Is investing in microfinance viable?

Microfinance is viewed as an important factor in promoting financial inclusion. As Israeli entrepreneur and microfinance advocate Sharone Perlstein says, microfinance is helping low income individuals inbecoming successful entrepreneurs. However, is it a good idea investing in microfinance? What is the process to take in investing in the microfinance sector?

Investing in microfinance

For individual investors, there are generally three main ways to invest in microfinance. These are as follows:

  • Direct investment in a microfinance institution. As the phrase implies, this is about making an investment to a specific microfinance company. This, however, is an undiversified way of investing. As such, it is regarded as the riskiest way to invest in microfinance. It is also considered as largely unfeasible for most individual investors.
  • Investment in a specialized microfinance fund (MIV). This is essentially an indirect investment in a microfinance institution. With this, an investor invests in a company that manages a specialized microfinance fund, which in turn invests in microfinance institutions that provides loans and other microfinance services to end borrowers.
  • Investing in a P2P platform. Peer-to-peer or P2P microfinance platforms are mostly web-based services that offer small loans to individuals or small businesses from other individuals/small companies. Investing in a P2P platform can be as low as $25.

Arguably, the most accessible microfinance investment option is investing in P2P platforms. These platforms can further be categorized into the the following:

  • Pure P2P. In pure P2P, loans are directly from individuals/small businesses to other individuals/small businesses. The platform simply facilitates the transactions and gets a small fee.
  • Indirect P2P. This involves a microfinance institution. What happens here is that the money being loaned is channeled through a microfinance institution, which is responsible for the management of client selection, disbursement, collection, monitoring, and the exercise of due diligence. As such, this is also known as “peer-to-platform-to-MFI-to-peer.”
  • Donation-based P2P. Here, the loan is basically a donation to a microfinance institution, which then loans it to individual borrowers. The repayments are then converted to a donation for the microfinance institution, which may use it as it deems fit. One good example for this is the World Vision Economic Empowerment Fund.

The viability of microfinance investments

Microfinance is a growing industry globally. As such, it can be considered a safe investment option. According to the Micro Banking Bulletin, as reported on Investopedia, 63% of the world’s leading microfinance institutions have an average return of roughly 2.5% of total assets. Institutional investors are also attracted to making microfinance-related investments. The outlook for this kind of investment is rather optimistic.

It’s also worth noting the repayment rates for microloans is relatively excellent. Based on Sharone Perlstein’s Microfinance site, 98.9% or almost all microfinancing loans are repaid in full. This suggests many positive points including the responsibility of borrowers and the good management of microfinance institutions.

Microfinance serves more than 130 million people globally, especially in developing countries. Many of those who avail of microfinance services use the money they get to start or sustain small businesses. In other words, they help foster economic activity among low income brackets of society. It can be said that putting money in microfinance is not just a safely viable investment, it’s also a good way to contribute to stimulating economic activity.