How Microfinance Works?

How microfinance works?

That is the BIG QUESTION.

To set the tone straight, let it be known that this is not a scholarly work. I drew only from my experiences as microfinance practitioner, from my readings and from my trainings for over ten years of doing microcredit.


While you are here to know how microfinancing works, I suggest that you still read why we have to focus on microloans and what is the origin of this concept.

Sources of Microfinance

Like what I asserted in my post on origins of microfinance, the system is a broad concept but it has only five important essences:

  1. small loan amount
  2. frequent payment schedule
  3. build in savings mobilization
  4. micro-insurance
  5. poor entrepreneurs

It does not mean that a true microfinance program has all these essences. But, ideally, it should. To better understand the concept, let us first know the sources of microfinance:

  1. Informal Microfinance Sources – these are moneylenders and shopkeepers
  2. Semi-Formal Microfinance Institutions- these are nongovernment organizations
  3. Formal Microfinance Institutions – these are rural/thrift banks, commercial banks, and co-operatives

Microfinance Hub (outside link) has a detailed article about these sources of microloans.

Every source has its own dynamics. I will only talk (for now) about the microfinance system from the Formal Microfinance Institutions.

Microlending Methodologies

The two major lending approaches are joint (or group) microloans approach and individual contracts approach.

  1. Individual Contracts Approach is a type of microfinance loan that is almost similar to traditional loan: a person receives a small amount of money as loan and must pay it within a scheduled time of repayment–daily or weekly–within few months (6 months is the longest) taking into account the interests. Oftentimes, this individual contract approach has higher loan amount compared to group loan.
  2. Joint or Group Microloans Approach is a type of microfinance loan granted to group of people who are jointly and equally liable, accountable and responsible for repaying the loan. Individual failures in payment due to sickness or ‘bad business week’ (or whatever acceptable reason there is) are avoided. Group pressure serves as a strong deterent to payment failure.

The Target Partners (Clients)

Every Microfinance Institution has its own target partners and partners classification methods. But here are the common denominators:

  1. Active Poor (poverty threshold defers in every country, so please see your country’s poverty index)
  2. Micro-Entrepreneurs
  3. Persons with existing micro-businesses
  4. Mostly women
  5. Persons who are 18 to 65 years old

There are biases on students, pregnant women, homosexuals and persons who have existing microfinance loans.

That’s it for now. I don’t want y to overwhelm you.

You now have two approaches and criteria for your target outreach. Think about your target area and be ready to learn the dynamics on the two approaches in my next post.

But, try to visit these (inside links) for further information:

What is Microfinance?

History and Origin of Microfinance?

Microfinance Opportunities

Microfinance Trends in the Philippines

So long…


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