Microfinance theory

There are more than 2 billion people living in extreme poverty – defined as living on less than $1.90 a day by the World Bank. Extreme poverty is an inability to meet even the barest of basic needs, typically characterized by food insecurity, having few or no assets, lacking access to education, and suffering from poor health. Often chronic and intergenerational, extreme poverty creates a trap that is incredibly difficult to escape.

Ending extreme poverty

Eradicating poverty is the first United Nations Sustainable Development goal. While there are many approaches to eradicate poverty, one particularly successful approach is to provide the very poor with access to capital.

Virtually everyone living in extreme poverty lacks access to capital. These “unbanked” people have no checking, savings or mobile money provider accounts, no access to financial products like insurance, loans or mortgages, and no protection for their money from theft or loss.

In 2006, Muhammad Yunus won the Nobel Prize for his practice of providing small loans to the very poor. He founded the Grameen Bank to develop this area of “microfinance”. The Grameen Bank model utilizes three important aspects that ensure success:

Targeting women

The vast majority of households suffering from extreme poverty are headed by women. Women are often marginalized by society and lack opportunities to improve their family’s quality of life. The Grameen Bank targets women for three reasons.

1. Women more typically engage in the type of economic activities that microcredit institutions invest in;
2. Women are more likely to reinvest their loans to better their entire family;
3. Finally, women are more reliable borrowers and they are more likely to use their loans productively and repay them promptly.

Group lending (solidarity groups)

Lending groups are used in place of collateral (because most loan recipients lack collateral for a loan). Lending groups create both support in the development of the business and peer pressure to pay a loan back. No member of a lending group may receive a subsequent loan unless all members of the lending group have paid back their previous loan.

Loan support

Borrowers are provided support and education on how to become financially responsible, make repayments, and successfully establish and grow a business.