Microfinance is a source of financial services for entrepreneurs and small businesses lacking access to banking and related services. The two main mechanisms for the delivery of financial services to such clients are:, relationship-based banking for individual entrepreneurs and small businesses; and group-based models, where several entrepreneurs come together to apply for loans and other services as a group (as defined by Wikipeadia). In some regions, for example Southern Africa, microfinance is used to describe the supply of financial services to low-income employees, which is closer to the retail finance model prevalent in mainstream banking. For some, microfinance is a movement whose object is “a world in which as many poor and near-poor households as possible have permanent access to an appropriate range of high quality financial services, including not just credit but also savings, insurance, and fund transfers.” Many of those who promote microfinance generally believe that such access will help poor people out of poverty, including participants in the Microcredit Summit Campaign. For others, microfinance is a way to promote economic development, employment and growth through the support of micro-entrepreneurs and small businesses.

Microfinance is a broad category of services, which includes microcredit. Microcredit is provision of credit services to poor clients. Microcredit is one of the aspects of microfinance and the two are often confused. Critics may attack microcredit while referring to it indiscriminately as either ‘microcredit’ or ‘microfinance’. Due to the broad range of microfinance services, it is difficult to assess impact, and very few studies have tried to assess its full impact. Proponents often claim that microfinance lifts people out of poverty, but the evidence is mixed. What it does do, however, is to enhance financial inclusion. In developing economies and particularly in rural areas, many activities that would be classified in the developed world as financial are not monetized: that is, money is not used to carry them out. This is often the case when people need the services money can provide but do not have dispensable funds required for those services, forcing them to revert to other means of acquiring them. In their book ‘The Poor and Their Money’, Stuart Rutherford and Sukhwinder Arora cite several types of needs: Lifecycle Needs: such as weddings, funerals, childbirth, education, home building, widowhood and old age. Personal Emergencies: such as sickness, injury, unemployment, theft, harassment or death. Disasters: such as fires, floods, cyclones and man-made events like war or bulldozing of dwellings.

As Marguerite Robinson describes in The Micro finance Revolution, the 1980s demonstrated that “micro finance could provide large-scale outreach profitably,” and in the 1990s, “micro finance began to develop as an industry”. In the 2000s, the micro finance industry’s objective was to satisfy the unmet demand on a much larger scale, and to play a role in reducing poverty. While much progress has been made in developing a viable, commercial micro finance sector in the last few decades, several issues remain that need to be addressed before the industry will be able to satisfy massive worldwide demand.

The obstacles or challenges to building a sound commercial micro finance industry include: Inappropriate donor subsidies, poor regulation and supervision of deposit-taking micro finance institutions (MFIs), few MFIs that meet the needs for savings, remittances or insurance Limited management capacity in MFIs, institutional inefficiencies, need for more dissemination and adoption of rural, agricultural micro finance methodologies.

Microfinance is the proper tool to reduce income inequality, allowing citizens from lower socio-economical classes to participate in the economy. Moreover, its involvement has shown to lead to a downward trend in income inequality. The basic problem that poor people face as money managers is to gather a ‘usefully large’ amount of money. Building a new home may involve saving and protecting diverse building materials for years until enough are available to proceed with construction. Children’s schooling may be funded by buying chickens and raising them for sale as needed for expenses, uniforms, bribes, etc. Because all the value is accumulated before it is needed, this money management strategy is referred to as ‘saving up’. Often, people don’t have enough money when they face a need, so they borrow. A poor family might borrow from relatives to buy land, from a moneylender to buy rice, or from a microfinance institution to buy a sewing machine. Since these loans must be repaid by saving after the cost is incurred, Rutherford calls this ‘saving down’. Rutherford’s point is that microcredit is addressing only half the problem, and arguably the less important half: poor people borrow to help them save and accumulate assets. Microcredit institutions should fund their loans through savings accounts that help poor people manage their myriad risks. Most needs are met through a mix of saving and credit.

A benchmark impact assessment of Grameen Bank and two other large microfinance institutions in Bangladesh found that for every $1 they were lending to clients to finance rural non-farm micro-enterprise, about $2.50 came from other sources, mostly their clients’ savings. This parallels the experience in the West, in which family businesses are funded mostly from savings, especially during start-up.

Recent studies have also shown that informal methods of saving are unsafe. For example, a study by Wright and Mutesasira in Uganda concluded that “those with no option but to save in the informal sector are almost bound to lose some money—probably around one quarter of what they save there.” The work of Rutherford, Wright and others has caused practitioners to reconsider a key aspect of the microcredit paradigm: that poor people get out of poverty by borrowing, building microenterprises and increasing their income. The new paradigm places more attention on the efforts of poor people to reduce their many vulnerabilities by keeping more of what they earn and building up their assets. While they need loans, they may find it as useful to borrow for consumption as for microenterprise.

A safe, flexible place to save money and withdraw it when needed is also essential for managing household and family. Microfinancing produces many benefits for poverty stricken, or low- income households. One of the benefits is that it is very accessible. Banks today simply won’t extend loans to those with little to no assets, and generally don’t engage in small size loans typically associated with microfinancing. Through microfinancing small loans are produced and accessible. Microfinancing is based on the philosophy that even small amounts of credit can help end the cycle of poverty.

Another benefit produced from the microfinancing initiative is that it presents opportunities, such as extending education and jobs. Families receiving microfinancing are less likely to pull their children out of school for economic reasons. As well, in relation to employment, people are more likely to open small businesses that will aid the creation of new jobs. Overall, the benefits outline that the microfinancing initiative is set out to improve the standard of living amongst impoverished communities. There are also many challenges within microfinance initiatives which may be social or financial. Here, more articulate and better-off community members may cheat poorer or less-educated neighbours. This may occur intentionally or inadvertently through loosely run organizations. As a result, many microfinance initiatives require a large amount of social capital or trust in order to work effectively. The ability of poorer people to save may also fluctuate over time as unexpected costs may take priority, which could result in them being able to save little or nothing some weeks. Rates of inflation may cause funds to lose their value, thus financially harming the saver and not benefiting collector.