Advantages and Disadvantages of Microfinance Banks in Modern Economy

Microfinance bank is a financial institution licensed by the central bank to carry out business of providing financial services to the micro-sector of the economy. Some of the activities of microfinance include:

  • accepting deposits and savings from less income earner individuals, groups and micro, small and medium enterprises,
  • providing short-term loans to individuals, groups and MSMEs,
  • domestic funds transfer and
  • non-financial services.

Objectives of Microfinance Banks in an Economy

  • To make financial services available to potentially productive unbanked population of the society
  • To integrate the informal sector of the economy into the financial system
  • Enhance financial service delivery to the MSMEs
  • To eradicate gender inequality by improving women`s access to financial services
  • To serve as a medium through which government and development banks` empowerment programmes could reach the rural dwellers, smallholder farmers, artisans etc.
  • Support agricultural development and sustainability 

Advantages of Microfinance Banks

Financial Inclusion

They provide financial services to the unbanked population in the rural areas, where commercial banks may have not reached. There are not much requirements to operate account with microfinance banks.

Encourages Savings

One of the profound advantages of microfinance banking system is deposit mobilization and promotion of savings at the community level. Funds are mobilized from the less income earners, self-help co-operatives in form of contributions. Microfinance banks encourage their customers to make any amount of savings. Most times savings deposits are made on regular basis. Microfinance provide safe place for their customers to keep savings to fight the temptation of spending such moneys,  and build up to large sums of money to meet their business, personal and household needs such as paying for business premises, goods and tools, schools fees, accommodation, home appliances etc. The customers also receive interests on their savings

Collateral free Loan

Another advantage of microfinance bank is collateral free credit facilities. Microfinance credit delivery system does not lay emphasis on collaterals, and are majorly targeted at the poorest of the poor, small co-operatives who may not have tangible collaterals to access credit from commercial banks and other landing institutions.

Quick Access to Loans

There are no much protocols and documentations to access credit facility from microfinance banks as the credit facility delivery system of microfinance banks does not lay much emphasis on collateral. Accessing loans in microfinance banks can be as quick as 24 hours. With the adoption of technologies in the financial sector, disbursement of loan can be in less than 60 seconds using the online and mobile apps platforms.

Promoting MSME and Entrepreneurship

Microfinance banks equally promote entrepreneurship and boost rural financial market that provides finance to startups and entrepreneurs that need financial resources. They also organize capacity building, skills acquisition training for rural entrepreneurs. They provide loan disbursement services for the delivery of credit programmes of the government agencies, development partners for poverty alleviation.

Supports Households

Unlike other banks and lending institutions that provide credits for business projects alone, microfinance banks in addition to business support credit, provide household support credit to poor families to pay hospital bills, school fees, accommodations, home appliances etc. Microfinance banks also provide quick loans to salary earners to meet their daily expenses before salaries are paid.

Easier to Establish

Initial paid up capital for establishment of microfinance bank is the least when compared with that of deposit money bank, merchant and investment bank, and mortgage bank. It does not require large structure. As a microfinance it does not require having offices across the state or region – it can operate in only one office. Regional and national banks are the ones required to have their operational branches across the region or nation.

Job Creation

Microfinance banks empower entrepreneurs to create jobs for themselves and employ others. The microfinance companies also employ people who work for them, and most times these employees are from the localities. Some of the bank staff are low skilled labour who may not have higher financial and banking knowledge to work in commercial banks. In essence, microfinance companies provide jobs for the lower carder of the society.

Wealth Distribution

Microfinance banks mobilise funds from those that have it and make them available to people that need them for business purposes. 

Read also: Advantages and Disadvantages of Islamic and Non-interest Banking

Disadvantages of Microfinance Banks

Small Amount of Loan

As the name implies, microfinance banks provide small amount of loans compared to other financial lending institutions.

High Interest Rates

Most of the times, microfinance loans come with very high interest rates. As short term loan providers, their interest rates are not calculated per annum  if the period is not up to 12 month, rather per loan duration.

Short Term Loan

Microfinance loan is usually short term. This makes the repayments difficult. For instance, a $100 loan with 3 months duration at 10% interest will  cost $10 for the 3 months period, making the total repayable amount $110 to be paid at average of $36.67 per month . While a loan of same amount  for12 months period at 10% rate p.a  will cost $10 making the total repayable amount $110 to be paid at average of  $9.17 per month. 

No Moratorium

Microfinance does not offer moratorium to the borrower. If you are given loan this week, you are expected to start repaying by next week. If you are given this month, you are expected to commence repayment from the subsequent months. If you are given salary-tied loan, you are to start repaying by your next month pay day. No grace period.

Harsh Repayment System

Microfinance banks deploy harsh repayment methods as there is no guidelines in offering credit facility, and the loans are not covered with collaterals. Easy and unsecure debt comes with stringent debt recovery approach. So microfinance banks adopt different tactics to coerce their debtors into repaying the loans. The methods sometimes include confiscation of property including household items, goods and working tools; public naming and shaming.

Read also: Advantages and Disadvantages of Commercial Banks in Modern Economy

Ikechukwu Evegbu

Ikechukwu Evegbu is a graduate of Statistics with over 10 years experience as Data Analyst. Worked with Nigeria's Federal Ministry of Agriculture and Rural Development. A prolific business development content writer. He's the Editor, Business Compiler

Previous Post Next Post