In our modern society we often take for granted the access to credit and banking services. However this is in not the case for half of the world’s adults, according to the World Bank. Even in the USA, almost 7% of households were considered unbanked, and an additional 20% underbanked in 2015 (FDIC).
What is microfinance?
Microfinance provides people who are excluded from traditional banking activities with access to financial services, from low-income individuals, to entrepreneurs and small business owners who have limited collateral. Microfinance clients are often just below or above the poverty line, commonly defined as earning $1.25 a day. Over the past decades, financial institutions have been developing a range of products to meet the needs of this broad underserved market.
The main activity of microfinance is micro-credit: granting loans to support small scale economic activities. There are at least 7 features of micro-credit that differ from traditional lending:
1/ Small transactions and minimum balances (whether loans, savings or insurance)
Other activities include micro-savings, micro-insurance, leasing and migrant remittances. These activities are contributing to boosting development and improving the living standards of lower-income populations.
Today, Microfinance is a $9 billion industry, and is expected to grow 19% annually over the next 4 years to $14 billion in 2019 (responsAbility Research).
What are the challenges today?
Nearly two decades ago, when the concept of microfinance emerged as a poverty reduction tool, there was hope that micro-credit would transform economic and social structures. However, several recent studies indicate that while micro-credit is useful, it has not typically generated dramatic increases in income (HBR).
Other pieces of research demonstrate promising effects of access to micro-savings products on the ability to smooth consumption and to boost investment in microenterprises, but the challenge is to make such products cost-effective for Microfinance Institutions (MFIs).
As for micro-insurance, it is faced with the key challenge of trust, because Insurance providers tend to avoid particularly risky customers in unstable economic environments.
How is technology helping microfinance address these challenges?
Innovative digital technologies are enabling MFIs to scale up their activities in ways that were not possible before. A case in point is the delivery of microfinance products using mobile phones. As mobile money services generate more transaction & behavioral data, mobile operators are looking to team up with financial services specialists. An example of this is “airtime lending”, which offers mobile phone users a way to top up their phone when they run out of credit and do not have cash. The airtime loan, for instance 30 minutes, is repaid a week later with an interest fee. The mobile phone operator is using the mobile number itself as collateral, disabling it if the user doesn’t repay his loan.
MFIs are designing tailored micro-insurance products (see WorldCover use case below) and establishing partnerships with retailers, utilities and mobile operators in order to reduce costs and increases customer loyalty.
Startups aim to use blockchain technology to reduce costs and transfer time of small transactions, with full audit trails. For instance, Jita micro finance platform aims to offer micro loans at a very low cost using Ethereum.
Examples of microfinance companies (MFIs) and other services