Microcredit is the extension of very small loans (microloans) to those in poverty designed to spur entrepreneurship. These individuals lack collateral, steady employment and a verifiable credit history and therefore cannot meet even the most minimal qualifications to gain access to traditional credit. Microcredit is a part of microfinance, which is the provision of a wider range of financial services to the very poor.
Microcredit is a financial innovation that is generally considered to have originated with the Grameen Bank in Bangladesh.[1] In that country, it has successfully enabled extremely impoverished people to engage in self-employment projects that allow them to generate an income and, in many cases, begin to build wealth and exit poverty.
Due to the success of microcredit, many in the traditional banking industry have begun to realize that these microcredit borrowers should more correctly be categorized as pre-bankable; thus, microcredit is increasingly gaining credibility in the mainstream finance industry, and many traditional large finance organizations are contemplating microcredit projects as a source of future growth, even though almost everyone in larger development organizations discounted the likelihood of success of microcredit when it was begun.
The United Nations declared 2005 the International Year of Microcredit.
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Ideas relating to microcredit can be found at various times in modern history.
Jonathan Swift inspired the Irish Loan Funds of the 18th and 19th centuries.[2][3] In the mid-19th century, Individualist anarchist Lysander Spooner wrote about the benefits of numerous small loans for entrepreneurial activities to the poor as a way to alleviate poverty.[4] At about the same time, but independently to Spooner, Friedrich Wilhelm Raiffeisen founded the first cooperative lending banks to support farmers in rural Germany.[5] Ideas relating to microcredit were mentioned in portions of the Marshall Plan at the end of World War II.
In the 1950s, Akhtar Hameed Khan began distributing group-oriented credit in East Pakistan. Khan used the Comilla Model, in which credit is distributed through community-based initiatives.[6] The project failed due to the over-involvement of the Pakistani government, and the hierarchies created within communities as certain members began to exert more control over loans than others.[6]
The origins of microcredit in its current practical incarnation can be linked to several organizations founded in Bangladesh, especially the Grameen Bank.The Grameen Bank, which is generally considered the first modern microcredit institution, was founded in 1976 by Muhammad Yunus.[6] Yunus began the project in a small town called Jobra, using his own money to deliver small loans at low-interest rates to the rural poor. Grameen Bank was followed by organizations such as BRAC in 1972 and ASA in 1978.[7] Microcredit reached Latin America with the establishment of PRODEM in Bolivia in 1986; a bank that later transformed into the for-profit BancoSol.[8] Microcredit quickly became a popular tool for economic development, with hundreds of institutions emerging throughout the third world.[6] Though the Grameen Bank was formed initially as a non-profit organization dependent upon government subsidies, it later became a corporate entity and was renamed Grameen II in 2002.[7] Muhammad Yunus was awarded the Nobel Peace Prize in 2006 for his work providing microcredit services to the poor.[9]
Microcredit is based on a separate set of principles, which are distinguished from general financing or credit.[10] Microcredit organizations were created to serve in the place of loca [loan-sharks] known to take advantage of clients.[6] Many microcredit organizations began as non-profit organizations, running off of government or private subsidies. By the 1980s, the ‘financial systems approach,’ influenced by neoliberalism and propagated by the Harvard Institute for International Development became the dominant ideology among microcredit organizations. The commercialization of microcredit began with the formation of Unit Desa (BRI-UD) within the Bank Rakyat Indonesia in 1984, which offered ‘kupedes’ microloans based on market interest rates. Most microcredit organizations now function as independent banks, leading to high interest rates and a greater emphasis on savings programs.[6] The application of neoliberal economics to microcredit has generated much debate among scholars and development practitioners , with some claiming that microcredit bank directors, such as Muhammad Yunus, are employing the practices of a loan shark for their own personal enrichment.[7] Indeed, a Wall-street style scandal involving the Mexican microcredit organization Compartamentos illuminated the limitations of profit-driven microcredit institutions.[6]
Microcredit emphasizes trust building,[11] which can enable micro-entrepreneurship,[12] so generating employment[13] and helping people to help themselves during enterprise initiation and during difficult times.[13]
Though group-lending has long been a key part of microcredit, microcredit initially began with the principle of lending to individuals.[7] Despite the use of solidarity circles in 1970s Jobra, Grameen Bank and other early microcredit institutions initially focused on individual lending.[14] Indeed, Muhammad Yunus propagated to notion that every person has the potential to become an entrepreneur. The use of group-lending was motivated by economics of scale, as the costs associated with monitoring loans and enforcing repayment are significantly lower when credit is distributed to groups rather than individuals.[14] Many times the loan of one participant in group-lending depends upon the successful repayment of another member, thus transferring repayment responsibility off of microcredit institutions to loan recipients.[14]
Lending to women has become an important principle in microcredit, with banks and NGO’s such as BancoSol, WWB, and Pro Mujer catering to women exclusively. .[14] Though Grameen Bank initially tried to lend to both men and women at equal rates, women presently make up ninety-five percent of the bank’s clients. Women continue to make up seventy-five percent of all microcredit recipients worldwide.[14] Exclusive lending to women began in the 1980s when Grameen Bank found that women have higher repayment rates, and tend to accept smaller loans than men. Subsequently, many microcredit institutions have used the goal of empowering women to justify their disproportionate loans to women.[6] Microcredit is a tool for socioeconomic development.[15][16]
In the past few years, savings-led microfinance has gained recognition as an effective way to bring very poor families low-cost financial services. For example, in India, the National Bank for Agriculture and Rural Development (NABARD) finances more than 500 banks that on-lend funds to self-help groups (SHGs). SHGs comprise twenty or fewer members, of whom the majority are women from the poorest castes and tribes. Members save small amounts of money, as little as a few rupees a month in a group fund. Members may borrow from the group fund for a variety of purposes ranging from household emergencies to school fees. As SHGs prove capable of managing their funds well, they may borrow from a local bank to invest in small business or farm activities. Banks typically lend up to four rupees for every rupee in the group fund. Groups generally pay interest rates that range from 30% to 70% APR,[17] or 12% to 24% a year, based on the flat calculation method. Nearly 1.4 million SHGs comprising approximately 20 million women now borrow from banks, which makes the Indian SHG-Bank Linkage model the largest microfinance program in the world. Similar programs are evolving in Africa and Southeast Asia with the assistance of organizations like IFAD, Opportunity International, Catholic Relief Services, Compassion International, CARE, APMAS, Oxfam, Tearfund and World Vision. Microfinancing also helps in the development of an economy by giving everyday people the chance to establish a sustainable means of income. Eventual increases in disposable income will lead to economic development and growth.
Jason Cons and Kasia Paprocki of the Goldin Institute, while quite critical of some unintended side-effects of microcredit, nonetheless acknowledge its "enormous potential as a tool for poverty alleviation."[1]
Tazul Islam suggests that the evidence demonstrates a “positive impact on enterprise and household income and asset accumulation, household consumption, and positive influence on social welfare indicators (education, expenditure on health and nutrition)”[18].
Abudulai argues that microcredit improves the standard of living by raising awareness, aiding decision making, and reducing poverty among rural beneficiaries[19][20]. In this regard, according to Cheston and Kuhn, Microcredit programs have the potential to transform power relations and empower the poor—both men and women—[21]. As for women’s empowerment, Goetz and Gupta show that women experience higher bargaining and decision making power within the family as they bring more income to the household[22]. The increase in the household income trickles down to impact higher consumption standards, education for children, and better nutrition[23].
Moreover, Putnam asserts that dense networks within society is shown to positively correlate with political democracy and economic growth, as reinforced by the evidence of economic stagnation that followed the declining stocks of social capital in neighborhoods and communities[24]. So in the last decade or two, we have seen the shift of development discourse from “basic needs” or welfare approaches to poverty alleviation to an alternative approach using social capital manifested in social networks and associational life as resources that could fuel development from the bottom up[25].
The principles of microcredit have also been applied in attempting to address several non-poverty-related issues. Among these, multiple Internet-based organizations have developed platforms that facilitate a modified form of peer-to-peer lending where a loan is not made in the form of a single, direct loan, but as the aggregation of a number of smaller loans—often at a negligible interest rate. There are several ways by which the general public can participate in alleviating poverty using Web platforms.
New platforms that connect lenders to micro-entrepreneurs are emerging on the Web, for example Kiva, Zidisha, Lend for Peace, the Microloan Foundation, and iMicroInvest. Another WWW-based microlender United Prosperity uses a variation on the usual microlending model; with United Prosperity the micro-lender provides a guarantee to a local bank which then lends back double that amount to the micro-entrpreneur. United Prosperity claims this provides both greater leverage and allows the micro-entrepreneur to develop a credit history with their local bank for future loans. In 2009, the US-based nonprofit Zidisha became the first peer-to-peer microlending platform to link lenders and borrowers directly across international borders without local intermediaries.[26] Vittana allows peer-to-peer lending for student loans in developing countries.[27]
Microcredit is not only provided in poor countries, but also in one of the world's richest countries, the USA, where 37 million people (12.6%) live below the poverty line.[28] Among other organizations that provide microloans in the United States,[29][30] Grameen Bank started their operation in New York in April 2008. According to economist Jonathan Morduch of New York University, microloans have less appeal in the US, because people think it is too difficult to escape poverty through private enterprise. Bank of America has announced plans to award more than $3.7 million in grants to nonprofits to use in backing microloan programs.[31]
Other developed countries in which the micro-loan model is in fact gaining impetus include Israel,[32] Russia, the Ukraine and more, where micro-loans given to small business entrepreneurs are also used to overcome cultural barriers in the mainstream business society. The Israel Free Loan Association (IFLA) has lent out over $100 million in the past two decades to Israeli citizens of all backgrounds.
Even so, efforts to replicate Grameen-style solidarity lending in developed countries have generally not succeeded. For example, the Calmeadow Foundation tested an analogous peer-lending model in three locations in Canada, rural Nova Scotia and urban Toronto and Vancouver, during the 1990s. It concluded that a variety of factors—including difficulties in reaching the target market, the high risk profile of clients, their general distaste for the joint liability requirement, and high overhead costs—made solidarity lending unviable without subsidies.[33] However, debates have continued about whether the required subsidies may be justified as an alternative to other subsidies targeted to the entrepreneurial poor, and VanCity Credit Union, which took over Calmeadow's Vancouver operations, continues to use peer lending.
Some organizations, however, have been able to find success bringing the microfinance model to the United States. ACCION USA, the US subsidiary of the better-known ACCION International, has been able to provide US$117 million in microloans since 1991, with an over 90% repayment rate.
Gina Neff[34] of the Left Business Observer has described the microcredit movement as a privatization of public safety-net programs.[35] Enthusiasm for microcredit among government officials as an anti-poverty program can motivate cuts in public health, welfare, and education spending. Neff maintains that the success of the microcredit model has been judged disproportionately from a lender's perspective (repayment rates, financial viability) and not from that of the borrowers. For example, the Grameen Bank's high repayment rate does not reflect the number of women who are repeat borrowers that have become dependent on loans for household expenditures rather than capital investments. Studies of microcredit programs have found that women often act merely as collection agents for their husbands and sons, such that the men spend the money themselves while women are saddled with the credit risk.[1][36] As a result, borrowers are kept out of waged work and pushed into the informal economy.
Many studies in recent years have shown that risks like sickness, natural disaster and overindebtedness are a critical dimension of poverty and that very poor people rely heavily on informal savings to manage these risks (see, for example, The Microfinance Revolution: Sustainable Finance for the Poor by Marguerite Robinson). It might be expected that microfinance institutions would provide safe, flexible savings services to this population, but—with notable exceptions like Grameen II—they have been very slow to do so. Some experts argue that most microcredit institutions are overly dependent on external capital. A study of microcredit institutions in Bolivia in 2003, for example, found that they were very slow to deliver quality microsavings services because of easy access to cheaper forms of external capital.[37] Global data tables from The Microbanking Bulletin show that savings represent a small source of funds for microcredit institutions in most developing nations.
Because field officers are in a position of power locally and are judged on repayment rates as the primary metric of their success, they sometimes use coercive and even violent tactics to collect installments on the microcredit loans. Some loan recipients sink into a cycle of debt, using a microcredit loan from one organization to meet interest obligations from another.[1] Also, counter to the original intention of the microcredit system to empower women, one of the effects of an infusion of cash into local economies has been to increase dowries, with women forced at times to take microcredit loans as the only means to pay these increased dowries for their daughters.[1]
Bangladesh's former Finance and Planning Minister M. Saifur Rahman charges that some microfinance institutions use excessive interest rates.[38] In recent years, there has been increasing attention paid to the problem of interest rate disclosure, as many suppliers of microcredit quote their rates to clients using the flat calculation method, which significantly understates the true Annual Percentage Rate.
The BBC Business Weekly program reported that much of the supposed benefits associated with microfinance, are perhaps not as compelling as once thought. In a radio interview with Professor Dean Karlan of Yale University, a point was raised concerning a comparison between two groups: one African, financed through microcredit and one control group in the Philippines. The results of this study suggest that many of the benefits from microcredit are in fact loaned to people with existing business, and not to those seeking to establish new businesses. Many of those receiving microcredit also used the loans to supplement the family income. The income that went up in business was true only for men, and not for women. This is striking because one of the supposed major beneficiaries of microfinance is supposed to be targeted at women. Professor Karlan's conclusion was that whilst microcredit is not necessarily bad and can generate some positive benefits, despite some lenders charging interest rates between 40-60%, it isn't the panacea that is purported to be. He advocates rather than focusing strictly on microcredit, also giving citizens in poor countries access to rudimentary and cheap savings accounts.[39]
Furthermore, there are widespread accumulations of studies that indicate that the Grameen Bank system does not reach very far down the poverty [[spectrum], either in absolute terms or relative to other income categories. So according to Tazul Islam, it risks the exclusion of the below poverty line, since the clients of the bank incline to be clustered around the poverty line of predominantly moderately poor or vulnerable non-poor[40]. Also, of the poor who join the bank’s microcredit program, a high percentage often dropout after only a few loan cycles, while many others eventually dropout in later loan cycles as loan amounts begin to exceed their repayment capacity. For women, their loans are seen as the source of capital acquisition and this may lead to manipulation of women by putting pressure on them to gain membership of a credit group. Also, there are criticisms over microfinance institutions (MFIs) in creating small-debt traps for the poor with high interest rates and coercive methods of recovery[41]. In Andhra Pradesh, the villagers who take out the loan often do not know the interest that they were being charged and are not aware of the consequences of taking multiple loans as they take the second loan to clear the first loan. Also, some studies reveal that the repayment rate of Grameen’s loans does not match anywhere near what the bank claims, that at least one quarter of its loans were being used for household consumption and there is no serious supervision of bank, which leads to bank delaying defaults and hiding problem loans[42].
Studies note that there is increase in domestic violence for women who do not get the loan or have to wait a long time to get the loan and often times their loans are given over to their male relatives or husbands. Women are more likely to retain control over their loans in traditional women’s work like livestock rearing that are considered “women’s work”[43]. Moreover, the bigger the size of the loan, women lose their control more. For example, Montgomery’s studies show that women have 100% control over loans that are smaller than 1000 TK but only 46% of control if the loan is bigger than 4,000 TK[44]. Women also face the situation that they have to depend on men when they cannot generate enough income, which can lead to gendered pattern of dependency and new source of tension within the household[45].
Because the large majority of microloans are awarded to women under the pretense of ensuring their empowerment, several improvements must be made to the distribution of microcredit in relation to women.[46] Parmar takes issue with the idea that empowerment can be given to women by (mostly male) development practitioners in the form of loans, arguing that empowerment is a self-directed process.[47] Rebecca Vonderlack believes that measures must be taken to ensure that female loan recipients exert full control over their loans, and have access to markets.[48] Johnson argues for the inclusion of more female employees in microcredit institutions, and gender awareness training for existing staff.[47] Additionally, Leach claims that men must be included in the process of lending to women in order to diminish gender antagonism, as men often feel excluded from microcredit services.[46]
Many scholars and practitioners suggest an integrated package of services (‘a credit-plus’ approach) rather than just handing out money. When access to credit is combined with other services, such as additional financial services (voluntary savings facilities, non-productive loan facilities, insurance), enterprise development (production-oriented and management training, marketing support) and welfare-related services (literacy and health services, gender and social awareness training), the adverse effects discussed above will be diminished[49]. Goetz and Gupta argue that more experienced [entrepreneurs] who are getting loans should be qualified for bigger loans to ensure the success of the program[50]. Furthermore, scholars assert that the use of microcredit programs in development should be limited to the natural of the potentially helpful tool that they are, i.e., for opening doors of economic opportunity for the poor in helping to alleviate the economic resources trap that they often face[51].
Following is a selected bibliography about microcredit.
Loan Use in Rural Credit Programmes in Bangladesh. World Development 24:45-63.
in Rural Bangladesh. IDS Discussion Paper 363.
Evidence and Ways Forward. The Open University Working Paper No 41.
Pays?” World Development 27(1): 67-82.
Lahore, AKRSP Pakistan.
Summit, Halifa, Royal Tropical Institute and Oxfam Novib. http://www.microcreditsummit.org/papers/Workshops/28_Mutalima.pdf
Impact Assessment of Microfinance Programmes."