With an initial microloan of 1,500 Egyptian Pounds—the equivalent of roughly 93 USD—Azza Abou Zeid Kobbes, a 36-year-old small business owner from Aswan, Egypt, transformed not only her own life but also the lives of those in her community. Azza used the money from her loan to buy garments that she could improve and then resell. With a second loan, she purchased a storefront to attract more clients. Through this growth, Azza has been able to increase her family’s savings and form a fund with her neighbors to share the wealth with community members in need. To this day, Azza continues to take out loans and invest in both her business and the needs of her community, thereby increasing economic prosperity for many of those around her.
In economically developed countries like the United States, an entrepreneur can apply for a loan at their nearest bank and get it approved in as little as two weeks, provided their credit is up to par. However, about a third of the world’s population lives miles away from their closest bank. What’s more, many potential entrepreneurs don’t have a formal credit history, steady sources of income, or educational qualifications that would make them attractive clients to conventional banks. Enter microfinancing: the provision of financial services to those that lack access to conventional banking. This includes lending small sums to entrepreneurs, especially women, in the developing world. It is through microfinancing that Azza, and others like her, are able to make a difference in the economic mobility of their communities. Microfinancing provides a unique opportunity for entrepreneurs to transcend many of the problems associated with investment and entrepreneurship in developing countries.
Though they vary from region to region, microfinance institutions around the world rely on similar means to provide loans at affordable rates by carefully hedging the risk of default. One such method is lending to small groups rather than to individuals. This reduces the risk of unpaid debt by relying on social and cultural pressure from group members to guarantee that each borrower pays their share. Another common practice is requiring payments in frequent installments.
The effects of microfinancing multiply: Per the B.E. Journal of Macroeconomics, “A small boost in microlending in the developing world could lift more than 10.5 million people out of extreme poverty. Microfinance not only reduces how many households live in poverty, but also how poor they are.” The impact of microfinancing can also be maximized by combining lending with other initiatives. For example, the Utkarsh Welfare Foundation has been able to successfully microfinance numerous projects in India. The company’s success can partly be attributed to its charitable foundation, which invests in financial literacy classes and vocational training for the women they lend to. This initiative helps the entrepreneurs succeed in all aspects of their business, increasing their ability to yield high returns. Another example is the global Aga Khan Agency for Microfinance, which aims to “reduce poverty, diminish the vulnerability of poor populations, and alleviate economic and social exclusion.” It focuses on women and lends to businesses that have end goals of benefiting entire communities, whether that be through increased employment or providing much-needed services.
Critics of microfinance often refer to it as a “discredited model” that leaves borrowers poorer than they started. It’s true that, in some situations, defaulting on a small loan could plunge a family into an even worse financial situation. But in most of these cases, families use microfinancing as a substitute for weekly income: Without a weekly paycheck, a family might take out a small loan to pay for groceries, school supplies, or electricity. Microfinancing is not meant to serve as a band-aid fix for individual families, but rather as a jump start for business opportunities—a way to harness the social and financial capital necessary to raise individuals and their families out of poverty. Financial mobility is best achieved by microfinancing business ventures, which diversify income and boost financial independence and help families avoid the dangerous cycle of debt.
Still, other critics of microfinancing initiatives deride how the practice focuses on the individual entrepreneur, not economies at large. These skeptics encourage more collectivist approaches to helping those in economically developing countries, such as increasing employment opportunities to create steady incomes for community members, investing in social movements for equitable access to land for farming, and building hospitals and schools. However, they fail to recognize that when implemented correctly, microfinancing actually uplifts entire communities. Individuals often reinvest business profits to establish social mobility programs in their communities. Moreover, as businesses grow, they typically require additional workers, thus increasing employment. Investment in an individual business’ growth, then, increases the amount of money in circulation, boosting the economic productivity of entire communities. Likewise, a majority of successful initiatives provide loans to communities. By providing a loan to a community to start a local farm, for example, those living in poverty gain resources that can help them lift themselves out of their existing financial situation.
As a whole, microfinancing gives small business entrepreneurs the invaluable opportunity to start their own ventures. As these businesses grow, they create jobs, uplift communities, and increase collective standards of living. Moreover, microfinancing is particularly helpful for women, who are often at a relative economic disadvantage. Though there are caveats in its implementation, microfinancing holds great potential to positively transforming impoverished communities around the world.
Photo: Image via Brian Evans (Flickr)