Microfinance is the practice of extending very small loans to entrepreneurs in the poorest sections of developing nations. A microfinance investment has the potential to generate returns that are twofold for investors. Microfinance is the largest financial movement toward alleviating global poverty and creating business opportunities in poor areas, so it becomes a socially responsible investment. Additionally, by investing capital into funds that issue microfinance loans, investors historically earn rewarding financial returns in comparison to the risk exposure. Although large sums of money already have been devoted to this nascent segment of the economy, the full potential for microfinance investments likely has yet to be realized.
Demand for microfinance loans is robust. As of 2007, there was a funding gap, a disconnect between the amount of money requested and the value of loans available, of $250 billion US Dollars (USD). The amount of money devoted to microfinance by institutional and small investors has continued to grow, however, across the United States and in Europe.
In order to make a microfinance investment, investors must select a microfinance institution (MFI), which is a company that lends to those in the impoverished world. This MFI extends loans to individuals that are deemed worth the credit risk and who are most likely to generate a profit by using those funds wisely. The MFI charges a reasonable interest rate for the loan, and investors share in the profits made from those interest payments. Were it not for these MFI loans, poor workers would be forced to borrow money from loan sharks that might charge as much as 1,000 percent annualized interest for a small loan.
The regions in which a microfinance investment might be allocated are some of the poorest areas in the world, ranging from East Asia and Eastern Europe to Sub-Saharan Africa. Loans are provided to the working class in the currency belonging to the nation of the borrower. These investments, also known as microloans, can range in sum anywhere from less than $100 USD to more than $1,500 USD.
Although any microfinance investment is at risk of a borrower default, there is a higher success rate lending to women than to men in impoverished areas. Women tend to take a more conservative business approach, which curtails the rate of failure. Additionally, because many female entrepreneurs also raise families, many operate businesses from their own home, which cuts out the element and risk of travel and makes it easier for lenders to locate them for matters related to microfinance investments.