AuthorChase, Gregory
PositionCase study


"Microfinance is banking the un-bankables, bringing credit, savings and other essential financial services within the reach of millions of people who are too poor to be served by regular banks, in most cases because they are unable to offer sufficient collateral. In general, banks are for people with money, not for people without" (van Maanen, 2004).

Microfinance in different forms has been around for a long time, but it is only in the last 30-40 years that microfinance has gained dominance as a way for the "poor" to improve their standard of living by having access to credit. The use of microfinance has allowed the poor to increase their income and standard of living (Choudhury, Das, & Rahman, 2017). The growth in microfinance has been between 25% - 30% over the last 10 years (Marku & Balili, 2016). With the number of current borrowers from microfinance institutions estimated to be between 150 and 200 million worldwide (Marku & Balili, 2016).

The impact of microlending extends beyond helping the borrowers, as it also has a positive impact on the overall economy (Ahmad, 2008). New and existing small enterprises are able to expand and create additional employment for the poor (Bakhtiari, 2006). The growth of these new firms in the informal sector is faster than the g+6+6+6++2+6+6+rowth rate of firms in the formal sector (Abdallah, 2017). Loans given out by the well-known Grameen Banks in Bangladesh are estimated to allow 5% of their customers to escape poverty each year (Yunus, 2007).

The poor have long been excluded from the formal banking sector due to the high administrative costs relative to the value of loans to the poor (Hudon & Traca, 2006). Microfinance allows individuals that in the past have been excluded from the formal banking sector to become financially included which has resulted in an increase in economic growth within the nation (Adeola & Evans, 2017; Lenka & Sharma 2017). However, microfinance suffers from what is called a poverty penalty due to the small value of loans given out and the higher operating costs associated with them (Cuellar-Fernandez et al, 2016). This has made giving loans to the poor unprofitable before taking into consideration the additional cost of defaults (Hudon and Traca, 2006). The best way to reduce the poverty penalty is to reduce the operating costs of microfinance institutions (Cuellar-Fernandez et al., 2016).

This study considers a sustainable model of microfinance by a firm in the Philippines using investor provided funding. The firm provides a return to investors while providing profit for the owners. Application of this model by other microfinance institutions could remove the need for donations and subsidies and increase the growth rate of these much needed institutions.


There have been numerous studies looking at the impact of microfinance and the results have been mixed based on the method of operation. However, most experts agree that microfinance overall has had a positive impact for borrowers by expanding opportunities for them (Hudon & Traca, 2006; Bakhtiari, 2006; Karlan & Zinman, 2010; Quaye & Hartarska, 2016; Agbola, Acupan, & Mahmood, 2017). Microfinance institutions currently operate in more than 100 countries, and have been instrumental in the creation of many new small businesses (Khan & Dewan, 2017).

It is estimated that half of the population in the world is deprived of funding which these individuals could use to invest in themselves and become self-employed (Yunus, 2007). When the poor have access to collateral free microloans, the borrowers experience increased income, improved nutrition, better housing, lower child mortality rates, access to better healthcare, and experience improved access to childhood education (Yunus, 2007). Urban and semi-urban borrowers that are moderately poor have shown the best results in lifting themselves out of poverty through microloans (Marku & Balili, 2016; Morduch, 2000).

In addition, microfinance institutions are more successful in countries with higher levels of human and women rights while at the same time empowering women in those countries (Asher & Khattak. 2014; Bremer & Krain, 2015). Women are able to increase their status, become more involved in family decisions, and increase the living standard for their children (Khandelwal, Gupta, & Aurora, 2017).

A major concern of making loans without collateral is the default rate, but the repayment rate for microlending is typically very high (Morduch, 2000). The Grameen Banks report repayment rates of up to 98% for microlending compared to the average repayment rate to banks in Bangladesh of 27% (Hudak, 2012). Microfinance institutions achieve this higher repayment by utilizing group lending, peer pressure, and collecting local credit information (Bakhtiari, 2006). An effective tool in the repayment of loans has been to exclude borrowers that default on repayment of past loans from future loans (Ahmad, 2008). The threat of exclusion from future loans provides an incentive for repayment of current loans so borrowers can have access to credit in the future (Bakhtiari, 2006).

Locations where microfinance institutions are most needed are also the locations with less information and less capacity. There is a negative correlation between public bureau cover, limited credit information, and the operation of microfinance institutions. However, these locations of microfinance institutions have a larger role in serving as a substitute for formal banking (Bakhtiari, 2006).

While there are clearly benefits to providing microloans to the poor, there are some problems facing the industry. The biggest problem has to do with the very high costs of administering the loans, which make it difficult for microfinance lending institutions to be profitable (Garmaise & Natividad, 2013; Morduch, 2000). The result is that only about 10% of microfinance lenders are able cover their costs of operation (Hudon and Traca, 2006). Microfinance institutions face a trade off in terms of financial and social efficiency so they have to do a balancing act between doing the best they can while still be financially viable (LeBovics, Hermes, & Hudon, 2016; Pinz & Helmig, 2015).

Those microfinance institutions that target the poorest borrowers, who are most in need of microloans, are only able cover about 70% of costs (Morduch, 2000). The interest rates charged on microfinance loans are typically between 20% and 70% annually (Fernando, 2006; Lewis, 2008). If fees and commissions are added in, the rates can go as high as 90% annually (Fernando, 2006; Lewis, 2008). The major factors causing the rates on microfinance loans to be so high are the cost of funds, operating expenses, loan losses, and profits for the institution.

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