The Impact of Micro financing on the Community

Micro-financing is a term that is used to describe loans made by private companies or individuals to businesses that cannot qualify for traditional financing from banks.  Micro-loans typically have interest rates of 25 percent or more per Annum, making them some of the most expensive loans available to business owners.  

While micro-loans provide needed financing for those who cannot obtain conventional loans, they also cost companies and individuals vast amounts of money in interest payments.  Some experts claim that micro-financing ultimately hurts small businesses and communities rather than helping them due to the exorbitant interest rates and the pattern of debt into which business owners can be pulled.



A recent study by the Department for International Development examined the effects of micro-financing on certain low-income groups.  The findings of this study are indicative of some conclusions that may be true regarding micro-financing’s effects on small businesses in general.  These findings can be summarized as follows:

•    Micro-credit clients tend to lose money rather than make it over time.  By availing micro-credit, many often pay extremely high interest rates.  Rather than, pay off their loans, these people tend to get locked into a cycle of borrowing to pay ever-growing interest costs, especially if the initial loan is taken in an emergency situation.

•   Micro-finance can help business owners, and individuals deal with unexpected emergencies, although not universally.  The ability to borrow money may, in itself, provide a business to stay afloat.  However, becoming mired in the borrow-repay-re-borrow pattern may eventually harm small business more than it helps.

•    Micro-financing cannot help everyone and should be used judiciously.  There has been a tendency for lenders to consider all borrowers equally.  However, while this may seem commendable, it may result in damage to the community at large since some people will never repay their loans, resulting in higher costs to those who do try to meet their obligations.  Ultimately, punishing those who seek to pay their debts hurts the community.

•    Micro-savings may be more valuable than micro-loans.  While there is a tendency to think of micro-financing in terms of loans, business organizations can help business owners become savers, as well.  When this plan is implemented, the results may be more beneficial in the long run to business owners as well as the community at large.  

•    Micro-finance has the potential to both hurt and help communities.  By making funds available to business owners and by helping these entrepreneurs to grow savers, micro-finance can help a community.  On the other hand, there is an enormous potential for harm to any group that becomes dependent on high-interest loans to support its businesses afloat.

Micro-financing does make funds available and when handled carefully can mean the difference in a community.  However, if micro-financing is abused, it also has the potential to destroy a group by causing a chain-reaction of bankruptcy among its businesses.  

Therefore, business owners should think carefully before relying on micro-financing for business operation costs.  A solid business model, supported by the community, is far more likely to survive economic ups and downs than a business that relies on emergency loans from lenders with high interest rates.

Byline:

This piece was composed by Jeffrey Nickerson, a freelancer based in Cincinnati who often writes on business, money and young entrepreneurship; to learn more about difficult financial and taxation issues. Visit RB Brenner Tax Help.