Microfinance took off in the 1970s as a solution to uplift poverty-stricken communities. It addresses the financing gap, which happens when small and medium-sized enterprises cannot access the capital they need. Today, many microfinance banks and institutions have emerged to provide affordable loans for financially disadvantaged borrowers.

Approximately 916 microfinance institutions operate around the world with an aggregate portfolio of $124 billion in 2021, according to the Asian Development Bank (ADB). More than 120 million low-income people worldwide have also directly benefited from microfinance-related activities in the past year, as per the Consultative Group to Assist the Poor (CGAP).

Let’s take a deep dive into the financing gap and what makes microfinance banks essential for empowering underserved business communities.

What is the Financing Gap and How Large is the Problem?

The financing gap happens when there are barriers that keep small businesses from accessing loans. While banks have money for funding, many small business owners usually cannot qualify for these loans.

People that are often left underserved include the following borrowers:

• Women
• Minority groups
• Immigrant communities
• Low-income communities outside major cities

To measure the U.S. financing gap, we looked at small business statistics by Fundera and the U.S. Small Business Administration (SBA) Office of Advocacy:

• There are approximately 31.7 million small businesses in the U.S. in 2020.
• Out of 31.7 million small businesses, an estimated 13.6 million small businesses applied for a loan, or 46% of all small businesses.
• Out of 13.6 million small business loan applications, 7.3 million loans went unprovided or underserved.

Based on these figures, more than half of all small businesses did not receive the capital they needed. The reality is alarming, considering how essential small business is for the economy.

Small businesses make up 99.9 percent of all firms in the country, as per the U.S. SBA Office of Advocacy. A small business is a company with a maximum of 250 to 1,500 employees. Independently owned and operated businesses and minority-owned operations are also classified as small businesses.

Between 2000 and 2019, small businesses created an estimated 10.5 million jobs in the U.S., while big companies only created 5.6 million jobs.

This data shows small businesses are one of the strongest drivers of employment and financial growth. However, without access to loans, many small businesses have limited potential for growth, which limit’s our entire economy’s growth.

Why the Problem Exists

America’s lending system is based on creditworthiness, or the ability of a borrower to repay their debt. Banks measure creditworthiness based on an indexed score, generated from a good credit history and the stability of your income.

Showing a record of timely payments on your credit card, mortgage, and other loans appear more favorable to banks. As such, banks are more likely to approve financially stable business owners for financing.

With high lending standards in place, low- to moderate-income borrowers cannot qualify for small business loans. Some of the reasons why they get declined include:

• Weak Financial Structures - They have unstable finances and may encounter payment delays from customers.
• Inconsistent Source of Funds - They build little savings because they lack a regular source of income.
• A Low Credit Score or Thin Credit Record - Many of them need to build their credit profile and improve their credit score to secure a loan.
• A General Perception as High-Risk Borrowers - Unstable finances and poor credit records are unfavorable for banks, who would want to reduce their lending risk.

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Microfinancing: What is it and How is it Different from Traditional Banking?

Microfinancing is a banking service offered to borrowers from lower socioeconomic backgrounds. Its ultimate goal is to give financially disadvantaged borrowers the chance to become self-sufficient and save.

What sets microfinance banks apart from traditional banks? They use innovative methods to reach out to underserved customers. Some of these unconventional banking techniques are:

• Short repayment installments
• Group lending and monitoring structures
• Zero-collateral loans

The most notable example of a microfinance bank is the Grameen Bank in Asia, founded in 1983 by economist Muhammad Yunus. In 2006, Yunus received the Nobel Peace Prize for his pioneering work in microfinancing to help the poor. Decades later, Yunus has inspired numerous organizations to extend microfinancing initiatives to underserved communities all over the world.

On the downside, microfinance banks have difficulty scaling their services to more underserved communities. They do not have the same resources and technology that traditional banks have to serve more clients in need.

Traditional banks, on the other hand, consider unconventional methods unsuitable for mainstream financing. They rely on creditworthy borrowers with good credit scores and incomes to ensure repayment. They tend to avoid offering small loans that are not as profitable as larger loans. Traditional banks prefer to service financially stable borrowers, enabling them to sustain adequate resources to scale their services.

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The Role of Microfinance Banks in Closing the Gap

Many microfinance banks offer low interest rates and do not require collateral for loans. Collateral is a security payment in case a borrower defaults on their loan. With no collateral required, it’s easier for low- to moderate-income borrowers to get loan approval.

Microfinance banks help underserved communities and close the financing gap by:

• Empowering Women and Minority Borrowers - It allows them to become entrepreneurs to improve their livelihoods and plan for the future.
• Making Financial Services Accessible - Offers savings accounts, money transfers, and insurance services. Also provides access to small loans for health, education needs, and emergencies.
• Helping Borrowers Avoid Predatory Lenders - Microloans are a better, safer option than taking risky payday loans with very high interest rates.
• Providing Financial Education - Many microfinance institutions offer financial literacy courses to help underserved borrowers manage their funds.

However, because microfinance banks have difficulty scaling their operations, they cannot reach more disadvantaged communities to give them access to loans. Here is where Asenso Finance comes in.  

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How Asenso Finance is Part of the Solution

At Asenso Finance, we help small businesses get the capital they need by assisting the institutions that help underserved communities. We do this by digitizing services for community banks and Community Development Financial Institutions (CDFIs) that reach out to low- to moderate-income borrowers.

Asenso Finance provides the expertise to help community banks and CDFIs scale their operations, enabling them to lower their servicing costs. As a result, they can offer low-interest, zero-collateral loans to small business borrowers at a wider scale.

Our model uses the social borrowing circle, a peer-to-peer lending structure inspired by Yunus's Grameen Bank model. In this structure, small business owners can come together in groups of five to apply for a loan. They co-guarantee each others’ loans and hold each other accountable to submit their applications and make monthly payments on time. Our model even provides financial literacy courses to equip borrowers with valuable financial management skills.

Joining a social borrowing circle also builds the borrower’s credit score, helping small business owners become eligible for future loans such as standard U.S. Small Business Administration loans.

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Our Bottom Line

The financing gap is a problem caused by a lack of access to traditional bank loans. If you can’t qualify for a small business loan, the good news is you can turn to microfinance banks and other institutions like CDFIs for affordable financing. These microfinance banks and CDFIs are dedicated to lowering barriers to lending, helping small business owners thrive. Through it all, Asenso Finance is here to help these institutions build financially inclusive solutions to scale their services.

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