Microcredit

This article is specific to small loans. For financial services to the poor, see Microfinance. For small payments, see Micropayment.

Microcredit is the extension of very small loans (microloans) to poor borrowers who typically lack collateral, steady employment and a verifiable credit history. It is designed to spur entrepreneurship, increase incomes, alleviate poverty and often also to empower women. Microcredit is a part of microfinance, which is the provision of a wider range of financial services, in particular savings, to the poor. As of 2009 it was estimated that there were 74 million recipients of microcredits with a total of $38 billion in outstanding loans. Modern microcredit is generally considered to have originated with the Grameen Bank founded in Bangladesh in 1983s. Many traditional banks subsequently introduced microcredit, even though they had earlier on discounted its likelihood of success. As of 2012, microcredit is widely used in developing countries and it is presented as having "enormous potential as a tool for poverty alleviation." The United Nations had declared 2005 the International Year of Microcredit.

Critics argue, however, that microcredit has not had a positive impact on gender relationships, did not alleviate poverty, has led many borrowers into a debt trap and constitutes a "privatization of welfare". Professor Dean Karlan from Yale University says that whilst microcredit generated benefits it isn't the panacea that it has been purported to be. He advocates also giving the poor access to rudimentary and cheap savings accounts. The first randomized evaluation of microcredit, conducted by Esther Duflo and others, showed mixed results: there was no effect on household expenditure, gender equity, education or health, but the number of new businesses increased by one third compared to a control group.

History

Early Beginnings

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. 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. At about the same time, but independently to Spooner, Friedrich Wilhelm Raiffeisen founded the first cooperative lending banks to support farmers in rural Germany. 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. 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.

Modern Microcredit

Nobel Laureate Muhammad Yunus, the founder of Grameen Bank, which is generally considered the first modern microcredit institution.

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. 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. Microcredit reached Latin America with the establishment of PRODEM in Bolivia in 1986; a bank that later transformed into the for-profit BancoSol. Microcredit quickly became a popular tool for economic development, with hundreds of institutions emerging throughout the third world. 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. Muhammad Yunus was awarded the Nobel Peace Prize in 2006 for his work providing microcredit services to the poor.

Principles

===Economic Principles of Microcredit===nigers is based on a separate set of principles, which are distinguished from general financing or credit. Microcredit organizations were created to serve in the place of loan-sharks known to take advantage of clients. 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. 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. Indeed, a Wall-street style scandal involving the Mexican microcredit organization Compartamos illuminated the limitations of profit-driven microcredit institutions.

Group Lending

Microfinance meeting in Tzaneen, South Africa. Group-lending is a key part of microcredit.

Though group-lending has long been a key part of microcredit, microcredit initially began with the principle of lending to individuals. Despite the use of solidarity circles in 1970s Jobra, Grameen Bank and other early microcredit institutions initially focused on individual lending. 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. 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.

Lending to Women

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. 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. 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.

Examples

Developing countries

Mumbai Headquarters of the National Bank for Agriculture and Rural Development of India, which on-lends funds to banks providing microcredit.

Grameen Bank in Bangladesh is the oldest and probably best-known microfinance institution in the world. 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. In Asia borrowers generally pay interest rates that range from 30% to 70% without commission and fees. 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.

Developed countries

In the USA, 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. 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.

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. 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.

Microcredits have also been introduced in Israel, 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.

Peer-to-peer lending over the Web

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. Vittana allows peer-to-peer lending for student loans in developing countries.

Impact

Microcredit is being justified by its positive impact on income, education and health as well as the empowerment of women. It is also claimed that repayment rates among the poor are very high. Critics argue that microcredit has driven poor households into a debt trap, that the money from loans is used for consumption, that men actually use the money for which their female relatives get into debt and that microcredit does not alleviate poverty or improve health and education. It is further argued that the risks to which the poor are exposed are better managed by a combination of flexible and safe saving opportunities with loans rather than an exclusive emphasis on loans. These arguments are reviewed in more detail below.

Impact on income

Microlending aims at increasing income through productive activities such as goat herding, as shown here in Rwanda on a cooperative funded through microlending.

According to Cheston and Kuhn, Microcredit programs have the "potential" to transform power relations and empower the poor—both men and women. Tazul Islam suggests a “positive impact on enterprise and household income and asset accumulation, household consumption. Abudulai argues that microcredit in rural Ghana reduced poverty among beneficiaries.

However, 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, two groups were compared: one African, financed through microcredit and one control group in the Philippines. The results of this study suggest that many microcredits 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 first randomized evaluation of the impact of introducing microcredit in a new market has been undertaken in slums in Hyderabad, India, in 2008. Half the slums were randomly selected for opening branches of banks that provided microcredits while the remainder were not. The study showed that fifteen to 18 months after lending began, there was no effect on average monthly expenditure per capita, but expenditure on durable goods increased and the number of new businesses increased by one third.

Gender impact

Meeting of clients of the Indian microlender ESAF in the state of Kerala.

A 1996 study in Bangladesh has acknowledges the "success" of reaching women with microcredit as "highly impressive", but also notes that their loans are often given over to their male relatives or husbands. In a minority of cases there was even an increase in domestic violence for women who do not get the loan or have to wait a long time to get the loan. The study also showed that women are more likely to retain control over their loans in traditional women’s work like livestock rearing that are considered “women’s work”. A 2008 study of microcredit programs in Bangladesh 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. The bigger the size of the loan, women lose their control more. For example, a study in Bangladesh showed that women have 100% control over loans that are smaller than 1000 Taka but only 46% of control if the loan is bigger than 4,000 Taka. Women may be put under pressure by their male relatives to join a credit group and indebt themselves. One of the alleged effects of microcredit 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. The first randomized eveluation of the introduction of microcredit found no impact on women's decision-making.

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. 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. 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. Johnson argues for the inclusion of more female employees in microcredit institutions, and gender awareness training for existing staff. 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.

Impact on indebtedness and level of repayment rates

Bangladesh's former Finance and Planning Minister M. Saifur Rahman charged in 2005 that some microfinance institutions use excessive interest rates. 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. Some loan recipients sink into a cycle of debt, using a microcredit loan from one organization to meet interest obligations from another. 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. 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 studies reveal that the repayment rate of Grameen’s loans are much lower than what the bank claims, that at least one quarter of its loans were being used for household consumption and that there is no serious supervision of bank, which leads to bank delaying defaults and hiding problem loans.

Impact on education and health

Tazul Islam asserts a positive influence of microcredit on the level of education, health and nutrition. It was asserted that the increase in income trickled down and led to better education for children and better nutrition. However, the first randomized evaluation of microcredit did not find any evidence of an impact on education and health.

Impact on poverty

Studies 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. 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. Of the poor who join Grameen bank’s microcredit program, a high percentage often drop out after only a few loan cycles, while many others eventually drop out in later loan cycles as loan amounts begin to exceed their repayment capacity. 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.

Impact on risks for the poor and on savings

Risks like sickness and natural disasters are a critical dimension of poverty and poor people rely heavily on informal savings to manage these risks. Microfinance institutions could provide savings services to this population to reduce these risks, 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. Global data tables from The Microbanking Bulletin show that savings represent a small source of funds for microcredit institutions in most developing nations.

Suggestions to improve microcredit

Many microfinance institutions also offer savings facilities, such as Banco Palma in Brazil shown here.

Many scholars and practitioners suggest an integrated package of services (‘a credit-plus’ approach) rather than just provicing credits. When access to credit is combined with 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 can be diminished. Some argue that more experienced entrepreneurs who are getting loans should be qualified for bigger loans to ensure the success of the program.

See also

• Cooperative banking
• Count Me In
• Flat rate (finance)
• Micro credit for water supply and sanitation
• Microgrant
• Project Enterprise
• Solidarity lending

Bibliography

Following is a selected bibliography about microcredit.

• Adams, Dale, Doug Graham and J.D. Von Pischke (eds.). Undermining Rural Development with Cheap Credit. Westview Press, Boulder, Colorado, 1984.
• Drake, Deborah, and Elizabeth Rhyne (eds.). The Commercialization of Microfinance: Balancing Business and Development. Kumarian Press, 2002.
• Rhyne, Elizabeth. Mainstreaming Microfinance: How Lending to the Poor Began, Grew and Came of Age in Bolivia. Kumarian Press, 2001.
• Fuglesang, Andreas and Dale Chandler. Participation as Process – Process as Growth – What We can Learn from the Grameen Bank. Grameen Trust, Dhaka, 1993.
• Gibbons, David. The Grameen Reader. Grameen Bank, Dhaka, 1992.
• Harper, Malcolm and Shailendra Vyakarnam. Rural Enterprise: Case Studies from Developing Countries. ITDG Publishing, 1988.
• Hulme, David and Paul Mosley. Finance Against Poverty. Routledge, London, 1996.
• Johnson, Susan and Ben Rogaly. Microfinance and Poverty Reduction. Oxfam, Oxford UK, 1997.
• Kadaras, James & Elizabeth Rhyne. Characteristics of equity investment in microfinance. Accion International, 2004.
• Khandker, Shahidur R. Fighting Poverty with Microcredit. Bangladesh edition, The University Press Ltd, Dhaka, 1999.
• Ledgerwood, Joanna. Microfinance Handbook. Washington, D.C., World Bank, 1998.
• Rutherford, Stuart. ASA: The Biography of an NGO, Empowerment and Credit in Rural Bangladesh. ASA, Dhaka, 1995.
• Small Enterprise Development. Intermediate Technology Publications, London.
• Todd, Helen Women at the Center: Grameen Borrowers After One Decade. University Press Ltd, Dhaka, 1996.
• Wood, Geoff D. & I. Sharif (eds.). Who Needs Credit? Poverty and Finance in Bangladesh. University Press Ltd., Dhaka, 1997.
• Yunus, Muhammad. Banker to the Poor: Micro-Lending and the Battle Against World Poverty. Public Affairs, 2003.
• Padmanabahn, K.P., Rural Credit, Intermediate Tech. Publ. Ltd., London 1988.
• Germidis D. et al.,Financial Systems and Development: what role for the formal and informal financial sectors?, OECD, Paris 1991.
• Robinson, Marguerite S., The microfinance revolution, The World Bank, Washington D.C., 2001.
• Mauri, Arnaldo, A new approach to institutional lending and loan administration in rural areas of LDCs, International Review of Economics, Vol. XLV, no. 4 (1995).
• Goetz, A.-M., and R. Sengupta. 1996. Who Takes the Credit? Gender, Power and Control over

Loan Use in Rural Credit Programmes in Bangladesh. World Development 24:45-63.

• Johnson, S. 1997. Gender and Micro-finance: guidelines for best practice. Action Aid-UK.
• Kabeer, N. 1998. 'Money Can't Buy Me Love'? Re-evaluating Gender, Credit and Empowerment

in Rural Bangladesh. IDS Discussion Paper 363.

• Mayoux, L. 1998a. Women's Empowerment and Micro-finance programmes: Approaches,

Evidence and Ways Forward. The Open University Working Paper No 41.

• Rahman, A. (1999). “Micro-credit Initiatives for Equitable and Sustainable Development: Who

Pays?” World Development 27(1): 67-82.

• CHESTON, S. and KUHN, L. (2002). Empowering Women through Microfinance. Pathways Out of Poverty: Innovations in Microfinance for the Poorest Families
• Harper, A. ( 1995). Providing women in Baltistan with access to loans - potential and problems.

Lahore, AKRSP Pakistan.

• Mutalima, I. K., 2006, Microfinance and Gender Equality: Are We Getting There?: Micro Credit

Summit, Halifa, Royal Tropical Institute and Oxfam Novib. http://www.microcreditsummit.org/papers/Workshops/28_Mutalima.pdf

• ZAIDI , S AKBAR, HAROON JAMAL , SARAH JAVEED and SARAH ZAKA. (2007). "Social

Impact Assessment of Microfinance Programmes."

External links

• Building a Microfinance Institution from Scratch Institution's objective is to offer financial services on a self-sustaining yet efficient basis to microentrepreneurs.
• Journal of Microfinance, a forum for practitioners in microfinance and microenterprise development to exchange information and ideas
• Omidyar-Tufts Microfinance Fund, a partnership between Pierre Omidyar and Tufts University.
• "Microfinance in the U.S." Helping ensure egalitarian access to needed financial services.
• The Promise of Microfinance for Poverty Relief in the Developing World
• Microcredit Regulatory Authority, MRA The central body to monitor and supervise microfinance operation of NGOs of Bangladesh
• Alleviation and poverty and enpowerment of the poor, BRAC Bangladesh
• The European Union Project "Credit Cooperatives - Russian Federation" official web site
• Small Fortunes: Microcredit and the Future of Poverty web site for a PBS documentary