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Managing finances will be difficult for small and individual business owners. It is often impossible for small businesses to access traditional financial resources from major institutions. As a result, it will be difficult for small business owners to grow and scale their businesses without having the access to loans, insurances, and investments.
Microfinance offers banking services to these kinds of small to medium-scale businesses that do not have access to traditional financing. It includes various banking services such as providing loans, credit, access to saving accounts, insurance policies, money transfers, etc. Small business owners can improve their businesses with the help of microfinance.
What is Microfinance?
Microfinance is an unconventional concept to provide banking services to unemployed or low-income individuals, and small business owners. Many small business owners, would-be entrepreneurs, and individuals do not have access to loans, insurance, and investments due to various reasons like poverty, geographic location, and other disadvantages. The concept of microfinance bridges the investment gap.
Microfinance is especially relevant in developing countries, and poverty-stricken communities. Microfinance institutions provide loans to individuals and small business owners. In addition to lending, they provide checking and saving accounts and micro-insurance products. The main aim of microfinance is to provide opportunities for destitute people to become self-sustained.
Microfinance vs. Microcredit
You might encounter situations where ‘microfinance’ and ‘microcredit’ words are synonyms. The definition of Microfinance is broader than microcredit though the terms are closely related. Microcredit only refers to loans, whereas microfinance refers to a wider range of financial services for individuals and small business owners.
Microfinance includes services such as insurance, savings facilities, and also microloans. For instance, entrepreneurs can open a savings account without a minimum balance. On the other hand, microcredit completely focuses on loans.
What are Microfinance loans?
Microfinance loans will be given to people from underserved communities to start a business or to create financial independence. Traditional loans require collateral or a good credit rating to issue loans. Whereas, microfinance loans are given without the eligibility requirements. As a result, microfinance loans usually charge high-interest rates.
Microfinance institutions provide loans that can be as small as $10 and as large as $25,000. International microfinance institutions make it mandatory for people to take basic money-management courses in return for a loan. The training courses usually include topics such as understanding interest rates, cash flow management, bookkeeping skills, how financing agreements and savings accounts work, how to budget and manage debt, etc to improve financial literacy.
How can small businesses benefit from Microfinance?
Small and medium-scale enterprises or businesses are one of the primary sources of employment and livelihood for people in developing countries. Microfinance helps individuals to start their businesses as well as scale the business by becoming a way of generating steady capital.
As small business owners or underserved community people are not eligible for normal financial services, microfinance is the only way to hurl many small businesses to the next league of augmented productivity and increased turnover. Let us look at some of how microfinance helps small-scale businesses in developing countries.
Provides easier access to credit facilities
Microfinance institutions act as primary credit and lending facilities for low-income individuals and small to medium-scale businesses. They provide easier access to loans as it is impossible for small business owners to get loans from organized financial institutions.
Most of the time, microfinance institutions provide microloans and other financial services like insurance and saving facilities at affordable interest rates. It involves simple procedures and minimal documentation. The ease with which small businesses avail loans from microfinance institutions is an important factor in the overall financial performance of small businesses.
Helps in business expansion
Micro financers offer a blueprint to small business owners for their business expansion and assist in expanding the operational footprint. This is the most significant function of microfinance institutions for small business growth.
A group of people having common aspirations and interests can benefit from the credit facilities of microfinance institutions. This way, when one of the participants defaults at the time of repayment, other group members will get the share. As a result, it will be easier for micro financers to recover the loans and that leads them to lend the loans further. Overall, the productivity and profits of small businesses will increase.
Implements inclusive policies
Usually, small businesses hire semi-skilled or unskilled laborers to carry out the operations. Most of them belong to impoverished communities and are economically deprived.
Microfinance lenders develop business models, and they collectively target the aspirations of the workers. These business models help laborers by relieving them from poverty and improving their standard of living.
Proponents of microfinance mention noble ideals like ending the poverty cycle, decreasing unemployment, and bringing money back into the economy, etc. But, Microfinance doesn’t always meet expectations. If individuals from underserved communities use their loans for necessities instead of starting a business, new income will not be generated, and individuals need to take another loan to pay off the initial loan which translates into a lot more debt.
However, microfinance is a powerful tool for small businesses and entrepreneurs. Developing nations have already embraced the concept of microfinance. Microfinance institutions have become lifelines of small businesses in developing nations.
Either way, microfinance is a significant concept in the financial domain. If used properly, it can provide a long-term solution to people living in poverty. Microfinance has the ability to break the poverty cycle of future generations.
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