Microfinance is often used to refer to financial services for poor and low-income clients. However, in practice, its definition is narrowed down to loans and other services from providers identifying themselves as "microfinance institutions," (MFIs). These institutions tend to use methods developed since the 1970s to deliver very small loans and take little or no collateral to borrowers who have no salary. More broadly, microfinance is a movement envisioning a world where low-income households have permanent access to variety of high-quality financial services, including savings, insurance and money transfers.
There have been formal and informal credit and savings institutions for the poor around the world for centuries. One of the earlier and longer-lived microcredit organizations, which provided small loans to rural poor with no collateral, was the Irish Loan Fund system, founded by author and nationalist Jonathan Swift at the beginning of the eighteenth century. In the nineteenth century, a wide range of larger and more formal savings and credit institutions started to emerge in Europe. These institutions, which were organized primarily among the rural and urban poor, were known as People's Banks, Savings and Credit Co-operatives and Credit Unions.
Friedrich Wilhelm Raiffeisen and his supporters developed the concept of the credit union. They wanted to help the rural population become less dependent on moneylenders and to improve their welfare. From 1870, the unions expanded rapidly across the Rhine Province and other regions of the German States. Then the movement quickly spread to other European countries and to North America, eventually reaching developing countries as well. The Indonesian People's Credit Banks or The Bank Perkreditan Rakyat opened in 1895 and became the biggest microfinance system in Indonesia. Various adaptations of these models started to appear across rural Latin America at the beginning of the twentieth century. Unlike the banks in Europe, which were owned by the poor themselves, these new banks were owned by government agencies or private banks. Over the years, these institutions became inefficient and sometimes abusive.
Between the 1950s and 1970s, governments and donors concentrated on providing agricultural credit to small and marginal farmers in a bid to raise productivity and incomes. Such supply-led government interventions were in the form of targeted credit provided through state-owned development finance institutions and farmers' cooperatives, receiving concessional loan and onlending to customers at below-market interest rates. These subsidized schemes rarely succeeded. In the 1970s, experimental programs in Brazil, Bangladesh and a number of other countries extended very small loans to groups of poor women to invest in micro-business. These programs were based on solidarity group lending, where the repayment of every member of a group was guaranteed by all other members. During the 1980s, a new school of thought called the "financial systems approach," developed, viewing credit not as a productive input needed for agricultural development, but as just one kind of financial service that should be freely priced so that it is permanently supplied.
In the 1990s, some MFIs were able to achieve long-term sustainability and reach large numbers of clients thanks to high repayment rates and cost-recovery interest rates. The microfinance sector grew in many countries, with multiple financial services firms serving the needs of poor households and micro entrepreneurs. In the middle of the 1990s, "microfinance," started to replace the term "microcredit," referring to a range of financial services to the poor, not just credit. In the past most MFIs started as not-for-profit organizations. However, in order to obtain license from banking authorities to offer savings services more and more MFIs are required to be organized as for-profit entities. For-profit MFIs may be organized as non-bank financial institutions (NBFIs), commercial banks specializing in microfinance or microfinance departments of full-service banks. Some MFIs also provide non-financial products, including business development or health services.
Typical microfinance clients are poor and low-income people without access to other formal financial institutions. Microfinance clients are mostly self-employed, household-based entrepreneurs, whose businesses include small retail shops, street vending, service provision, and artisanal manufacture. In rural areas, such enterprises usually include small-income-generating activities such as food processing and trade. Most microfinance clients are often women. Government can support microfinance by setting sound macroeconomic policy, providing stability and low inflation. Government can also avoid interest rate ceilings, which can be too low and not permit sustainable delivery of credit that involves high administrative costs. It can also adjust bank regulation to facilitate deposit taking by solid MFIs and also create government wholesale funds to support retail MFIs.