Microfinance is an alternative to the traditional banking system. It is designed to improve access to financial services for people with lower incomes and marginalised communities.

Microfinance provides financial services to client groups that are underserved or overlooked by traditional financial services providers. These can be individuals or businesses, including micro-entrepreneurs.

Microfinance initiatives are designed to create inclusive financial systems and support micro-entrepreneurs in both developing countries and the developed world. The goal of microfinance is to help people become self-sufficient and reduce reliance on informal lenders who charge high interest rates. Microfinance helps create jobs and alleviate poverty by enabling income-generating activities and supporting small businesses.

While commercial lenders can offer microfinance services, much of the microfinance sector is run by not-for-profit entities. Microfinance institutions (MFIs) provide loans and additional services such as savings accounts, microinsurance, and business education to help clients become self-sufficient. Digital integration in microfinance, such as mobile banking and AI-driven credit assessments, is expanding outreach to unbanked populations in 2026.

In the UK, for example, a significant percentage of the microfinance services on offer are run by credit unions. Globally, microfinancing options are often run by charities and non-governmental organisations (NGOs). The microfinance market was valued at an estimated $224.6 billion in 2023 and is expected to exceed $506 billion by 2030. Microfinance organisations support a range of activities, including providing checking and savings accounts, startup capital for small businesses, and educational programs.

What is a microfinance loan?

As the name suggests, microfinance loans are loans issued for small amounts. Microfinance institutions are focused on providing loans to clients who might otherwise rely on informal lenders, who typically charge exorbitant interest rates. For clarity, what this means in practice will depend on the current standards in the specific market. Despite being relatively low in value, they may require more administrative effort to set up. This is because microfinance loans tend to be highly customised to each client. Microfinance institutions often charge interest on these loans, and the average interest rate can be significantly higher than that of traditional banks.

For example, instead of looking for collateral and/or guarantors, microfinance providers will look very closely at the potential borrower’s situation. They will use this analysis to determine not just how much they can reasonably lend but also how they lend it. In particular, it will often guide their decision on how to manage repayments. Microfinance institutions may require borrowers to set aside some income in a savings account as insurance against default. However, high interest rates can create a burden for borrowers, making it difficult to repay their debts, and many borrowers take out multiple loans from different microfinance institutions, increasing the risk of over-indebtedness.

Understanding microfinance in developing countries

At present, there is no official microfinance definition. There are, however, certain defining features of microfinance that generally make it recognisable. Microfinance includes microcredit, savings accounts, microinsurance, and payment systems. Probably the most obvious of these is that it is only used for small amounts of money. Microfinance loans can range from as little as £50 to under £50,000, depending on the institution and the borrower’s needs (loan size).

As a result, it’s suitable for those on low incomes and/or those with poor or non-existent credit records. This means that it can be accessed by people with a lower income. Microfinance institutions often provide small business loans to entrepreneurs and micro-entrepreneurs, supporting economic growth and job creation among underserved populations.

Microfinance is often provided on a non-commercial basis. This generally means that products (e.g. loans) have to cover their costs but little or nothing more than that. When profits are made, they are often low and intended for reinvestment in the service. These microfinance providers are likely to be driven by social/environmental goals. Many borrowers are assessed based on their social capital and business viability rather than their formal credit histories.

That said, there are microfinance products which are highly commercial and usually very expensive. For example, credit-building products often meet the criteria for microfinance, as do “payday loans” and the equivalents for business.

In the UK (and some other markets), microfinancing providers often leverage technology. For example, they may have their own mobile apps. This is, however, not universal, even in the UK. Some microfinancing providers actually use a very traditional approach.

History and Evolution of Microfinance

Over the decades, the microfinance sector has evolved rapidly, expanding its reach across developing countries, emerging and frontier markets. Microfinance organisations such as FINCA and Opportunity International have played a crucial role in providing microfinance services, including microfinance loans, savings accounts, and financial education, to millions of clients. These organisations have shown that microfinance can be both a profitable business and a powerful tool for poverty alleviation and economic development.

Key milestones in the sector’s evolution include the creation of the Microfinance Network in 1993, which brought together leading MFIs to promote sustainable and responsible microfinance operations. The launch of the Smart Campaign in 2009 further advanced the cause of responsible financial inclusion, setting global standards to protect the rights of microfinance clients and ensure ethical practices among microfinance providers.

The microfinance sector has also benefited from technological innovation. The adoption of mobile banking and digital payment systems has made it easier for low-income individuals in rural areas and frontier markets to access financial services, manage savings accounts, and repay loans. This digital transformation has increased the efficiency of microfinance operations and improved access for those previously excluded from the formal financial system.

In recent years, the private sector has become increasingly involved in microfinance, recognising the potential for responsible investment and impact investing. Banks, credit unions, and other financial institutions are now active microfinance providers, helping to expand financial inclusion and support small businesses in impoverished communities. The World Bank and other international organisations have also provided significant support, acknowledging the role of microfinance in driving economic development and job creation.

Despite its many successes, the microfinance sector continues to face challenges, such as high interest rates, over-indebtedness, and the need for greater financial literacy among clients. In response, microfinance institutions are placing a stronger emphasis on financial education and capacity building, equipping clients with the knowledge and skills needed to make informed financial decisions and achieve financial independence.

Today, microfinance includes a diverse range of financial products and services, from microinsurance to pension plans, tailored to the unique needs of low-income people. As the sector continues to innovate and grow, microfinance remains a vital force for responsible financial inclusion, poverty alleviation, and economic empowerment in developing countries and emerging and frontier markets.

What are the benefits of microfinance?

From the perspective of a potential client, the main advantage of microfinance is that it’s available. Microfinance improves the socio-economic status of clients by enabling income-generating activities and supporting job creation. Access to microfinance can increase average income levels for borrowers between 15% and 25%. Other benefits include flexibility and a very strong emphasis on serving a particular target market. Microfinance can help families create income-generating activities and better cope with risks, often leading to local hiring and increased opportunities for education and employment.

From a provider’s perspective, the benefits of microfinance depend on the provider’s goals.

For commercial lenders, the main benefit of supporting microfinancing is that it helps them to reach new client bases. Depending on their business model, they may aim to generate profit in the short term or build these clients into higher-value customers (or a combination of both). Another benefit is that adopting microfinancing can help to diversify a provider’s income stream.

For non-commercial providers, the benefits of microfinancing tend to relate to the achievement of social and/or environmental goals. Essentially, non-commercial microfinance is often used as a tool to help the economically disadvantaged to help themselves.

What are the disadvantages of microfinance?

From a potential borrower’s perspective, the main disadvantage of microfinance is that it’s micro. For example, microloans are highly unlikely to be enough for significant business investment, and often do not provide enough money for borrowers to make substantial improvements in their lives, such as building a home or funding education. There is also a risk of debt and over-indebtedness, especially when borrowers face high interest rates or take out multiple loans from different microfinance institutions, making it difficult to repay their debts.

High interest rates on microfinance loans can create a significant burden for borrowers, and the average interest rate is often much higher than that of traditional banks, raising concerns about exploitation. Additionally, some studies suggest that microfinance loans are often used for consumption rather than productive investments, which undermines their intended purpose. Microfinance has also been criticised for creating market saturation, leading to excessive competition among micro-entrepreneurs, and for high transaction costs that can limit its effectiveness as a poverty-fighting tool. Some microfinance institutions have been criticised for prioritising profit over the original mission of poverty alleviation.

From a commercial provider’s perspective, the main disadvantage of microfinance is that its short-term profits do not necessarily justify the amount of work involved. With some products (e.g. loans), offering microfinance may increase the provider’s risk.

For non-commercial lenders, the main disadvantage of microfinance is that it can require a lot of resources and effort to manage effectively. There is also no guarantee that it will achieve the desired goals.

What Microfinance schemes are available?

Three of the best-known microfinancing schemes are Kiva, the No Fixed Address initiative and the credit union network.

Kiva is essentially a peer-to-peer lending platform specialising in microloans to entrepreneurs and students. The organisation itself operates on a non-profit basis. Its mission is driven by the belief that lifting one can lift many. Similar microfinance initiatives operate in rural regions and the Middle East, supporting entrepreneurs and small businesses in areas that often lack access to traditional banking.

As the name suggests, the No Fixed Address initiative aims to offer basic banking services to people without a fixed address. Giving these people access to bank accounts enables them to access opportunities they would otherwise have been denied. In particular, it enables them to work for employers who pay by bank transfer rather than cash payments.

Credit unions are also an example of microfinancing schemes. They are all very small-scale financial providers offering a limited range of financial services to a restricted client base. In the UK, credit unions often serve a particular geographic area. They may, however, choose other criteria for their client base, such as a profession or vocation. Savings banks and postal savings banks also play a significant role in microfinance by providing savings accounts and supporting financial inclusion, especially in underserved communities.