This year’s winner of the Nobel Peace Prize does not fit the usual profile. He is not to a statesman or a diplomat, a human rights worker or a peace activist. He is a banker. But the work of Muhammad Yunus and bankers like him is doing much more for the betterment of mankind than the idle talk of so many past winners of the prize. Yunus was given the award in recognition of his work in pioneering the theory and practice of microfinance, a financial system that offers basic financial products and services to the poor of the developing world. In the three decades since its inception, microfinance has achieved incredible success in raising millions out poverty. Yet the full promise of microfinance has yet to be fulfilled.
The great appeal of microfinance lies in the emphasis it places on the power of individuals to improve their own state and lift themselves out of poverty. Microfinance theory posits that the billions of the world’s poor are capable and productive but lack the financial tools necessary to realize their full potential. Microfinance institutions offer to the poor exactly the same kinds of loans, saving accounts and insurance that workers in advanced economies need to smooth consumption between periods of high and low income, mitigate risk, and make long term investments to increase their future productivity.
Microfinance holds incredible potential for accelerating economic growth in much of developing world. It takes advantage of one of the basic tenets of macroeconomics—that the infusion of capital increases productivity most where current levels of capital are lowest in relation to the supply of labor. This principle has motivated decades of development aid from capital-rich Western governments to those of capital-poor developing nations. But instead of following a top-down method that encourages all manner of corruption and inefficiency, microfinance directs its efforts from the bottom up, supplying capital to individuals who know much better than their governments the most productive use for their money.
The key to the success of microfinance is that it works not to counteract market mechanisms but in fact to strengthen and extend them in where they are weak or failing. For three basic reasons—the high cost of providing financial services to individual clients, counterproductive government regulations, and an unwillingness on the part of large commercial institutions to even consider catering to the poor—the global market has failed to provide basic financial services to all but the very rich. Estimates show that only half the world’s population has any form of bank account and that no more than 15 percent has ready access to bank loans.
Microfinance bridges this failure in the market. Strategies developed by Muhammad Yunus and other micro-pioneers have used characteristics particular to the poor of developing countries—the power of local social networks and the superior fiscal responsibility of women, for example—to lower the cost both of service provision and default risk. They have largely kept operations small enough in scale to avoid excessive regulation and, most importantly, they have defied the conventional wisdom and succeeded in making microfinance for the poor a profitable venture.
The true success of microfinance will come, however, when the market failures that microfinance endeavors to remedy become market successes, when financial services are provided to the poor not by an alternate set of micro-institutions, but by the same mainstream commercial entities serving richer populations. That day is fast approaching as the barriers that once held the market back are steadily overcome. The cost of providing financial services is dropping thanks to microfinance marketing practices and, above all, to new technologies like mobile telephone banking that radically improve the ease and cost-efficiency of executing inancial transactions.
Overregulation and underdeveloped property laws still pose the greatest obstacle to the advance of microfinance. Interest rate caps make business unsustainable for microlenders, while weak property rights make it impossible for the poor collateralize their property to obtain loans. But in regional leaders such as Argentina and India, momentum is growing behind banking reforms targeting these problems.
Part of that momentum is coming from the entry of large multinational banks into the microfinance arena. Taking their cue from the success of smaller microfinanciers like Yunus, financial behemoths Citigroup, Deutsche Bank and HSBC, among others, have begun forays into large-scale, for-profit microfinancing. These developments mark the beginning of a new phase in the evolution of microfinance. Muhammad Yunus’s greatest achievement has been bringing that evolution about, bringing closer the day when all the world has access to the same financial tools—the day, ironically, when microfinance will be a thing of the past.