Have you been lead to believe these common misconceptions?

Microcredit and microfinance more broadly have become widely misunderstood. They didn’t live up to the promises of becoming the “silver bullets” of eradicating poverty – but what has?

This disappointment gave microfinance a bad name. Predatory lenders and a lack of regulation in underbanked regions lead to further misunderstandings about microcredit and its possibilities.⁠

Microfinance vs. Microcredit

Microcredit: Loans or credit, typically smaller than what traditional banks are willing to offer. Microcredit is usually sought out by low-income and underbanked individuals. This is one tool belonging to a suite of services that fall under the umbrella of microfinance.

Microfinance: Financial services offered to low or moderate-income individuals and businesses. This includes a range of services, such as micro-insurance, microcredit, savings accounts, and more. Often, these services are not attractive to traditional banks and are offered by Microfinance Institutions, NGOs, or Nonprofit organizations.

For more on this, check out our article “Defining Microfinance.

Common Myths & Misconceptions

#1 Microcredit doesn’t help people.

False. Microcredit is critical to many of the 1.4 billion unbanked individuals around the world. Imagine if you couldn’t get student loans or pay for large purchases with credit?

This is especially imperative for people who don’t have access to traditional financial services – in particular, those with unpredictable income streams or seasonal businesses.

Much of the world’s underbanked population work in the informal economy. Access to small sums of money can help:

– Get through tough times

– Build resilience in the face of climate change (e.g. climate-resistant crops)

– Increase product offerings

– Diversify income streams

– Purchase solar panels

– Improve farming output with fertilizers and machinery

– And more.

#2 Microcredit is always good.

False. Microcredit can be harmful for some borrowers – especially if the organization does not employ client protection principles. It’s important for organizations to ensure suitability of credit for each client.

For more on the client protection principles, check out this article from the Center for Financial Inclusion.

The good news: The microfinance industry has come a long way. Regulations are improving around the world. Research around impact continues to evolve, evaluating different structures for microcredit for various clients and different local contexts.

People on a dirt road in a rural community, carrying baskets of fruit or riding motorcycles.

#3 Microcredit only works for high-potential entrepreneurs

Also not true. If you’re looking for increased profits and consumption as the measures for success, this is often the case. However, many microfinance clients are not necessarily aiming for these goals.

Many borrowers are seeking to smooth consumption, get through tough times, or diversify their income streams to build resilience against shocks.

Modifications to traditional microcredit models can improve business outcomes.

Many studies around the world have shown that modifications, such as reflexible payment terms and deferral options result in increased profits and household income.

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Abdul Latif Jameel Poverty Action Lab (J-PAL). 2023. “Microcredit: impacts and promising innovations.” J-PAL Policy Insights. Last modified May 2023. https://doi.org/10.31485/pi.2268.2023

Barboni, Giorgia and Parul Agarwal. 2023. “How Do Flexible Microfinance Contracts Improve Repayment Rates and Business Outcomes? Experimental Evidence from India.” Working Paper, February 2023. https://doi.org/10.2139/ssrn.4358795.

Asian Development Bank. 2020. “How Microfinance is Helping Poor Households and Businesses Survive and Thrive: 6 Things to Know.” https://www.adb.org/news/features/how-microfinance-helping-poor-households-and-businesses-survive-and-thrive-6-things