What is Microfinance?
In simple terms, microfinance gives those in need a means to lift themselves out of poverty.
For anyone living in the developed world, the role of microfinance can sometimes be difficult to understand. It’s tough to imagine what life would be like without access to even the most basic financial services. When the Five Talents team gives someone an introduction to microfinance, we ask them to imagine starting a small business without access to a bank or to imagine trying to plan for your children’s future without a savings account. For the 2 billion people who don’t use formal financial services, these situations are a reality.
Find out more about how microfinance works below:
History of Microfinance
The history of microfinance dates back to the 1970s when it was pioneered by the Nobel Prize winner Muhammad Yunus. Since then, the purpose of microfinance has changed - modern microfinance is much more diverse than many people realise. Whilst most people think simply of credit and loans, there's a whole range of small-scale economic tools which enable the world’s poorest to save, borrow, insure, and educate themselves.
Today, the purpose of microfinance is to meet the needs of the 50% of poor households worldwide who are ‘unbanked’. In practical terms, this means providing a community with a safe place to save, the means to take small loans from a communal pot, and access to basic business training.
How does microfinance work?
For more than a decade, Five Talents has been developing a model of microfinance in Africa which allows our clients to build a sustainable income and forge a route out of poverty.
As a microfinance charity, we provide services to more than 20,000 Kenyans, Tanzanians and Ugandans. Our aim is to give our clients the means to who save together (in groups we call Trust Groups) and take small business loans to invest in their micro-enterprises. All Trust Groups are unique and progress at different speeds but most follow a basic model:
Mobilisation: Members form Trust Groups of 75-100 people, subdivided into groups of 3-5 people who know each other well and are prepared to co-guarantee one another’s loans.
Formation: Members begin savings and are trained in financial literacy and business skills. A Board is elected from amongst the members who are trained in good governance and oversee all Group meetings and transactions. Groups write their own Constitution and hold elections each year.
Launch of loan scheme: After around 6 months, members start lending microloans to each other and the fund grows through the charging of interest (which is shared out as dividends at the end of the year). Experience shows that groups make very strong credit decisions since all have invested in the loan fund. Throughout this period members continue to receive training in basic business skills.
Trust Group matures: After around 18 months our involvement will begin to decrease as groups mature and are able to operate independently. Groups continue saving and lending together, giving them an ongoing safety net through their savings and the means to keep growing their businesses.
This microfinance model is designed and operated by our local partners who know their communities best. Because the model builds sustainable programmes, it allows us to move on to start new programmes through which to provide an ever increasing amount of microfinance in developing countries in East Africa. Since 2016, as a result of the generosity of our supporters, we have been accelerating the number of programmes we are starting.
Benefits of microfinance
Over the past ten years, Five Talents supporters have impacted the lives of our clients in a range of ways. The most important effect we see is an increase in dignity; rather than being given a handout each entrepreneur is provided with the tools to lift themselves out of poverty. The benefits of microfinance include:
Growing a safety net of savings: Microfinance effectiveness can be measured in financial terms. A central impact of microfinance is that those who have joined the programmes three years ago have grown their savings more than fivefold and each has an average of £133 in their savings account today. It’s important to think about these financial figures in a human context. Our group members typically have no savings when they join and live on less than $2.50 a day so this is a truly significant change. The practical result of this is that events such as drought or illness no longer push households into absolute poverty.
Building and expanding business and incomes: The main microfinance benefits are the investments made from loans which enable members to establish and grow their small businesses. And this is a long-term impact. Repayment rates in our Embu programme in Kenya, for example, are always above 98%, which shows that members are able to run successful businesses after receiving our training.
Being able to meet basic household needs: Children indirectly benefit as members have the income to invest in their children’s schooling, diets, and improve the quality of the family’s healthcare. As a typical family has 4 dependents, by impacting 22,000 households our donors are supporting around 80,000 children. When we visit our clients, the biggest change mentioned by the majority of members is: ‘Now my children can go to school.’
Female empowerment: For Five Talents, the importance of microfinance is also linked to the impact it has on gender relations. Women are empowered to make decisions about how to save and invest their incomes and earn money for themselves, which increases their decision-making power in their households and communities more widely.
Microfinance success is always achieved when the model is designed with the client in mind. Each of these benefits is a result of a long-term focus on the dignity of the people we work with. It’s a pro-poor model that takes a long-term view, but we’ve seen it work again and again. If you’re ready to make the next step and bring help bring these benefits to more people, you can sign up to make a gift here.
What Is Microcredit
Microcredit and microfinance are separate but related concepts. The history of microcredit in Africa dates back to soon after Muhammad Yunus first began work in Bangladesh. The original microcredit organisations aimed to provide small amounts of credit (as little as £2 or £3) to those in need. Unsurprisingly, this is known as microcredit or microcredit loans.
When Five Talents first started, some of our programmes were purely ‘credit-led’ but in the years since we have moved towards a broader form of ‘savings-led’ microfinance. The difference between microcredit and microfinance is subtle but very important. Rather than providing external funds (known as capital) for loans, the majority of our programmes provide our clients with the financial infrastructure they need to save together. The cumulated amount of savings (known as the ‘pot’) forms the capital for the microcredit loans.
These days, when someone talks about microfinance rather than microcredit, they are referring to a broader range of financial services than just credit. That could include everything from savings facilities to insurance.
The debate over microcredit vs microfinance has been going on for decades, but our experience has shown that microcredit loans that depend on external loan capital are less sustainable and less impactful than the form of savings-led microfinance that Five Talents uses. Since 2007, we have only formed savings-led programmes.
Does Microfinance Reduce Poverty?
Over the past ten years, we have seen hundreds of cases which show the impact of microfinance on poverty. Over a three-year period, our monitoring shows that the clients in our savings-led programmes will have increased their savings fivefold (to an average of £133). That might not sound a lot, but when you’re living on less than $2.50 a day it represents a big change.
Whilst the savings provide a place to turn during tough times, loans help businesses grow. The members pull their savings together to form loans. At first, these loans are small, generally no more than £150. However, as businesses grow, members save more and the loan fund grows. Over the last three years, the average loan size in our programme in Nakuru has grown nearly threefold. This shows the impact of business growth on poverty reduction.
There are many ways to reduce poverty, but in the rural area in which we work, microfinance and development go hand-in-hand. And what’s more, poverty alleviation through microfinance is highly efficient! Over the past ten years, every pound donated to our Kenyan programmes has unlocked £12 of economic activity, either in the form of savings or loans.
Microfinance for Women
Empowering women through microfinance is at the heart of what we do.
70% of the world’s poor are female. What’s more, studies have found that internationally, women are more ‘financially excluded’ than men. This means that in both the developing and developed worlds, women struggle to access basic financial services like a safe place to save the small amounts they can. Before joining our microfinance programmes, many of our female clients were forced to use the bank accounts of their husbands, fathers, or brothers. For women in poverty, microfinance offers an opportunity they have never had before.
Women’s empowerment through sustainable microfinance is important, not only because it offers a route out of poverty, but also because it addresses problems of inequality. For this reason, some of our programmes specifically offer microfinance for women only. Research has shown that women are also more reliable when it comes to repayments, which is important when our clients are borrowing from a communal savings pot!
When accompanied by business training, microloans for women increase decision-making power in the household and improve their socio-economic status in the community. In essence, for our female clients, it’s all about respect and self-empowerment. In our opinion, women and microfinance are a great combination!
And what’s more, the benefits aren’t limited to the women themselves. Studies have shown that women are more likely to invest extra income on the children’s education. Whenever we ask our clients what difference the programme has made, the answer is normally simple: “now my children can go to school.”