A strategic way to help beginning entrepreneurs in the poor areas of the world is by providing microloans. These are loans to people who do not have collateral, steady employment, or verifiable credit history. Effective microfinance institutions (MFI) provide financing to individuals and to groups. Larger microloans, up to several thousand dollars, can be extended to individuals who have demonstrated competence and reliability. MFIs extend smaller loans, less than $100 up to several hundred dollars, to individuals in groups who hold one another accountable. Each individual is responsible to repay her loan, but if any member of the group defaults, no one in the group will receive another loan from the MFI. Peer pressure increases repayment percentages which usually reach 95% or higher.

Microfinance institutions desire to improve the lives of poor people by encouraging and supporting entrepreneurship, uplifting communities, and empowering women. Microloans were scarce until recently. The microcredit industry received a big boost when the United Nations declared 1995, “The International Year of MicroCredit.” Now there are hundreds of organizations who provide microloans.

As is true with other industries, some microfinance institutions are effective, many are not. To measure and encourage increased effectiveness, standards are being developed.  In 2007, Forbes.com published a list of the “Top 50 Micro-Finance Institutions.” They used four factors to filter their list: scale, efficiency, risk, and returns. I agree that scale, the size of the organization’s loan portfolio, is important. However, it is unfortunate that this is one of the determining factors of the “top 50” list. Some of the most effective and efficient microfinance organizations are not large.

Recently there has been growing concern about the impact of extending microcredit. Some have criticized this strategy because of the high interest rates that must be charged for it to be sustainable. At least one study suggests that extending microcredit does not lead to real improvement in poor people’s lives. Also, even though women are often loan recipients, that doesn’t necessarily mean they are benefiting.

Personally, I believe it is good for those of us who have more to give a hand up to those who are trapped in cycles of poverty. Giving handouts generally does not help. However, a well-placed loan can help an entrepreneur get started in business and that can lead to many other positive changes. I particularly applaud organizations who are providing microloans in Jesus’ name. For example, Hope International has four distinctives: focus on microfinance, intentional witness for Christ, commitment to stewardship, and dedication to the hard places around the world.

What is your experience with microfinance institutions? I would like to interact with others about this topic.