Why We Provide Microloans
What’s the Deal with Microloans? The Nobel Peace Prize, for One
In 2006, the Nobel Foundation awarded the Nobel Peace Prize jointly to Muhammad Yunus and the nonprofit he founded, Grameen Bank, for their pioneering work with microloans. The Nobel Committee believed their efforts were generating “economic and social development from below” and that such loans have become an “ever important instrument in the struggle against poverty.”
Microloans, as the name suggests, are “small dollar” loans offered to poor, underserved and socially marginalized individuals and small business owners who are often neglected by mainstream financial service providers and taken advantage of by predatory lenders.
Microloans in the Developed World
While the concept originated in the developing world, such credit has been shown to have a transformative impact in the developed world as well, especially for small businesses.
In the US, they are used to fund both new businesses and to help established ones prosper through investments in working capital, new and upgraded equipment, enhanced marketing, etc. The U.S. Small Business Administration defines a microloan as one with a principal amount of $50,000 or less. Opportunity Fund does make loans larger than $50,000, but only to clients who don’t qualify for bank loans, and these loans don’t require any subsidy from fundraising.
Most of the criteria that are used to evaluate traditional business loans – such as personal credit scores, collateral, years in business, revenue, profitability, industry characteristic, etc. – must also be considered in microloan underwriting. Any lender failing to do so would likely go out of business quickly.
The problem with doing detailed underwriting like this, however, is that it is costly. For-profit lenders only do full underwriting on much larger loans. If they make microbusiness loans at all, they base their entire decision on either a personal credit score or easily verifiable monthly cash inflows, like credit card receipts or regular deposits in a business checking account. And they typically charge very high rates to help them cover the cost, and risk, of making small loans without thorough underwriting.
At Opportunity Fund, our fundamental mission is to seek out and serve clients that have faced disadvantages like racism, sexism, homophobia, language barriers, trauma from military service, or simply poverty. For that reason, we take the time to look at what is behind a low credit score. Was it simply bad luck (medical debt, for example)? We also take the time to understand their business and their personal lives. Yes, we look at cash inflows, but we also analyze their business and personal expenses, and sources of income from other family members, or part-time jobs. We also get to know our clients’ industries, like food trucks, truck driving, and selling at swap meets.
Because we take this extra time, we can approve loans that others would decline, or price with a triple digit interest rate.
Subsidized to Make Affordable
As we have shown, microloans are just as costly to originate and service as larger loans, but provide much less revenue. It is not profitable to provide them unless enormously high interest rates are charged. Our loans are offered to clients on affordable terms, below our cost, subsidized by our donors and financial partners.
In 2018, Accion and Opportunity Fund, two of the nation’s leading microfinance lenders, conducted a first-of-its-kind longitudinal impact study on a nationwide cohort of 350 clients for as long as three years post loan to understand the impact on their businesses, financial security, and quality of life.
We were thrilled with the findings:
- 60% of the businesses studied increased sales and 56% increased profits.
- 40% added employees, and a significant percentage increased employee monetary and non-monetary benefits, such as paid holidays and investments in professional development.
- The vast majority felt an increased sense of financial stability across a variety of indicators by the study’s end.
- 94% of the sample were still in business at the end of the study.
A subsequent study by Opportunity Fund found that 33% of our clients increased their credit score by at least 25 points.
Our Work Has Just Begun
Small businesses are a driving force of our economy, providing 49% of private sector employment and generating 64% of net new private sector jobs. Yet nationwide, there’s an $87 billion shortfall every year between the capital these firms need and what’s made available through loans. The shortfall is particularly acute for minority- and women-owned businesses, and for small dollar loans.
Opportunity Fund’s mission is to provide affordable, responsible capital – usually microloans – to hard working, low-income entrepreneurs, enabling them to transform their lives and the communities they live in for the better. Our five-year plan calls for investing $1.4 billion nationwide in entrepreneurs and the hope they provide. Come join us.