In a time when almost 70% of Sub-Saharan Africa is living on less than $2 a day, there has been a collective realization that outdated charity methods are doing little to alleviate the suffering. So it’s refreshing to see that NGOs and nonprofits have finally made a shift in the way they provide aid to those suffering from extreme poverty. By capitalizing on a growing western population and an increased awareness of the realities of worldwide poverty, the microfinance movement has finally earned some plaudits for it’s role in mitigating global poverty.
If your financial know-how is not up to scratch and that opening paragraph has left you feeling a little lost, let me explain what microfinance is and why it is such an effective way of alleviating poverty around the world.
Microfinance is a form of financing that brings relatively free capital to people around the world who have fallen below the poverty line and out of sight of traditional financing institutions. Still lost? Basically, microfinance allows for people all around the world to borrow money when banks, credit unions, and other forms of financial institutions, are out of reach or don’t exist at all.
Although a term largely applied to loan financing, microfinance is a broader finance definition that includes services for savings, insurance and money transferring. Basically, microfinance provides people with any financial service they may need. To better understand how it works, let’s take a look at the fictional-yet-applicable story of Francis and his chickens…
Francis lives in the rural grasslands of Uganda and is well known for his ability to build chicken cages. His cages aren’t just run of the mill, no sir; they are top of the line. Everyday, Francis wakes up to hoards of people outside his home, all desperate to accommodate their chickens in one of his cages. However, he can’t meet the demand for his products because he doesn’t have enough cash to build the cages. He would like to employ a local farmer to help build with him part-time, but can’t afford to pay him. Francis estimates that he would need $1000 to help him expand his business. If he lived in a developed country, he would walk down to the nearest Bank of America and have access to financial services that were ready and willing to fund his expansion plans. Unfortunately, he doesn’t. He lives in the rural grasslands of Uganda. The chicken caging industry is booming and he’s about to miss the boat.
Francis is in need of a loan. The problem is, why would anyone loan Francis the $1000 he needs to get his business off the ground? All it takes for the loaner to lose their investment is for the economy to stumble, an outbreak of disease, or shortage in raw materials, and Francis’s business will fall through, taking with it the $1000 loan. Regardless of how reliable Francis’s chicken cages are, he’s just too risky of an investment. This is one of the main issues facing many entrepreneurs in developing countries. Because the risk is too great for a bank to loan them the money, they ignore these risky demographics and finance more reliable borrowers.
Francis is in desperate need of financing, and without any access to the simple financial services that most of us take for granted, his chicken cage business is clucked. Luckily for Francis, microfinancing is a great alternative. And the good news is, there are many organizations around the world who are geared to providing these services. San Francisco based nonprofit, Kiva, have constructed a financing model that provides people like Francis with small loans to help them to recognize their entrepreneurial potential. By drawing on the power of close to a million lenders worldwide, Kiva asks for $25 loans and pools them into larger loans that are then sent to where they are needed most. The key to Kiva’s microfinance model is the way the total risk is distributed among the various loaners. Rather than one person bearing the total risk of the investment, the risk is dispersed amongst all those who donated. Losing $25 is far easier to accept than losing $1000. That’s why Kiva have a million loaners who will happily lend $25 to people like Francis, knowing all too well that they might end up losing their money. It’s easier to borrow a dollar from a thousand people than a thousand dollars from one person.
Microfinance is still developing as a financial service and faces many challenges around the world today. One of the main problems facing microfinancing institutions in developing countries is the contrasting business cultures in which those in need have functioned their whole lives. Interestingly enough, many of those in need of microfinancing have conducted their businesses in a non-monetized fashion. That is, money is not used in their daily business transactions. Instead, these local businessmen and women use an effective a system of trade that bases value on what they need, and what they have to offer, rather than a complex financial system. So, when rural entrepreneurs are given a virtually free loan to expand their business, there are several learning curves that must be faced before a loanee can fully understand the nature of their loan.
Microfinance has certainly grown in popularity around the world since the turn of the century. The internet has catalyzed a rapid growth of globalization and increased the awareness of developed nations for those in desperate need of help. Organizations such as Kiva have recognized the ripe conditions for global scale microfinancing and have begun to spread the word that twenty five dollars can go a long way to changing someone’s life.
Plain old charity is no longer going to cut it when providing aid to those in need. Organizations that facilitate microfinancing have the power to empower these people out of poverty and into sustainable income homes. Those living below the poverty line are just as innovative and motivated as those anywhere around the world. All they need is a little help from you, and me, and fifty of our closest friends.