The Principle of the Micro Loan

In the world of financing and capital, the micro loan is one of those unique products that have proven to be very successful for its intended purposes as long as it's used responsibly. Micro loans have been successful in lifting entire groups of people out of poverty and putting them into a position where they could finally fend for themselves and be productive. Micro loans are part of a larger concept known as microcredit; a principle that emerged in its modern form in the late 1970s.

Even prior to its modern incarnation, microcredit and micro loans were used extensively in the 18th and 19th centuries. It's important to note that micro loans are designated for groups of people rather than single entrepreneurs. They are granted both domestically and internationally to groups of all sizes.

Purpose of the Micro Loan

The main purpose of the micro loan is to establish a means for people with no financial resources of their own to create something that would give them earning power in the future. For example, imagine a poverty-stricken community in the Appalachian Mountains just barely getting by on a limited amount of farming. This community may go for several generations without ever lifting themselves out of poverty because their resources are so limited. They would be willing to increase their productivity if they could afford modern equipment, but they are caught in a cycle where they don't earn enough money to purchase the equipment yet their production is not great enough to lift them out of poverty.

A micro loan would provide the financing to purchase that equipment and help that community establish more productive farming methods. As production increased, a certain percentage of the profits would be used to pay off the loan while the remainder would be put back into the farms to develop them further. In essence, a micro loan is similar to seed capital in that it provides the initial finances to get a project off the ground.

Investment Sizes

The term micro loan takes its name from the fact that typical financing amounts are relatively small. For example, the small business administration might loan $25,000 to a single entrepreneur to open a restaurant in suburban Chicago. That's a significant amount of money for one businessman. A micro loan, on the other hand, would provide that same $25,000 to the Appalachian community for their new farming equipment. The amount of money is the same in both cases, but distributed among all the parties involved, the micro loan is less per-person.

Micro loans are not as common in the United States as they are in other countries that are poorer and less developed. That's because most Americans have the resources to take on conventional business loans. Groups of people in other countries don't necessarily have those resources.

Furthermore, the economies in some of these other countries makes every dollar loaned go that much further. For example, a nonprofit organization in Liberia was able to rent two buildings with a combined 3000 ft.² of space for just $600 per year in 2010. Those same buildings in the United States would carry an annual lease in excess of $20,000.

The fact is, micro loans are effective in poorer and less developed countries because the money goes so much further. While the $25,000 loan to our fictional Appalachian community might buy a piece or two of equipment, it could set up an entire agricultural community from scratch in Liberia.

Micro Loans as an Investment Tool

There are quite a few different companies in the United States providing brokerage services for micro loans. As a broker, one of these companies matches a group in need with an individual or group willing to loan the money. With the continued shaky stock market and currency issues in both Europe and the United States, investors are beginning to move their money to micro loans as an alternative. They have found that recipients of these loans are very faithful in repaying them at a good rate of interest. After just a couple of years the investor can see his original amount back with a fairly good return on top of it.

Of course, the risk with the micro loans is that a foreign entity does not repay the money. As an investor you have very little leverage in a legal sense, especially if that money was loaned in a country where the legal system does not treat defaulted debts as anything serious. So while investors typically do very well with micro loans, it's not always guaranteed.

Success of Micro Loans

Micro loans have proven to be very successful on several fronts. So successful, in fact, that the United Nations declared 2005 as the International Year of the Micro Loan. Loaning money in this way has enabled millions of people, divided into hundreds of thousands of groups, to establish themselves and lift themselves out of poverty. Like it or not, the micro loan is proof that capitalism works much better than government redistribution.

Most importantly, a micro loan works because it provides the resources to help people become self-sufficient. Rather than depending on government handouts and international charity, those groups that secure loans set up their own profit-making ventures and repay the money given them. As their businesses grow, wealth is created and their communities and economies grow along with them. By contrast, when groups of people subsist on handouts, they never learn to become self-sufficient, their communities don't prosper, and their economies don't grow.§yu

The concept of the micro loan is, without a doubt, a huge success on an international level. It is unfortunate that they are not promoted more heavily as investment tools among the wealthier nations of the world. If we could replace much of our charity with microcredit, the world would be a different place.