Microfinance institutions all begin with value capital. Aid organizations, depositors and banks all borrow them money. They borrowed according to their ability in terms of payback schedule, amount and interest rate without going beyond thresholds risk put up by conglomerates of lenders, the board of directors and management, also not breaking regulations set by local banking. Microfinance bank owns divisional offices that being headed by credit officers who have cordial affairs with members of the community to deliberate on microfinance institutions’ products loan with them. They also take back interest and major payback if those that borrow money must pay back in cash, which they have no means to take it to the divisional offices. The head office and marketing department are the determinants of the loan approval processes. Which is subsequently implemented by the marketing department, department of operations, credit, and product department at the head office, divisional office staff inclusive.
There are MFIs that are non-profit oriented, but these are just an exception, not the norm. Although many MFIs kick-off as non-profits later transformed to for-profits. Investors are profit-motivated such are MFIs owners. Sometimes socially motivated funds are used by the owners to make investments, not always though. Large MFIs heads such as CEOs, COOs and CFOs are in mindsets similar to the managers of same sized banks in countries like U.S or another country. They give back value to shareholders through planning to execute plans drafted with the concerted effort of the board of directors. To achieve this there is need to build a profitable, effective and lasting organization that earns respect and trust from its customers, lenders, workers and rural regulators. Some managers do feel concerned on building their countries to create opportunities for their people. While some don’t care. Putting their interest rates may be thirty percent annually and their motives for profit-making, the importance of microfinance is obvious looking at the other options costumers would opt-in for if MFIs are not in existence. These other options could be local money lenders that lend money at an interest rate not less than 500% per annum.
The highlight here are some factors distinguishing microfinance bank from commercial banks:
(A) LOWER COSTS OF CAPITAL RELATIVE TO RISKS: This can make MFIs more lucrative than traditional banks. Most investors put their money in MFIs are not only motivated socially but also have minimal rates of return if required social standards are met. Far below-market interest rates MFIs borrowed from their lenders e.g. aid organization, or perhaps part of a large western bank. MFIs grow by often taking deposits from their customers, motivating them with huge interest rates of 10% annually on the savings account. Unlike FDIC in the US, the government of countries where MFIs operate doesn’t guarantee these deposits. Deposits are attractive to financing independent because it helps them makes provision for financing independent of international capital markets. However, there increased regulation and high cost that often comes with deposits.
(B) NO COLLATERAL: Lending in traditional commercial banks is not unsecured but often secured by assets like land, vehicles, etc. In contrast, MFIs’ lending usually not secure. That is, the borrower’s assets are safe even if they fail to pay back their loans, but with a penalty not to lend to such customer again. Also, they may report such borrowers to community leaders or may also lead to the social consequences of such a community by increasing interest rates on loans by any members of the community. Why didn’t MFIs take collateral? This is because the borrowers are almost poor or at the poverty line. Hence it is unutterable by MFIs to investors who are socially inclined or local media.
Furthermore, MFIs jurisdiction’s legal systems are too feeble to support loan collateral. However, assets lending is not uncommon in MFIs when the loan is meant to acquire specific assets.
(C) GREATER LEVERAGE THAN TRADITIONAL BANKS: Microfinance is often at mercy of central banks compared to other banks in any country they operate. For instance, higher for MFIs than other banks are the maximum asset to equity ratio. A low-income individual often benefit from a certain percentage of their loans, this also makes them be licensed as MFI instead of a bank. MFI loan size average is usually under a certain amount. MFI make access to capital easier for low-income earners compared to other banks. This is as a result of their looser capital requirement.
(D) TARGET MARKET: The microfinance target market is low-income learners that are not using the bank. For instance, peasant farmers or petty traders earning between $800 to $5000 per annum. However, this doesn’t mean they are more generous knowing fully well that they charge these people higher interest rates more than the high-income earner in the communities who possess assets that can be used as collaterals. The low-income individuals given loans relative to their level of income are not riskier, provided their income is steady.
These MFI borrowers can also be diligent workers in their businesses just like other rich members of their community. They can as well be spurred to give their families opportunities even as they maintain their dignity and reputation in the community.
(E) GROUP LENDING: one of the leading methods in MFI is group lending. A group of individuals in a community may come together to secure loans and also acts as a guarantor to one another. The idea behind this is if one person could not refund others have to pay back or they all face the penalty of not getting loan from microfinance again. Due to the operating costs that accompany the implementation of this method, it yields lesser profits compare to individual loans. However, it is not without benefit, among which is social pressure, also helps the community.
Furthermore, MFI also has many players they partner with such as platforms like crowd-funding as well as insurance from micro-insurer. Some sellers of goods do partner with microfinance to boost the finances of their business.
Difference between microfinance and commercial bank by definition
Commercial banks as a financial institution are established based on the banking regulation act. They function solely to accept money and lend money out to costumers. Other functions include brokerage, insurance, stocks, security, etc. All of these are non-banking activities. Commercial banks are profit-oriented. Among the characteristics of commercial banks are dividends, payment of tax, registration, etc.
Microfinance is not profit-minded. The activity in microfinance is done more in a group. Each member of the group has savings, thus the microfinance aims at giving the loan to any member of the group. The group ensures the money is being used and the group member earns profit from any income making enterprises they engage in. Each and every member of the group is entitled to loan or perhaps get a loan. This, in turn, self-sustain the group. Unlike a commercial bank, microfinance is devoid of registration, dividends, and taxation.
Difference between microfinance and commercial bank
They deal with different costumers in terms of definition. Microfinance renders financial assistance and or gives loans to low-income earners of local families. While commercial banks, on the other hand, give loans to people and big organizations that open accounts with them. The worth of note is that their difference per se is based on the costumers they deal with not even the magnitude of the loan.
MFIs basically lend money, funded by private equity holders and or individuals. So, sources of funds for microfinance institutions can different from private equity holders to individuals. Commercial banks offer financial services range from lending, savings to insurance and pensions. Commercial banks are funded through stock markets.
MFIs services are DOOR STEP that is, their staffs take financial services to customers ’ doorsteps. Whereas commercial bank services are BANK DOOR services, that is, the costumers have to go to the bank to carry out any financial services.
Commercial banks’ loan risk is quite low. Thus, charge lower interest rates ranging from 10% to 16%. This low loan risk is predicated on the fact that they deal with people of high level of income. Contrastingly, the microfinance loan interest rate is high say 20%-25% due to the fact that they operate collateral-free loans, also the loanees are riskier.
Among other differences are dynamics in manpower, structures of governance, use of or ICT use, physical presence, etc.
History recorded that in India, commercial banks do not understand the requirements of the local market. This birth the idea of micro-financial institutions. They offer financial help to local families of low income that couldn’t transact business with commercial banks. With free collateral loans, they offer financial services to several poor people.
Whereas commercial banks cannot cope with the high risk of the given loans to the poor that residents in rural areas whose small loans are hard to maintain in terms of cost. The challenges of commercial banks, microfinance rose to conquer by giving loans to the destitute.
MFIs help the poor in the remote areas to scale up their business by giving them small loans. No provision of other facilities like insurance, cash withdrawal from automated teller machines, credit/debit card provision, etc. Whereas such services are available in commercial banks. Commercial banks also help to manage customer cash, give reports on their accounts, etc.
There is no collateral-free loan in commercial banks. MFIs give collateral-free loans. There’s extensive scrutiny in commercial banks before issuing out the loan. Such scrutiny is not available in Microfinance.
In terms of deposit, some amount has to be deposited to the MFI before they give out loans to any group members. Whereas in commercial banks the depositor is required to pay a fixed rate of interest corresponding to specific amount to be given out as a loan
MFIs seek to bridge the gap in the segment of the society not touch by commercial banks which exposed them to private borrowers.
Commercial banks’ lending operations cover areas like renewable energy, agriculture, housing, micro, small and medium enterprises, education, etc.
They also differ in their approaches to risk management. MFIs manage risk by contacting their customers often. Also, train their staff (off-field staff) and customers. Self-deserved, as well as an imposed risk management system that is advanced, are used in commercial banks.
To meet up with their cost and make service available are reasons microfinance charge rates are higher than other banks.
However, the local money lenders whose interest rates can be up to thousands received far above this from people.
The microfinance still face challenges sustaining themselves in the rural areas. A case study that exposed MFI environment is the Andhra Pradesh microfinance saga.
MFIs are not profits oriented, experts in giving loans to people in local communities, be it group or individual. They are into micro-financing and do not lend huge money to customers.
On the other hand, commercial banks do a wide range of financial services corporate bodies and individuals. They are profit-minded. They offer other financial services like guarantees, savings, credits letters, etc.