What is the difference between bank and microfinance?

The two major players in the financial world are banks and microfinance institutions. They are both part of the same industry, and in general, their roles are similar. They provide financial services to individuals and businesses. But their similarities stop there. They differ in so many ways, including their target audience, how they operate, and the regulatory bodies governing them. 

In this article, I will compare banks and microfinance institutions so you can understand the differences between them. 

What is a bank?

A bank is a financial institution that accepts deposits from members of the public, which can be withdrawn on demand, makes loans, and provides a range of other financial services for individuals and businesses.  

What is microfinance?

Microfinance is made up of services provided to low-income individuals and small businesses. These services may include loans, savings, insurance, financial training, and more. They target people and businesses that may not have access to traditional banking institutions, mostly due to their low income. They aim to alleviate poverty by providing services to the lower-income class of society. 

Key differences

There are many differences between banks and microfinance, we will explore the most important in this article:

1. Target audience: Banks cater to a broad range of audiences, including individuals, businesses, corporations, and even government bodies. Banks target every member of the society. On the other hand, the target audience of microfinance institutions is low-income individuals and small businesses, particularly those living in rural areas where there is limited access to banks. 
2. Money lending: Since microfinance caters to low-income individuals, the size of the loan they offer is much lower than that of banks. As a result of the debtors’ near-poverty or poverty status, microfinance does not require collateral. On the other hand, the need for collateral as security has long characterized the operations of commercial banks.  

   Compared to standard bank loans, microfinance loans often have higher interest rates. This is because they provide small loans without asking for collateral. The risk they bear is high, so their interest rates are higher to mitigate that risk

3. Social Impact: Compared to banks, MFIs are more likely to provide training programs to members of society. To establish a connection with their beneficiaries, MFIs first take the initiative to educate the public about their financial situation and how to improve it. MFIs invest in training programs to assist their borrowers in accomplishing their financial goals more effectively. 

   Since they cater mostly to the unbanked and underbanked, they foster financial inclusion and social welfare.

4. Loan repayment plans: The most crucial factor in every bank’s credit operations is unquestionably the capacity to repay. It is challenging to determine the outcomes, and the whole lending procedure is dependent on that one element, which makes it more difficult for banks to streamline loan distribution and assist the underprivileged. 

   MFIs’ lending facilities are thoughtfully crafted to fit the borrower’s financial situation. Their repayment plan is also more flexible as a result. Traditional banks may decide not to implement weekly or bi-weekly payments. However, microfinance products offered by MFIs are more adapted to accommodate the financial circumstances of the borrowers.

5. Regulatory bodies: Banks are usually regulated by the central bank, which in turn is under the legislation of the Government. As such, the Government oversees the operations of banks to a great extent. 

   Microfinance institutions, however, have less strict regulations and are usually regulated by financial regulatory bodies or NGOs. 

Advantages and disadvantages

Banks and Microfinance each have their benefits and drawbacks. Let’s compare both of them to more clearly highlight their differences.

Advantages of banks

There are so many benefits of banks for both society and the individual. Here, we will highlight the advantages of banks over microfinance institutions. 

• Offers a wide range of financial services 
• Provides large-scale loans 
• Provides lower-interest loans 
• Heavily regulated, thus ensuring financial stability and security

Disadvantages of banks

Compared to microfinance, there are several disadvantages of banks to be highlighted:

• Strict eligibility criteria make it hard for low-income individuals to qualify.
• Requires collateral which limits access for some people.
• More bureaucratic processes, making loan approvals slower than microfinance.

Advantages of microfinance

The introduction of microfinance is more recent than banks and has not yet gained widespread use as much as banks have. Their scope is quite limited compared to banks, so has a lower audience than banks. Regardless, it is still superior to banks in certain aspects:

• Serves underserved communities and low-income individuals, so fosters financial inclusion.

• Requires minimal or no collateral, making it accessible to many.
• Often includes financial literacy training to educate borrowers.

Disadvantages of microfinance

Microfinance might be considered superior in some aspects, but compared to banks there are still areas it falls short.

• Higher interest rates
• Smaller loan amount

Which is better?

Whether to use banks or microfinance will depend on the specific situation of the individual. 

A low-income entrepreneur who needs a small loan to start a business will benefit more from microfinance. They most likely will not have the collateral to be able to get a loan from the bank. They will also benefit from the financial education that might be provided by microfinance institutions. 

The owner of a large, flourishing business who needs a large amount of money to expand their business will benefit more from a bank. Likewise, someone who just wants to save money or needs other financial services that banks offer will be better suited to visit a bank than a microfinance institution.

Conclusions

Banks and microfinance institutions serve the community by providing financial services for its members. Despite their most basic being essentially the same, there is a world of difference between them. 

The choice of which to use will depend on your special circumstances. A particular situation may require the service of a bank, and vice versa. So whether you use a bank, a microfinance institution, or both, will depend on your needs at that moment.