Difference Between Traditional Banking and Microfinance Institutions

Difference Between Traditional Banking and Microfinance Institutions

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Comparing MFIs with traditional lending institutions, it is frequently the case that they operate under a different operational model. The following are the key distinctions between regular banks' operations and those of microfinance institutions:

1. Eligibility Assessment - Microfinance organisations don't evaluate a borrower's eligibility for loans based on substantial financial guarantees, unlike traditional lenders that do. Before approving a loan, mainstream banks evaluate the applicant's income and assets. Instead, microfinance banks place a greater emphasis on "human" characteristics. The likelihood of the loan being approved is high if it aids in the establishment of a new business that generates money for the borrower. Speaking with the borrower will be part of the viability assessment of the loan, in addition to simply looking over the loan application.

2. Group cohesion as guarantee - The traditional banks view hypothecation as a guarantee for some loans but the MFIs substitute a system of community solidarity in place of this approach. For instance, each borrower acts as a guarantee for each of the other investors in the group while making mutual fund investments. Self-help groups are an instance of this.

3. Training programs - MFIs are responsible for forming ties with the recipients of microloans, unlike regular banks. They also provide the borrowers with a lot of help. MFIs also conduct training initiatives with the primary goal of educating participants on project budgeting because the motivation is to assist borrowers in the success of their projects.

4. Flexible repayment plans - MFIs typically design the microloan repayment mechanism to fit the financial capacities of the intended client population. As a result, unlike regular banks, certain MFIs are likely to offer loans with weekly repayment schedules.

5. Flexible credit arrangements - The goods offered by microlending are typically tailored to the borrowers' capacity for repayment. One of the key distinctions between a conventional lender and an MFI is this.

In the case of group loans, this distinction is very obvious. An MFI asks potential borrowers to form a group, after which it makes a single loan to the group. The poorest borrowers typically receive this. These microloans rely on the group's unity, which serves as a sort of social guarantee, rather than any specific guarantee. Each member of the group, hence, becomes answerable to the MFI and the co-borrowers.