Microfinance

By Whitni Thomas
Investment Manager, Triodos Bank

Highlights

• Microfinance organisations (MFIs) provide financial services to people on low incomes who do not have access to credit and other financial services.
• Microfinance is now a proven model, and commercial banks are getting involved.
• The potential market is estimated at £150 billion, compared with available capital of £2 billion.
• There are various intermediaries and funds through which individuals can invest in microfinance.

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Microfinance’s profile is increasing by the day, bolstered by Muhammed Yunnis and Grameen Bank winning the Nobel Peace Prize “for their efforts to create economic and social development from below”, and a UN Year to champion the movement in 2005.

Microfinance organisations, or MFIs as they are often called, provide financial services to people on low incomes who do not have access to credit and other financial services. While the services and products vary, MFIs typically make small loans (of around £50) to poor people for short periods of time. The original premise of microfinance was that people who were traditionally excluded from the banking sector because of lack of income or collateral could borrow to meet their credit needs. These needs either go unmet or are met at the exorbitant terms set by moneylenders or loan sharks.

For microentrepreneurs, not being able to access credit can mean not being able to buy inputs at wholesale price because of a lack of working capital or not being able to invest in even the smallest assets such as buying a goat or a stall at the market.

Proven model

Contrary to the perceived wisdom of thirty years ago, the microfinance model¹ has demonstrated that poor people can, and do, repay loans. Although microfinance came to prominence in the 1980s, experiments in it started three decades earlier in Bangladesh and Bolivia.

Since its early days, the industry has come into its own. Microfinance has grown tremendously, but recent estimates suggest that its potential market is £150 billion, compared with available capital of £2 billion. While it is difficult to quantify, recent estimates put the number of people of working age who lack access to financial services at three billion. Indeed, in many developing countries the number of people excluded from the mainstream banking sector is high, reaching 50% in Brazil, for example.

The microfinance industry has shown that poor people are bankable and can be offered financial services in a sustainable manner. On the back of the industry's success, some commercial banks have followed MFIs' lead and partnered with them to reach out to lower income customers. In other markets, microfinance provision is still dominated by non-profit providers.

There remains an inherent tension between microfinance’s social goals (inclusion for the poor) and its financial ones (the need for a sustainable MFI). The need to balance the two is what makes MFIs such a powerful  example of social businesses, creating social benefits while also generating a financial return on investment. The tension of these dual objectives has generally been good for the sector and has spurred innovation and more efficient delivery models. Many MFIs have branched out to offer other, more sophisticated financial services for their clients such as insurance products.

Microfinance in the UK

The UK microfinance sector operates in a slightly different context than in other countries. British microfinance institutions identify with the community development finance sector. While they share a common purpose to fill gaps in access to finance for socially or economically excluded enterprises or individuals, UK community development finance institutions (CDFIs) adopt a range of different operating structures, products and target groups compared to most microfinance institutions.

Access to finance in the UK is more broadly understood than simply microfinance or start-up finance. Organisations may focus on different market niches, such as: small loans to previously unemployed female entrepreneurs; cultural or creative industry enterprises; business start-ups in deprived areas; or socially driven organisations ('social enterprises'). While some institutions specialise in microfinance loans, the sector as a whole consists of a range of product offerings to address financial exclusion and to channel finance to deprived communities.

How to support microfinance

There are various ways to support microfinance in developing countries as well as in the UK. How the support is structured will vary depending on the amount of money the donor has to invest, her motivations and risk profile.

The most common form of support is a donation to a charity, such as the Microloan Foundation, or fund which makes microloans to individuals or enterprises.  There are normally higher costs associated with making small loans to hard-to-reach people, so many MFIs also rely on donations and grants as part of their funding stream, particularly to fund operating costs.

Social investors also have opportunities to combine financial with social returns, though as with any investment decision, we advise you to consult an investment professional in evaluating your options.

For example, an investor could structure her investment as a loan, an equity investment or a donation. For example, those wishing to support microfinance internationally might invest in one of the funds accessible to UK investors, like the Triodos Microfinance Fund.

Meanwhile, those wishing to support microfinance activity in the UK could buy shares in one of the MFIs/CDFIs that are registered as industrial and provident societies. Some of these investments would also qualify for Community Investment Tax Relief. More information is available on the website of the Community Development Finance Association (CDFA). Most CDFIs focus on lending to small businesses and to social enterprises. Examples of CDFIs in the UK that focus on lending to sole traders/microentrepreneurs are Street(UK), The Women's Employment, Enterprise & Training Unit (WEETU), and Fair Finance in London.

MIX is a global information exchange for the microfinance industry. The MIX Market aims to facilitate exchange and investment flows, promote transparency and improve reporting standards in the microfinance industry. MIX is an excellent resource for investors and donors looking to support microfinance in developing countries. There is little information about microfinance in developed countries. For more information on microfinance in Europe and potential European MFIs to invest in, please see the European Microfinance Network.

More information on microfinance is available from a number of resources, including the World Bank's Consultative Group to Assist the Poorest (CGAP).

Recommended resources

• Community Development Finance Association (CDFA) 
• Consultative Group to Assist the Poorest (CGAP) 
• Coutts Philanthropy Services - Coutts Microfinance Pilot Donor Advised Fund 
• Fair Finance
• MIX
• New Economics Foundation (nef)
• Street(UK)
• Triodos Bank
• WEETU

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¹ Microfinance offers social investors an opportunity to combine financial with social returns. As with any investment decision, we advise you to consult an investment professional in evaluating your options.  

About the author

Whitni Thomas is an investment manager for Triodos Bank, investing venture capital in growing social and environmental businesses. Previously, she was Head of Access to Finance at the New Economics Foundation.  Whitni also has helped to run a microfinance programme in Mexico, and has spent six years financing leveraged buy-outs at JP Morgan.

Triodos is Europe's leading ethical bank, with offices in UK, the Netherlands, Belgium, Spain and Germany. Triodos offers a comprehensive range of savings and investments, which it uses to finance organisations that benefit people and the environment: from organic farming to fair trade and microfinance, and recycling to renewable energy. www.triodos.co.uk