Although the importance of microfinance in the process of poverty eradication is realized, it faces multiple problems. Offering financial services to the poor individual (the definition of microfinance) is a complex process and that in itself leads to various challenges.

We’ve divided all these challenges into two sets; problems faced by micro entrepreneurs (this article) and problems/challenges faced microfinance providers (another article).

Microfinance Challenge 1: The poor’s inability to offer marketable collateral for loans

Microfinance clients are either very small businesses or poor individuals who usually have few assets,  non-existent credit histories, and low income levels. This is a problem because it means these clients have cannot offer any collateral to microfinance providers against loans. As a result, microfinance institutes (MFIs) may either raise their interest rates (which are already high for small loan transactions) or turn down hundreds of applications (read 10 determinants of interest rates in microfinance).

Microfinance Challenge 2: Poor institutional viability of micro enterprises

Poorly constructed business ideas with a lack of consideration of demand and costs render the micro venture unsustainable, and microfinance may incorrectly get the blame for it. For instance, in the case of micro crop farming, farmers often fail to account for their personal consumption between the sowing and harvesting periods and realize they face a shortage of money.

As a result, they often end up using the loan for personal matters. The problem arises when its time to pay back the loan – the farmer is forced to take up a second loan to pay the original loan. This may lead to a vicious cycle where the farmer gets inundated with debt. You may want to see how this problem was addressed as a challenge by Micro-Crop Loans in Philippines.

Microfinance Challenge 3: Lack of knowledge about microfinance services

Many micro entrepreneurs live in far off rural areas, often remote villages, and have little formal education which lead to two issues:

• a lack of knowledge about the existence of financial services for the poor, (solution – financial literacy campaigns)
• little access to microfinance services offered by MFIs.

This issue was also mentioned in the post about challenges faced by microfinance institutions because a natural consequence of this is that loan providers face difficulty in targeting these potential clients.

Microfinance Challenge 4: Shortage of Financial Capital – Or Misallocation?

Under 10 million of the 500 million people who run micro and small enterprises have access to financial support for their businesses. Data Snapshot, The Virtual Library on Microcredit.

As a result of the above three problems, a fourth problem arises for micro entrepreneurs – a lack of funds. Without credit, the micro ventures may not grow or quickly take advantage of opportunities. Since, 20% of the world’s population accounts for 86% of consumption (Global Issues Website), one can deduce that the problem isn’t related to the shortage, but rather, mis-allocation of funds.

Read four more challenges faced by micro-entrepreneurs.