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- 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 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.
The modern invention of microloans is credited to St. Louis entrepreneur Menlo Smith who was struck by the abject poverty he saw in the Philippines.
Microcredit is a financial innovation that is generally considered to have originated with the Grameen Bank in Bangladesh. 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.
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. Ideas relating to microcredit were mentioned in portions of the Marshall Plan at the end of World War II.
The origins of microcredit in its current practical incarnation, with attention paid by economists and politicians worldwide, can be linked to several organizations founded in Bangladesh, especially the Grameen Bank in the 1970s and onward, for which its founder Muhammad Yunus was awarded the Nobel Peace Prize in 2006.
Microcredit is based on a separate set of principles, which are distinguished from general financing or credit.
Microcredit emphasizes building capacity of a micro-entrepreneur, employment generation, trust building, and help to the micro-entrepreneur on initiation and during difficult times.
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, 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 Opportunity International, Catholic Relief Services, CARE, APMAS and Oxfam. 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."
Microcredit and 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 and the Microloan Foundation. 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.
In the developed world
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. Among other organizations that provide microloans in the United States, 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.
Other developed countries in which the micro-loan model is in fact gaining impetus include 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.
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.
Some organizations, however, have been able to find success bringing the microfinance model to the United States. ACCION USA, which is the US subsidiary of the more well-known ACCION International, has been able to provide US$117 million in microloans since 1991, with an over 90% repayment rate.
Gina Neff of the Left Business Observer has described the microcredit movement as a privatization of public safety-net programs. 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. 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. 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. 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.
Bangladesh's former Finance and Planning Minister M. Saifur Rahman charges 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.
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.
Role of developing countries—a recent Forbes ranking
The US business magazine Forbes ranked the world's top 50 microfinance institutions. Forbes made the ranking of MRIs by using data available from the Microfinance Information Exchange and the analysis from rating firms Micro-Credit Ratings International Limited and MicroRate. The ranking was based on six key variables: gross loan portfolio, operating expense, operating expense divided by the average number of active borrowers as a proportion of gross national income per capita, outstanding balance of loans overdue by more than 30 days as a proportion of gross loan portfolio, return on assets, and return on equity. "Each microfinance institution earned scores in four equally weighted categories—scale, efficiency, portfolio risk and profitability. Rankings were then based on the combined average score of those four categories."
India and Bangladesh together are home to the most MFIs. Seven of the 50 were little-known institutions from India. Those in other countries included five from Bosnia and Herzegovina, four each from Morocco and Peru, three from Colombia, two each from Ecuador, Ethiopia and Serbia, and one each from 15 other countries, including Russia, Pakistan, Mexico and Brazil.
Forbes magazine said that "microfinance has become a buzzword of the decade, raising the provocative notion that even philanthropy aimed at alleviating poverty can be profitable to institutional and individual investors."
"Billionaires, global leaders and Nobel Prize recipients are hailing these direct loans to uncollateralised would-be entrepreneurs as a way to lift them out of poverty while creating self-sustaining businesses," it stated.
- Cooperative banking
- Flat rate (finance)
- Micro credit for water supply and sanitation
- Solidarity lending
- Jason Cons and Kasia Paprocki of the Goldin Institute, "The Limits of Microcredit—A Bangladeshi Case", Food First Backgrounder (Institute for Food and Development Policy), Winter 2008, volume 14, number 4.
- University of Calgary
- SSRN-Micro Finance: The Pillars of a Tool to Socio-Economic Development by Vrajlal Sapovadia
- Sapovadia, Vrajlal K., "Micro Finance: The Pillars of a Tool to Socio-Economic Development" . Development Gateway, 2006
- "Zidisha Set to "Expand" in Peer-to-Peer Microfinance", Microfinance Focus, Feb 2010
- University of Michigan
- Svivatomehet.org.il (in Hebrew)
- Cheryl Frankiewicz. "Calmeadow Metrofund: A Canadian Experiment in Sustainable Microfinance", Calmeadow Foundation, April 2001.
- Microcredit, microresults The Left Business Observer #74, October 1996
- Goetz, A.M. and R. Sen Gupta. "Who takes the Credit? Gender, power and control over loan use in rural credit programmes in Bangladesh." World Development Vol. 24, January 1995.
- Hillary Miller. The paradox of savings mobilization in microfinance: why microfinance institutions in Bolivia have virtually ignored savings. Development Alternatives Inc. and USAID, Washington, 2003.
- Saifur takes swipe at micro-credit
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).
- 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