, create and sell items they make in their homes, and in rural areas. Small-scale farmers and those who process or trade crops and goods can also be considered as the target audience for microfinance.
As we have discovered, microfinancing is one of the forces that can significantly impact financial inclusion in a positive way. MFIs are an extremely viable alternative to traditional bank loans, which the population in the developing world can’t usually afford.
The microfinance companies are ranked by the Multilateral Investment Fund, which lists institutions based on the:
- size of their gross loan portfolio
- efficiency, which considers operating expense and the cost per borrower as a percent of the gross national income per capita of their country of operation
- risk, which looks at the quality of their loan portfolios, measured as the percent of the portfolio at risk greater than 30 days
- return, which is measured as a combination of return on equity and return on assets
Ecuador, Bolivia and Mexico to foster financial inclusion in LAC
The highest number of top microfinance institutions is in Ecuador (15%), Bolivia (14%), Mexico (14%), Colombia (12%) and Peru (12%).
Microfinance institutions by country
There are more than 100 MFIs operating in LAC region that are bringing financial services closer to the poor population.
In terms of economic efficiency, the highest return on assets for microfinance in the LAC region is around 30%, according to the Multilateral Investment Fund.
What is the main problem with all MFIs?
One of the main problems with MFIs is that small loans are more expensive to process than large ones because they take longer to process. Clients often don’t have an employment history or collateral, which is why microfinance loans require a more hands-on, time-intensive assessment to determine creditworthiness.
There is usually an agent involved in the origination and assessment, which creates even more challenges for MFIs as it is quite costly to send representatives to remote areas.
In case the loan is approved, the agent then will have to distribute the funds and then collect payments. It is a very costly and time-consuming activity, which banks have mastered through technology and automation. MFIs have a hard time generating a profit and covering expenses, which leads to higher rates.
However, as technology evolves, MFIs are slowly but gradually able to cut the costs and reach a wider audience with more accessible services. Mobile money is an example of a FinTech that can make a significant positive impact on the way MFIs operate and at the end, to reduce the charges to clients.