The third of nine children, Yunus was born on 28 June 1940 to a Bengali Muslim family in the village of Bathua, by the Kaptai road in Hathazari, Chittagong in the Bengal Presidency of the British Raj, present Bangladesh.

In 1944, his family moved to the city of Chittagong, and he moved from his village school to Lamabazar Primary School.

By 1949, his mother was afflicted with psychological illness.

In 1957, he enrolled in the Department of Economics at Dhaka University and completed his BA in 1960 and MA in 1961.

After his graduation, Yunus joined the Bureau of Economics as a research assistant to the economics researches of Professor Nurul Islam and Rehman Sobhan. Later, he was appointed lecturer in economics in Chittagong College in 1961. During that time, he also set up a profitable packaging factory on the side.

In 1965, he received a Fulbright scholarship to study in the United States.

From 1969 to 1972, Yunus was assistant professor of economics at Middle Tennessee State University in Murfreesboro.

In 1967, while Yunus attended Vanderbilt University, he met Vera Forostenko, a student of Russian literature at Vanderbilt University and daughter of Russian immigrants to Trenton, New Jersey, United States. They were married in 1970.

Inspired by the birth of Bangladesh in 1971, Yunus returned home in 1972, to help Mujib rebuild the nation shattered by a long and bloody war.

He obtained his PhD in economics from the Vanderbilt University Graduate Program in Economic Development (GPED) in 1971.

During the Bangladesh Liberation War in 1971, Yunus founded a citizen's committee and ran the Bangladesh Information Center, with other Bangladeshis in the United States, to raise support for liberation. He also published the Bangladesh Newsletter from his home in Nashville.

In 1975, he developed a Nabajug (New Era) Tebhaga Khamar (three share farm) which the government adopted as the Packaged Input Programme. In order to make the project more effective, Yunus and his associates proposed the Gram Sarkar (the village government) programme.

In 1976, during visits to the poorest households in the village of Jobra near Chittagong University, Yunus discovered that very small loans could make a disproportionate difference to a poor person. Yunus lent US$27 of his money to 42 women in the village, who made a profit of BDT 0.50 (US$0.02) each on the loan. Thus, Yunus is credited with the idea of microcredit.

In December 1976, Yunus finally secured a loan from the government Janata Bank to lend to the poor in Jobra. The institution continued to operate, securing loans from other banks for its projects.

Yunus's marriage with Vera ended within months of the birth of their baby girl, Monica Yunus, in 1979 Chittagong, as Vera returned to New Jersey claiming that Bangladesh was not a good place to raise a baby.

Yunus married Afrozi Yunus, who was then a researcher in physics at Manchester University. She was later appointed as a professor of physics at Jahangirnagar University. Their daughter Deena Afroz Yunus was born in 1986.

By 1982, it had 28,000 members. On 1 October 1983, the pilot project began operation as a full-fledged bank for poor Bangladeshis and was renamed Grameen Bank ("Village Bank").

The inaugural ceremony of Grameenphone, the largest telephone service in Bangladesh, took place at Hasina's office on 26 March 1997.

Yunus was awarded the 2006 Nobel Peace Prize, along with Grameen Bank, for their efforts to create economic and social development.

On 11 January 2007, Army General Moeen U Ahmed staged a military coup. Meanwhile, Yunus turned down his request to become the nation's fourth Chief Advisor after Khaleda Zia's term ended. Yunus, however, suggested the general pick Fakhruddin Ahmed for the job.

Yunus finally announced that he is willing to launch a political party tentatively called Citizens' Power (Nagorik Shakti) on 18 February 2007.

There was speculation that the army supported a move by Yunus into politics. On 3 May, however, Yunus declared that he had decided to abandon his political plans following a meeting with the head of the interim government, Fakhruddin Ahmed.

In January 2008, Houston, Texas declared 14 January as "Muhammad Yunus Day".

In July 2009, Yunus became a member of the SNV Netherlands Development Organisation International Advisory Board to support the organisation's poverty reduction work.

Since 2010, Yunus has served as a Commissioner for the Broadband Commission for Digital Development, a UN initiative which seeks to use broadband internet services to accelerate social and economic development.

A Danish documentary, Caught in Micro Debt, produced and directed by journalist Tom Heinemann, aired on Norwegian national television NRK in November 2010. It made a number of allegations against Yunus and Grameen Bank.

On 6 December, NORAD (The Norwegian Agency for Development Cooperation) published a statement clearing Yunus and the Bank from any wrongdoing on this point, following a comprehensive review of NORAD's support commissioned by the Minister of International Development.

The Government announced a review of Grameen Bank activities on 11 January 2011, which is ongoing.

On 27 January 2011, Yunus appeared in court in a food-adulteration case filed by the Dhaka City Corporation (DCC) Food Safety Court, accusing him of producing an "adulterated" yogurt whose fat content was below the legal minimum. According to Yunus's lawyer, the allegations are "false and baseless". At the request of Yunus's lawyers, pointing procedural irregularities and errors, this case is now considered by the High Court.

On 15 February 2011, the Finance Minister of Bangladesh, Abul Maal Abdul Muhith, declared that Yunus should "stay away" from Grameen Bank while it is being investigated.

In March 2011, Yunus petitioned the Bangladesh High Court challenging the legality of the decision by the Bangladeshi Central Bank to remove him as Managing Director of Grameen Bank. The same day, nine elected directors of Grameen Bank filed a second petition.

On 2 March 2011, Muzammel Huq – a former Bank employee, whom the government had appointed Chairman in January – announced that Yunus had been fired as Managing Director of the Bank. However, Bank General Manager Jannat-E Quanine issued a statement that Yunus was "continuing in his office" pending review of the legal issues surrounding the controversy.

The High Court hearing on the petitions, was planned for 6 March 2011 but postponed. On 8 March 2011, the Court confirmed Yunus's dismissal.

On 2 August 2012, Sheikh Hasina's approved a draft of "Grameen Bank Ordinance 2012" to increase government control over the bank.

On 4 October 2013, Bangladesh's cabinet has approved the draft of a new law that will give the country's central bank closer control over Grameen Bank, raising the stakes in a long-running dispute with the pioneering microlender.

The new Grameen Bank law was passed by parliament on 7 November 2013, and replaced the Grameen Bank Ordinance, the law that underpinned the creation of Grameen Bank as a specialised microcredit institution in 1983.

In March 2016, he was appointed by United Nations Secretary-General Ban Ki-moon to the High-Level Commission on Health Employment and Economic Growth, which was co-chaired by presidents François Hollande of France and Jacob Zuma of South Africa.