Over the years, microfinance has been widely acclaimed as the "most effective" poverty alleviation tool worldwide. It has been generally accepted that provision of financial products, through systematic and all inclusive microfinance, in a long term sustainable manner, would improve the latent capacity of the poor for entrepreneurship.

Today, microfinance plays a major role in the development of many African, Asian, and Latin American nations. Its impact is substantial enough to have warranted acknowledgment by the United Nations who declared 2005 "The international year of microfinance", reminding people that millions worldwide benefit from microfinance activities.

Three main features distinguish microfinance services from those provided by formal financial institutions, namely; the smallness of the loans advanced or savings collected, the absence of asset-based collateral, and simplicity of operations.

Instead of asset-based collateral, the microfinance decision to lend is based on the borrower's character, integrity and cash-flow. However, cash flow not withstanding, the operations costs of providing microfinance financial services are higher than those of formal financial institutions, due to the administrative cost of the large number of small loans processed.

In most countries, microfinance services are provided largely by NGO microfinance institutions (MFIs) and other traditional providers of credit to low income groups.

Consequently, a microfinance institution (MFI) has come to be defined as any institution that provides credit and other financial services to low income entrepreneurs who are traditionally not served by formal financial institutions.

A microfinance services provider can be a non-profit organisation such as an NGO MFI, a regulated microfinance bank, a subsidiary of a commercial bank, or a combination of these, that devotes all or part of its resources to provide microfinance products to low income clients, mainly credit.

Available studies strongly suggest that increased access to finance, that result in a country's financial deepening, causes growth and improves income distribution. Further studies have shown that increase in individual household income does result in increased access to education and health care for the poor.

Further, it could and often does, lead to effective mobilisation of local savings, increases individual household income, creates local employment, encourages accumulation of assets and adds to wealth creation, resulting in noticeable and measurable financial well-being in the lives of those served.

Microfinance programmes have succeeded in serving poor clients where formal finance sector service providers have not. This success has been attributed to factors such as better local knowledge, better information about clients and the use of peer-group monitoring (where microfinance clients themselves monitor loans).

In recent years microfinance programmes have adapted to address different aspects of poverty – basic needs, vulnerability, capabilities and so on. The focus has shifted from providing loans to providing a range of financial services which help meet the complex livelihood needs of poor people.

Research carried out in 2001 for the Small Industries Development Bank of India (a formal finance sector organisation with a microfinance programme) finds that:

Most poor households in India are not only poor, but are also vulnerable to unexpected events. MFIs reduce vulnerability by helping clients to diversify their income sources, build-up assets and save. In rural areas, using loans for productive purposes is particularly important in helping poor people escape poverty and protect themselves from shocks.

Today Microfinance is often considered one of the most effective and flexible strategies in the fight against global poverty. It is sustainable and can be implemented on the massive scale necessary to respond to the urgent needs of those living on less than $1 a day, the World's poorest.

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