Microfinance – research shows a two-sided tool

Microfinance has long been seen as an opportunity to increase financial inclusion and promote the potential of the private sector in developing countries, which in turn addresses challenges such as poverty, inequality and unemployment. Microfinance institutes (MFIs) provide microloans to entrepreneurs, small enterprises and low-income earners, who can then use the loans to purchase revenue-generating assets. These microloans are an important supplement to bank loans because banks often require a different type of security or a credit history or only offer larger loans. Globally, 75 percent of the MFI market is currently located in Asia, while sub-Saharan Africa accounts for less than ten percent.

Research shows different results
‍Extensive research has been conducted concerning microfinance. Numerous studies show many positive results in Bangladesh, Myanmar, India, Chile and elsewhere. The results show that it can help to reduce poverty and hunger, improve children’s access to education, raise the standard of living of women, and strengthen the empowerment of female borrowers. Other results have suggested that households and businesses accessing financial services are better placed to withstand financial shocks.

Recently, however, there has been criticism of the effectiveness of microfinance in reducing poverty and boosting women’s economic empowerment. Microfinance is intended to help reduce poverty and is thus targeted at people with the greatest need, many of whom live in rural areas. However, progress towards financial inclusion in rural areas has been slow. There is often a lack of information and education about financial services, as well as low literacy levels, which can lead to difficulties in understanding the terms of a loan. In turn, this can result in higher transaction costs which impact on the ability of microfinance institutions to remain financially sustainable.

Another aspect of the criticism of MFIs relates to interest rate levels. Interest rates are normally higher for microloans, because institutions offer a higher number of small short-term loans compared with traditional banks, and customers often do not have a credit history or are unable to provide security for the loan. In addition, regulation and oversight of the microfinance industry is inadequate in many countries. Among other things, this contributes to an informal sector within the microfinance industry, where operators provide loans without being registered and are thus not covered by central regulations. These operators often set high interest rates and sometimes use unethical debt collection methods, which can hit customers hard.

Swedfund’s investments are preceded by a solid selection process
‍Swedfund primarily invest in MFIs which are well placed to contribute to good results within Swedfund’s three pillars. In practice, this means that we invest in MFIs that focus on loans to individuals or micro-enterprises in order to boost income generation Swedfund always takes into account the interest rates that MFIs charge for their loans. As a rule, we do not invest in MFIs that charge interest rates that are significantly higher than the market average for comparable loans.

We are aware of the challenges that borrowers face and the criticisms that have emerged, which is why the selection process is so crucial for us. In order for Swedfund to consider an investment in an MFI, the institute must be certified through the Client Protection Pathway, or be able to demonstrate that it has implemented the CPP principles within its business. If the institution does not have such a certificate in place, a commitment to meet these requirements within a specific time frame is incorporated into the agreement between Swedfund and the portfolio company. Through this, Swedfund’s investments help to promote responsible lending in developing countries.