Microfinance Paper Eco 228

Lenny Morgese

Paper #2 – Economics 228

Microfinance

According to the Microfinance Information Exchange (MIX) microfinance is defined as “the supply of loans and other financial services to the poor.” (poor being defined by those living at or below the international poverty threshold ($1 or less/day) for the remainder of the paper) It is called “micro” in reference to the amount of money that is borrowed: microloan principal amounts are generally $3,000 or less, the majority of these loans are for less than $1,000. Professor Muhammad Yunus is credited with developing the concept of microfinance. According to his website Yunus discovered the fruits of microfinance when he lent $27 out of his own pocket to a group of women in Jobra, Bangladesh so they could buy bamboo to make furniture. Previously the women had to take out loans with exorbitantly high interest rates in order to purchase bamboo because they were borrowing so little. They would often have to sell the furniture back to the creditors to repay them and only netted $0.02 in profit after paying back the loans; not nearly enough to provide for a family. Yunus realized by lending smalls amounts of money to individuals living in poverty he could disproportionately improve the quality of life for the poor.

Microfinance developed from problems poor face within the traditional financing industry. Generally banks incur significant costs associated with managing their client’s accounts. For example, a bank will receive nearly the same revenue if it loans $1000 to one hundred clients or $100,000 to one client. However, the fixed costs associated with processing and maintaining accounts for those loans is nearly 100 times higher than managing just one loan. Often times the cost of maintaining these low principle loans will outweigh the benefits, as a result it was very difficult for the poor to obtain small loans at a reasonable interest rate. Furthermore, often times the users of microloans are not...