Microcredit

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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 impoverished borrowers who typically lack collateral, steady employment and a verifiable credit history. It is designed not only to support entrepreneurship and alleviate poverty, but also in many cases to empower women and uplift entire communities by extension. In many communities worldwide, in developed and developing nations alike, women lack the highly stable employment histories that traditional lenders tend to require. This reality might result from factors such as leaving the paid workforce to care for children and elderly relatives. As of 2009 an estimated 74 million men and women held microloans that totalled US$38 billion.[1] Grameen Bank reports that repayment success rates are between 95 and 98 per cent.[2]

Microcredit is a division of microfinance, which is the provision of a wider range of financial services, especially savings accounts, to the poor. Modern microcredit is generally considered to have originated with the Grameen Bank founded in Bangladesh in 1983. Many traditional banks subsequently introduced microcredit despite initial misgivings. The United Nations declared 2005 the International Year of Microcredit. As of 2012, microcredit is widely used in developing countries and is presented as having "enormous potential as a tool for poverty alleviation."[3]

Critics argue, however, that microcredit has not had a positive impact on gender relationships, does not alleviate poverty, has led many borrowers into a debt trap and constitutes a "privatization of welfare".[4] 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.[5] Professor Dean Karlan from Yale University says that whilst microcredit generates benefits it isn't the panacea that it has been purported to be. He advocates also giving the poor access to savings accounts.[6]

Contents

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.[7] 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.[8] At about the same time, but independently to Spooner, Friedrich Wilhelm Raiffeisen founded the first cooperative lending banks to support farmers in rural Germany.[9] 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.[10] 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.[10]

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.[10] 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.[11] Microcredit reached Latin America with the establishment of PRODEM in Bolivia in 1986; a bank that later transformed into the for-profit BancoSol.[12] Microcredit quickly became a popular tool for economic development, with hundreds of institutions emerging throughout the third world.[10] 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.[11] Muhammad Yunus was awarded the Nobel Peace Prize in 2006 for his work providing microcredit services to the poor.[13]

Principles

Economic principles

Microcredit is ideally based on a unique set of principles that are readily distinguished from trends in the wider credit market.[14] Microcredit organizations were initially created as alternatives to the "loan-sharks" known to take advantage of clients.[10] Indeed, many microlenders began as non-profit organizations and operated with government funds or private subsidies. By the 1980s, however 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 officially began in 1984 with the formation of Unit Desa (BRI-UD) within the Bank Rakyat Indonesia. Unit Desa offered ‘kupedes’ microloans based on market interest rates.

Ironically, many microcredit organizations now function as independent banks. This has led to their charging higher interest rates on loans and placing more emphasis on savings programs.[10] Notably, Unit Desa has charged in excess of 20 per cent on small business loans.[15] 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, apply the practices of loan sharks for their personal enrichment.[11] Indeed, the academic debate foreshadowed a Wall-street style scandal involving the Mexican microcredit organization Compartamos.[10]

Even so, the numbers indicate that ethical microlending and investor profit can go hand-in-hand. In the 1990s a rural finance minister in Indonesia showed how Unit Desa could lower its rates by about 8% while still bringing attractive returns to investors.[16] Today, smaller investment firms are adopting the microlending movement's original ideals. For instance, whereas small coffee farmers in Honduras are typically charged an 18% bank rate, a private investment firm in the US has room to offer more ethical loan terms and offer an attractive return to investors.[17]

Group lending

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

Though lending to groups has long been a key part of microcredit[citation needed], microcredit initially began with the principle of lending to individuals.[11] Despite the use of solidarity circles in 1970s Jobra, Grameen Bank and other early microcredit institutions initially focused on individual lending.[12] Indeed, Muhammad Yunus propagated the 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.[12] Many times the loan to one participant in group-lending depends upon the successful repayment from another member, thus transferring repayment responsibility off of microcredit institutions to loan recipients.[12]

Lending to women

Lending to women has become an important principle in microcredit, with banks and NGOs such as BancoSol, WWB, and Pro Mujer catering to women exclusively.[12] 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.[12] 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.[10]

Examples

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.[18] 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.

Grameen Bank launched their US operations in New York in April 2008.[19] Bank of America has announced plans to award more than $3.7 million in grants to nonprofits to use in backing microloan programs.[20] ACCION USA, the US subsidiary of the better-known ACCION International, has provided US$117 million in microloans since 1991, with an over 90% repayment rate.[citation needed] One research study of the Grameen model shows that poorer individuals are safer borrowers because they place more value on the relationship with the bank.[21] 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 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.[22] Microcredits have also been introduced in Israel,[23] Russia, Ukraine and other nations where micro-loans help small business entrepreneurs overcome cultural barriers in the mainstream business society. The Israel Free Loan Association (IFLA) has lent more than $100 million in the past two decades to Israeli citizens of all backgrounds.[citation needed]

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, 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.[24] Vittana allows peer-to-peer lending for student loans in developing countries.[25]

Impact

Microcredit is being justified by its positive impact on poverty reduction, income, consumption, the creation of businesses, education and health, the empowerment of women and the empowerment of the poor in general.

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.

At the 2008 Innovations for Poverty Action/Financial Access Initiative Microfinance Research conference, economist Jonathan Morduch of New York University noted there are only one or two methodologically sound studies of microfinance's impact.[26] Grameen Foundation has released two papers summarizing the state of research on the impact of microfinance on poverty: "Measuring the Impact of Microfinance, Taking Stock of What We Know" by Nathanael Goldberg[27] (now with Innovations for Poverty Action) and an update, "Measuring the Impact of Microfinance: Taking Another Look" by Professor Kathleen Odell. These two papers identify scores of findings indicating positive impact in research conducted over the last twenty years, as well as some findings that suggest limited or negative impact in some cases.

Income, consumption and the creation of businesses

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

Tazul Islam suggests that microcredit has a "positive impact on enterprise and household income and asset accumulation".[28] However, the positive economic impacts associated with microcredit are not as extensive as once thought.[6] A study by Dean Karlan of Yale University in the Philippines compared two groups in Manila: a treatment group, financed through microcredit, and a control group that did not receive microcredit. The study showed that in this case many microcredits were loaned to people with existing business, and not to those seeking to establish new businesses. The businesses became more profitable and laid off unproductive employees including friends and relatives that they previously had felt obliged to employ.[29]

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.[5]

Poverty

Milford Bateman, the author of Why Doesn't Microfinance Work?, argues that microcredit offers only an "illusion of poverty reduction". "As in any lottery or game of chance, a few in poverty do manage to establish microenterprises that produce a decent living," he argues, but "these isolated and often temporary positives are swamped by the largely overlooked negatives." Bateman concludes that "The international development community is now faced with the reality that, overall, microfinance has been a development policy blunder of quite historic proportions."[30]

Sociologist Jonathan H. Westover, Ph.D. found that much of the evidence on the effectiveness of microfinance for alleviating poverty is based in anecdotal reports or case studies. He initially found over 100 articles on the subject, but included only the 6 which used enough quantitative data to be representative, and none of which employed rigorous methods such as randomized control trials similar to those reported by Innovations for Poverty Action and the M.I.T. Jameel Poverty Action Lab. One of these studies found that microfinance reduced poverty. Two others were unable to conclude that microfinance reduced poverty, although they attributed some positive effects to the program. Other studies concluded similarly, with surveys finding that a majority of participants feel better about finances with some feeling worse.[31]

According to Islam the Grameen Bank does not reach the poorest, since the clients of the bank tend to be clustered around the poverty line of predominantly moderately poor or vulnerable non-poor.[32] 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.[33]

Some problems with microcredit are mistakenly alleged in The Micro Debt, a film by the Danish journalist Tom Heinemann.[34] After a thorough investigation in December 2010 by the Norwegian Foreign Ministry, the alleged problems have been proven to be false and no further actions against the Grameen Bank and its founder, Muhammad Yunnis, have been taken.[35] The documentary by Heinemann also looks at the effectiveness of Grameen Bank and alleges that it has little impact on poverty by highlighting the purported continued poverty of Sufiya Begum, the original loan recipient of Grameen, in Jobra Village. This allegation is disputed, since documentary maker Gayle Ferraro found the woman alive and well, confirming the original Grameen story.[36]

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 not all of them have been successful at doing so. For example, 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]

Microcredit has been blamed for many suicides in India: aggressive lending by microcredit companies in Andhra Pradesh is said to have resulted in over 80 deaths in 2010.[38]

Interest rates, stock offerings and repayment rates

There has been much criticism of the high interest rates charged to borrowers. For example, Bangladesh's former Finance and Planning Minister M. Saifur Rahman charged in 2005 that some microfinance institutions use excessive interest rates.[39] Sharma has criticized microfinance institutions for creating small-debt traps for the poor in Andhra Pradesh in India with high interest rates and coercive methods of recovery.[33] A 2008 study in Bangladesh showed that some loan recipients sink into a cycle of debt, using a microcredit loan from one organization to meet interest obligations from another. Field officers who are in a position of power locally and are remunerated based on repayment rates sometimes use coercive and even violent tactics to collect installments on the microcredit loans.[3] The real average portfolio yield cited by the sample of 704 microfinance institutions that voluntarily submitted reports to the MicroBanking Bulletin in 2006 was 22.3% annually. However, annual rates charged to clients are higher, as they also include local inflation and the bad debt expenses of the microfinance institution.[40] Muhammad Yunus has recently made much of this point, and in his latest book[41] argues that microfinance institutions that charge more than 15% above their long-term operating costs should face penalties.

A related issue is interest rate disclosure: Many suppliers of microcredit quote their rates to clients using the flat calculation method, which significantly understates the true Annual Percentage Rate.[citation needed] In Andhra Pradesh, the villagers who take out the loan often did not know the interest that they were being charged and were not aware of the consequences of taking multiple loans as they take the second loan to clear the first loan.[42]

The issuing of stocks through IPOs (Initial Public Offerings) by microfinance institutions has also been criticized. In July 2010 India's biggest MFI, SKS Microfinance also went public. In both instances Muhammad Yunus publicly stated his disagreement, saying that the poor should be the only beneficiaries of microfinance.[43][44]

Tucker argued in 1995 that the 98% repayment rate of Grameen’s loans only refer to first-time loans, that they are often repaid by new loans and that the practice of lending only to groups of women puts lenders under pressure because each member can only obtain a new loan if each member has repaid the previous loan.[42]

Gender

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

A 1996 study in Bangladesh acknowledges the "success" of reaching women with microcredit as "highly impressive", but also notes that loans are often given over to male relatives or husbands. In a minority of cases there was even an increase in domestic violence for women who did not get the loan or had 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”.[45] 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.[3] 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.[46] A study in India showed that women may be put under pressure by their male relatives to join a credit group and indebt themselves.[33] A study in Bangladesh showed that microcredit increases dowries, with women forced at times to take microcredit loans as the only means to pay these increased dowries for their daughters.[3] The first randomized evaluation of the introduction of microcredit, carried out in Hyderabad in India, found no impact on women's decision-making.[5]

A large majority of microloans is awarded to women, often under the pretense of ensuring their empowerment.[47] 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.[48] Johnson argues for the inclusion of more female employees in microcredit institutions, and gender awareness training for existing staff.[48] 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.[47]

Some authors argue that microcredit not only empowers women, but men as well. For example, Cheston and Kuhn say that microcredit programs have the "potential" to transform power relations and empower the poor — both men and women.[49]

Education and health

Tazul Islam asserts a positive influence of microcredit on the level of education, health and nutrition.[28] However, the first randomized evaluation of microcredit, carried out in Hyderabad in India, did not find any evidence of an impact on education and health.[5]

Improvement

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 providing 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.[50] Some argue that more experienced entrepreneurs who are getting loans should be qualified for bigger loans to ensure the success of the program.[45]

One of the principal challenges of microcredit is providing small loans at an affordable cost. The global average interest and fee rate is estimated at 37%, with rates reaching as high as 70% in some markets.[51] The reason for the high interest rates is not primarily cost of capital. Indeed, the local microfinance organizations that receive zero-interest loan capital from the online microlending platform Kiva charge average interest and fee rates of 35.21%.[52] Rather, the principal reason for the high cost of microcredit loans is the high transaction cost of traditional microfinance operations relative to loan size. [53] Microcredit practitioners have long argued that such high interest rates are simply unavoidable. The result is that the traditional approach to microcredit has made only limited progress in resolving the problem it purports to address: that the world's poorest people pay the world's highest cost for small business growth capital. The high costs of traditional microcredit loans limit their effectiveness as a poverty-fighting tool. Borrowers who do not manage to earn a rate of return at least equal to the interest rate may actually end up poorer as a result of accepting the loans.[54] According to a recent survey of microfinance borrowers in Ghana published by the Center for Financial Inclusion, more than one-third of borrowers surveyed reported struggling to repay their loans.[55] In recent years, microcredit providers have shifted their focus from the objective of increasing the volume of lending capital available, to address the challenge of providing microfinance loans more affordably. Analyst David Roodman contends that in mature markets, the average interest and fee rates charged by microfinance institutions tend to fall over time. [56]

See also

References

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Bibliography

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."

External links