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Microcredit

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This is an article about small loans. For small payments see Micropayment


Microcredit is an integral part of the microfinance concept which also includes microenterprise training, microinsurance and other financial innovations aimed at serving the very poor. Microcredit is the extension of very small loans to unemployed, poor entrepreneurs and others living in poverty who are not bankable. These individuals lack collateral, steady employment and a verifiable credit history and therefore cannot meet even the most minimum qualifications to gain access to traditional credit. Microcredit is a financial innovation which originated in developing countries where it has successfully enabled extremely impoverished people (mostly women) 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. Although almost everyone in larger development organizations discounted the likelihood of success of microcredit when it was begun in its modern incarnation as pilot projects with ACCION and Muhammad Yunus in the mid 1970s, the United Nations has declared the year 2005 as the International year of Microcredit.

An hour-long documentary about microcredit called Small Fortunes[1] aired on many PBS stations in the United States.

History

The concept of microcredit can be traced back to portions of the Marshall Plan at the end of WWII in the middle of the 20th century or even back to the 1800's and New York's Providence Fund. However, in its most recent incarnation and with its current momentum and success it can be linked to several organizations starting in the 1970s and onward.

Opportunity International

In 1971, Al Whittaker resigns as president of Bristol Myers and establishes Opportunity’s first US office in Washington DC. The first loan is made to Carlos Moreno in Colombia to expand his one-man spice and tea business - cited in The Economist as the first "microloan". Opportunity International provides opportunities for people in chronic poverty to transform their lives by creating jobs, stimulating small businesses, and strengthening communities. Small loans ranging from $25 to $500 help poor families lift themselves out of poverty with dignity.

ACCION International

In 1973 Accion International, a Peace Corps-like group, started to switch their focus toward providing economic opportunity to poor people instead of working on construction/infrastructure projects. Evidence of this first appeared in Recife, Brazil 1973 when ACCION staff there began to offer microloans to provide those poor people who had the will to start small businesses, partly to subvert the exploitation of the poor by loan sharks.

Within four years, the experiment had shown its success in having provided 885 loans, and helping to create or stabilize 1,386 new jobs, while the loans had over a 90% repayment rate. This success in making a lasting impact in peoples lives, as contrasted with the previous projects they had done seemingly steered ACCION firmly in the direction of being a microfinance organization.

ACCION claims, and recorded dates seem to indicate that these loans were the first modern pioneers of microcredit.

Muhammad Yunus and Grameen Bank

Around the same time as ACCION's experiment, and apparently independently, Muhammad Yunus, a U.S.-educated professor of economics started a similar experiment. Around 1974 during a famine in his native Bangladesh Yunus discovered that very small loans could make a significant difference in a poor person's ability to survive, but that traditional banks were not interested in making tiny loans to poor people, who were considered poor repayment risks. His first loan consisted of $27 from his own pocket which he lent to 42 people including a woman who made bamboo furniture, which she sold to support herself and her family.

In 1976, Yunus founded the Grameen Bank to make loans to poor Bangladeshis. Since then the Grameen Bank has issued more than $5 billion in loans to several million borrowers - at the close of 2005 the number of outstanding loans is more than 4 million. To ensure repayment, the bank uses a system of "solidarity groups": small informal groups, nearly all of them exclusively female, that meet weekly in their villages to conduct business with representatives of the bank, and who support one another's efforts at economic self-advancement. As it has grown, the Grameen Bank has also developed other systems of alternate credit that serve the poor. In addition to microcredit, it offers housing loans and well as financing for fisheries and irrigation projects, venture capital, textiles, and other activities, along with other banking services such as savings.

The success of the Grameen model has inspired similar efforts throughout the developing world and even in industrialized nations including the United States. Many, but not all, microcredit projects also emulate its emphasis on lending specifically to women. Close to 96 percent of Grameen loans have gone to women, who have been found to be much more likely than men to repay loans and to devote their earnings to serving the needs of the entire family. Originally the program started with men and women, but later focused on women when data showed an extremely lower credit risk in women.

FINCA International

In the 1980's FINCA International continued the successful trend of microcredit in Bolivia. John Hatch, founder of FINCA, had worked on other international credit programs and started doing microcredit on his own in Bolivia stressing local autonomy and putting the poor in charge of the programs. “Give poor communities the opportunity, and then get out of the way!” he said. He called the idea "Village Banking".

One of the unique things about John Hatch's "Village Banking" was how quickly he implemented it. After he had assembled a team, within four weeks, they had created 280 village banks serving 14,000 families with loans worth $630,000. While the original program was shutdown, it was not because of a lack of success, but because its backers felt uncollateraled lending was too risky.

John worked to resume his work and incorperated FINCA in 1985, this time working in El Salvador. In El Salvador the program focused on women, as many of the other micro credit programs have, presumably because of the reduced credit risk.

It is estimated that in 2005 FINCA will reach over 2 million borrowers. FINCA works in 23 countries, mostly with women, and has a loan repayment rate of 97 percents.

Today

The World Bank estimates that there are now more than 7,000 microfinance institutions, serving some 16 million poor people in developing countries. In November 2002, more than 2000 delegates from 100 countries gathered at a Microcredit Summit in New York City, with the goal of reaching 100 million of the world's poorest families, with credit for self-employment and other financial and business services by the year 2005. Support for these goals has come from prominent world leaders and major financial institutions.

UNDP Year of Microcredit Logo

The Economic and Social Council of the United Nations proclaimed the year 2005 as the International Year of Microcredit to call for building inclusive financial sectors and strengthening the powerful, but often untapped, entrepreneurial spirit existing in communities around the world. There are five goals associated with "The Year" which are:

  1. Assess and promote the contribution of microfinance and microcredit to the MDGs;
  2. Increase public awareness and understanding of microfinance and microcredit as vital parts of the development equation;
  3. Promote inclusive financial sectors;
  4. Support sustainable access to financial services, and
  5. Encourage innovation and new partnerships by promoting and supporting strategic partnerships to build and expand the outreach and success of microcredit and microfinance for all.

Fundamental Principles

An increasingly large body of published literature and conference proceedings has begun to seriously study the implications and debate the relative significance of different aspects of this important financial innovation. For those who are interested in a reading more detailed, theoretical studies of this field of economics and finance, a separate Journal of Microfinance has existed since the fall of 1999. From published literature and conference proceedings, it is possible to surmise several fundamental lessons from the microcredit success and failures over the last three decades.

A savings|investment as preferable aid: Independent borrowers earn the dignity and lasting self-confidence associated with responsible loan repayment. Institutional managers are more careful to ensure borrower success and generally perform better when there are risks involved.

Entrepreneurial talent and energy are scarce invaluable resources for economic growth: Our economies cannot afford not to find and develop independently responsible entrepreneus and public bankers who are financial critical thinkers. These individuals can be attracted to the microcredit industry, but they are individuals with options – they will not risk their future on short-term or unpredictable bureaucratic support.

Traditional private banks should not be expected to offer microcredit: Existing banks with a traditional operating philosophy typically have significant investments in facilities and costly operating structures. Because of the significant overhead of such banking operations, it will be necessary for these bank operations to naturally gravitate to large, profitable transactions with affluent borrowers. Unfortunately, that costly mode of operation is so engrained that it is the only one that the existing banking management will be able to understand. Eventually, of course, it is likely all private banks will understand that they must aggressively cut costs AND instead invest primarily in relationships with “pre-bankable” customers. There is no longer any room for arrogance in the banking, insurance and securities industries, but a change toward a much leaner, strictly value-driven operational pardigm will be absoloutely necessary for survival. Low costs and volume operations will be necessary in order to develop and retain a larger customer base [in order to be able to offer higher returns to savers, lower interest rates for borrowers and lower costs for financial transactions]. By the time that the operational paradigm is obvious, it will be too late for most of the current population of traditional bankers. In spite of this, forcing these bankers to prematurely adopt a different opreration philosophy too early could have disastrous consequences for traditional banks [and their customers] as well as the microcredit movement.

A new generation of banking institutions [and the banking professionals to run them] is arising: Banking institutions motivated by a less myopic vision of profitably serving the common good can be capitalized for the primary purpose of entry-level economic development. By lowering the transaction costs through institutional specialization and innovation in delivery systems, they will be able to operate profitably in markets characterized by very small transaction sizes and less affluent clients.

Poor entrepreneurs possess the same survival skills as the toughest, most affluent business operators: Poor entreprenuers save money, carefully apply their entrepreneurial energy and repay debts as scheduled to maintain access to future loans. In other words, poor entrepreneurs are not only prebankable, they represent the population from those individuals who will come who will be aggressively pursued as successful, very affluent captains of enterprise in 10, 25 or 50 years from now.

A radically efficient, large-scale, NEW banking operating infrastructure required: Simply modifying old methods will not successfully expand poor people's participation in the their country's economy. Investment in self sustaining institutions that finance poor residents is a comparatively cost-effective use of scarce subsidies for economic development. The costs of doing research in the microcredit and microenterprise areas are extremely low compared to other strategies to stimulate economic development such as tax abatement or continued support for welfare programs.

Strengths

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 of 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 pay a reasonable 11-12% annual rate of interest. 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. 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.

Criticism

The microcredit movement does have critics, who say that some lending programs charge excessive interest rates. Also, there is concern that funding for microcredit programs will be diverted from other needed programs such as health, water projects and education. Credit programs may enable poor people to improve their situation, but they do not eliminate the need for other basic social and infrastructure services.

Some other problems that have been reported with microcredit:

  • Turning a profit on the loan
  • Inability to reach the poorest of the poor
  • Microcredit dependency
  • Durability of poverty reduction

While microcredit dependency is an issue raised by critics of the microcredit system, it also raises the issue of bias in the critics' worldview. Most of the developed world is dependant on continual access to credit. Defenders of microcredit argue that there is no reason to expect the poor in developing countries to behave any differently.

Investing in Microcredit

Books

For who are interested in reading more about the practical details of becoming directly involved in the world of microcredit and microbanking, there is a lot of reading materials available. Several books on this topic are available and are in a list of books on Amazon which is entitled Start Your Own Microcredit.

Another list of books and articles is available here

Investment Groups

It is also possible to invest in microcredit via certain investment groups including:

  • ACCION Investment Funds, Since 1984, ACCION's financial experts have been successfully investing for double bottom line returns. Visit our site to learn more about socially responsible investment possibilities with ACCION International including the ACCION Global Bridge Fund, ACCION Latin America Bridge Fund, ACCION Investments in Microfinance, and the ACCION Gateway Fund.
  • Calvert Foundation, Community Development Financial Institutions (CDFIs) are organizations which provide financing programs to do microenterprise lending and microcredit development work, providing the means for your community investment capital to impact disadvantaged communities. Many CDFIs accept direct investments from relatively wealthy individuals; on the other hand, financial intermediary facilities from socially-responsible investing organizations such as the Calvert Foundation allow individuals with a smaller amount to commit (as little as $1000) to purchase notes that is a piece of a larger pool of CDFI investments.
  • The Council of Microfinance Equity Funds(CMEF) is the first membership organization bringing together the leading private entities that make equity investments in microfinance institutions (MFIs) in the developing world. The Council’s members seek both social and financial returns from their investments in these institutions, all of which provide a range of financial services to poor households in developing countries.
  • PENSCO Trust Company, PENSCO Trust Company, chartered in New Hampshire, is a single-service special asset custodian for self-directed IRAs. Since 1989, the company has exclusively focused their services on the administration and custody of IRAs invested in non-traded assets, such as real estate and private placements. There are few limits to the possibilities in this area, but ten of the permissible alternative self-directed investments typically handled by PENSCO include: 1) commercial, residential, multi-family and vacation real estate, 2) foreclosures and other investment property, 3) business start-ups, 4) franchise opportunities, 5) tax liens, 6) business loans, notes and privately-held mortgages, 7) limited liability companies (LLC), 8) limited partnerships (LP), 9) C Corporation, 10) Socially-responsible charitable investing

References

The Economist. "Capitalism for the Poor: A survey of microfinance" November 2005.

Further Information

Microcredit or Microfinance Institutions

  • Accion International, a large network of microfinance institutions working in Asia, Latin America, and Africa
  • The Aga Khan Agency for Microfinance
  • Freedom from Hunger, a large network of microfinance institutions focused on the very poor in Asia, Latin America and Africa. Freedom from Hunger is a pioneer for sustainably integrating education with microfinance. The Organization is currently exploring new models for increased scale under its Reach initiative and new innovations to integrate health and microfinance
  • Grameen Foundation USA, replicating the Grameen Bank model around the world
  • Grameen Bank, generally regarded as the originator of the microcredit movement in finance
  • Microfinance Information eXchange (The MIX), The global information service for the microfinance industry
  • MIX Market, MIX's microfinance information platform featuring profiles on microfinance industry participants
  • Namaste-Direct.org a non-profit devoted to providing credit for first-time women borrowers in Guatemala.
  • Omidyar-Tufts Microfinance Fund, a partnership between Pierre Omidyar and Tufts University.
  • Opportunity International, a large microfinance network focusing on giving the poor around the world a working chance. Also a pioneer in using microfinance to fight HIV/AIDS in Africa.
  • ProCredit Holding- ProCredit group consists of 19 different banks in developing countries. The core business of the banks is lending to micro and small enterprises.
  • SafeSave pioneers basic banking services (not just microcredit) for very poor people
  • Sarvodaya Nano Finance Ltd., A Microfinance NBFC in India.
  • TrickleUp.org gives small grants to emerging entrrpreneurs among the very poor. Currently operating in 14 countries including USA. Offers business training to the poor and encourages savings groups among the entrepreneurs. Started by Millie Leets and her husband 27 year ago, it has helped over 130,000 poor start their own businesses, gain self esteem and join savings groups.
  • Unitus, a global microfinance accelerator, acting as a social venture capital investor for the microfinance industry. Also, they have launched a blog which discusses microfinance and microcredit topics.

Humanitarian Organizations Supporting Microfinance

  • CARE International CARE - Empowering the vulnerable.
  • PlaNet Finance, PlaNet Finance is an international non-profit organisation dedicated to the development of microfinance as a tool to alleviate poverty in the world.
  • World Relief
  • WorldVision, runs and finances microcredit programs through the world.
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