The term micro-credit can be defined as small loans directed towards the very poor or marginalized who need money for self-employment projects in order to generate income or for urgent family needs such as health issues and basic education. It is designed to lend small amounts of money for a short tenor. Hence the money which is lent is in small proportions and the borrower is supposed to repay within a short time frame, usually with a year at most. Microloans thorough micro-credit programs help reduce dependency among the poor, alleviate poverty, empower women and create long-lasting benefits for future generations. There are however critics to the system which raise concerns regarding the micro-credits ability to address the deep-rooted cause of poverty. There are concerns regarding micro-credits sustainability from the economic perspective as it fails to address or attempt to improve the economic indicators, income levels to rise or poverty to reduce significantly. ‘Nevertheless, microcredit has proved to be an effective and popular measure in helping to alleviate poverty, enabling those without any collateral to borrow at bank rates from various financial institutions and start small businesses.
While it is relatively easy to obtain credit in developed or western countries, through large commercial banks and financial institutions, in the developing world where people lack the necessary collateral or strong credit history, access to credit although one of the most desirable financial tools for the poor, is also the most difficult to secure.
Credit leverages the human capital with the physical capital and serves as a means to increase income among the poor, but due to the problems arising from moral hazard and adverse selection the lender needs to trust the borrower before enhancing any loan, thus hinders the poor people from accessing credit (Hollis, 1999).
Microfinance, in many ways, has tried to overcome these difficulties in obtaining loans. Generally defined as an extension of small loans or microloans to the poor entrepreneurs, the unemployed, and others in poverty and who are considered nonbankable since they are unable to meet even the minimal requirements for a loan extension, like stable employment, basic collateral, and certifiable credit history. Microfinance is a broad field that basically involves the extension of different types of financial assistance, thus one of the branches of microfinance is known as microcredit which extends small loans to the low-income households (Krieger, 2004).
The origin of micro lending
Although the term microcredit or micro-lending got its boost recently, its origin can be traced out in all parts of the world even back to the 17th century (Hollis, 1999). These saving clubs have been operating from one region to another and had developed their own names in history. For example, they developed as “tontines” in West Africa, “pasanaku” in Bolivia, and “tandas” across Central America and Mexico (Hollis, 1999). All these alien words represent microcredit in one way or the other, for example in Spanish the word “tandas” means “shift. This refers to a group of people who contribute money which shifts to that person in the group who is in most need. The traces of “tontines”, named after the famous Italian banker Lorenzo de Tonti, can be traced back to the 17th century in the region of West Africa.
Thus the concept of small group-based lending has been with us for centuries. Small but formal saving and loan associations have also existed in our society for decades providing an opportunity to the poor, who are neglected by the banking system to obtain collateral-free loans. Introduced in the early 1700s, one of these earlier lending institutions was known as the Irish Loan Fund system. Introduced by Jonathan Swift, a nationalist and a writer, it helped many Irish people who were living in improvised conditions. Swift worked around the idea of providing credit to impoverished but honest tribesmen, who had been facing hard times, yet maintained a respectable position in the society.
Another factor that contributed to the success of micro-lending was that the other alternatives available were usually exploitative of the poor. These alternatives were pawnshops and private money lenders. The two major problems associated with these alternatives were, first that money lenders provided loans similar to that of loan funds but a comparably much higher rate which the poor were sucked up any additional profits these poor people earned. Second that the pawnshops provided credit up to £1, which greatly restricted the number of investments that could be financed, and the borrowers, mostly agricultural laborers didn’t even possess assets greater than £1 which they would be able to pawn.
Swift at first established a fund out of his own pocket worth around £500. His criteria to assess the credit rating required the borrower to obtain a guarantee for that loan from at least two neighbors. The reason behind this criterion according to Swift was that if a man is honest, industrious and respectable in the society would easily secure such a guarantee while the dissolute would be eliminated by this exercise. In this way Swift was able to draw on social capital, similar to the way of group lending we see today by Grameen bank. This lending strategy proved to be very successful (Hollis, 1999).
In 1837, this system was standardized and the Loan Fun Board took control over many independent loan funds after which in accordance with the law loans could not exceed a limit of £10 and had to be repaid within a term period of 20 weeks. As compared to other local profiteers the interest rates charged on these loans were lower and settled at approximately 8 percent (Hollis, 1999).
This idea of microlending given by Swift emerged slowly, but by 1840 it had emerged as a widespread institution spreading over all of Ireland with about 300 funds. The aim was to provide short-term loans at a lower interest, which at their peak stretched out to almost 205 of all households in Ireland annually (The History of Microfinance, 2006).
In the 1800s there emerged various types of financial institutions in Europe were mostly organized around the urban and the rural poor. Some of these institutions were known as Credit Unions, Savings and Credit Cooperatives, and People’s Banks.
Initiated by Friedrich Wilhelm Raiffeisen, the altruistic determination behind the credit unions was to help the poor break free the chains of the money lenders reduce their dependence on the money lenders, and thus improve their own welfare. This movement helped the unions expand over to other German states by 1870. It also spread over Europe and North America as a cooperative movement supported by these countries and eventually reached the developing countries. With almost 9000 units, Indonesian People’s Credit Banks (BPR), opened in 1985, became the largest system of microfinance (The History of Microfinance, 2006).
In 1900, several adaptations of the models defined above began to surface. The goal of this intervention in rural financing was based on the modernization of the agricultural sector, which in turn could be achieved through two objectives. One was to commercialize the agricultural sector by lending easy credit which can be invested and idea savings can be mobilized for new investments and repayment of loans. The second objective was to reduce the dependency on feudal lords and the oppressive relations that were reinforced through indebtedness.
These banks were not owned by the poor, but by government or private commercial banks, and with time they became abusive as well as inefficient. The loans were mostly targeted for provided agricultural credit to increase the productivity of farms, and hence increase income. However, these subsidized agricultural loans were not very successful and rural banks witnessed the erosion of their capital base due to poor management of loan repayments.
Pioneers of modern day micro credit
Meanwhile, there were other experiments being carried out in Brazil and Bangladesh where small loans were being extended to women, for the purpose of starting a micro business. This type of credit facility was structured around a group-based lending system, where each member of the group served as a grantor of the loan, guaranteeing the repayment of loans of all the other group members. Thus we see that in this type of “microenterprise lending” program, the focus shifted from agricultural lending to “income-generating activities” (The History of Microfinance, 2006) and whose target audience was not farmers but very poor borrowers, which were mostly women.
The entire concept of microloans to help the poor took a huge leap when the process was institutionalized by Yunus’s Grameen Bank and ACCION International in Bangladesh and Venezuela respectively.
- Established as one of the premier microfinance organizations, ACCION International was a volunteer student program, initiated by Joseph Blatchford, a student of law in Caracas by raising $9000 from private organizations. Today, its network of lending partners spreads over Latin America, Africa, and the United States.
- Established as a trade Union in 1972 in India, to improve the income and social security access of women, the Self Employed Women’s Association (SEWA), went on to form a bank of its own in 1973 to address the issue of scarcity of financial services available to its members. The contribution of four thousand women helped to form the Mahila SEWA Co-operative Bank. With more than 30, 000 clients, the bank extends microloans to illiterate, self-employed, and poor women.
- Professor Muhammad Yunus, in 1976, designed a credit extension program to address the problems faced by the poor in obtaining credit, with the help of its students of Chittagong University. This experimental research-based program was so successful; it spread quickly to a large number of villages. Although this venture with the rural banks was very successful in disbursing and recovering thousands of loans, the banks were reluctant to adopt this project after the pilot phase was completed, arguing that it was a risky venture. But with the endless efforts of Professor Yunus and the help of some donors, The Grameen Bank came into existence serving more than 4 million borrowers today (The History of Microfinance, 2006).
According to Professor Yunus, credit was the key to unlock the door to a poverty-free world. He believed that the answer to poverty did not lie in providing food aid to the poor, or the extension of loans from donor agencies to the governments of these poor countries or welfare payments, instead the solution lied in providing small loans to the poor people directly which would help them invest in return generating businesses (Jolis., 1998).
As an economics professor at the University of Chittagong, in Bangladesh, Mr. Yunus was deeply appalled to witness the severe conditions of the poor people in the area surrounding the university. What was more disturbing to Mr. Yunus was the fact that all theories of development failed to provide a solution when it came to alleviating the poverty faced by these poor people. Committed to finding a solution to the problem, Mr. Yunus decided to conduct a survey and explore the real difficulties faced by the poor. Among his first interviewee was a woman who borrowed credit in order to purchase raw materials and make bamboo stools. But these stools had to be sold to the moneylender only at a price below the market price, leaving the woman with barely any money after repayment of the loan and interest, to feed her family. Thus for the next batch of stools, she had to return to the moneylender and this exploitative cycle continued.
After studying certain cases Mr. Yunus came to the conclusion that if these poor people are given small amount of loans and allowed to sell their goods at market prices, they would be able to feed their families, service their debts and eventually even earn profits. But these poor people posed the greatest default risk to the banks and hence the banks were reluctant to extend credit to them.
Mr. Yunus argued against this, stating that the poor had greater incentives to pay back the loans and get rid of destitution. He proved his claim by establishing his own bank known as the Grameen Bank with a less than 1% default rate, much lower than many commercial banks. Most of the borrowers of the Grameen bank around 94% are women, as according to the founder they are the world’s poorest people and more reliable than men
The bank’s strategy of group-based lending helps to keep the number of defaults under control as according to this requirement if one group member defaults the other cannot get a loan.
Today, microcredit is not limited to the Grameen Bank and has spread beyond Bangladesh to other developing countries like India and even America, and Europe. The efforts of Mr. Yunus have helped changed the lives of many poor, as will be illustrated with some of the examples below but on the whole, it has only scratched the surface of world poverty. To eliminate poverty from the world, much more effort and determination like that of Mr. Yunus is needed.
Microcredit programs can serve as a basis to save third-world countries from the severity of poverty that exists within them. One argument in favor of microcredit programs as a solution to the problems of capital deprived third world countries can be viewed in the light of the two.
Alleviation of poverty
The provision of credit to purchase capital or raw materials, empowering the poor by providing access to factors of production to carry out income-generating activities, promotes self-employment among the developing countries, fosters enterprise rather than dependency. This can help reduce dependence on money lenders or aid from other countries.
The purpose of microcredit programs to lend out to the poor for them to expand their business is indeed an effective way to reduce poverty in poor countries. These businesses are usually breathtakingly simple and satisfy the credit hunger of poor people less brutally as compared to loan sharks. Taking the example of a successful entrepreneur Pakmogda Zarat, from one of the poorest African countries, Burkina Faso. She owns a small restaurant in Ouagadougou the capital of Burkina Faso. As it’s a very small venture and the outlook of the restaurant is such that it does not have any walls and is made of roughly-hewn logs which support the ceiling made of thatch, it cost her nothing to build that restaurant. Even the menu is very unpretentious as the restaurant only serves rice. But with the help of microloans, from a local branch of the countries microlender, Fédération des Caisses Populaires du Burkina Faso, Ms. Zarata, the owner of the restaurant was able to buy rice at a lower price at wholesale rather than the retail price (Kampala, 2001). This resulted in small profits which grew with time, and today Ms. Zarata has enough money to employ seven people, pay her children’s education fees and own a second-handed motorcycle to swagger across town.
The second aspect of this approach is that microcredit programs also contribute towards improving social capital by vocational training, information about civil responsibilities, and in areas of health. These contributions though costly are very effective in achieving the success of these programs. According to a study measuring the effectiveness of microcredit programs towards alleviating poverty and increasing productivity among third world countries, it was proven that there is a positive impact of these programs and can be used as a viable strategy to improve productivity among the poor by 175 % for the landless poor (McKernan, 2002).
The additional role of microcredit organizations towards improving social capital is also very important. It has been observed in poor countries that, the severity of killer diseases such as AIDS and diarrhea also makes it difficult and sometimes impossible for people to work, or repay loans taken to start a small business. In Africa alone, a survey of micro borrowers in 14 African countries should that as much as 95% of these borrowers found it difficult to pay medical bills, usually arising from AIDS and around 77% were unable to pay for funerals for those who had died of disease. It was also observed that these people had an extra burden to take care of the children of their relatives who had died of disease. Thus microlenders can make a difference in the life of these people by conducting health educational programs, to create awareness among these people regarding the importance of hygiene, washing their hands before eating, and promote the usage of condoms (Kampala, 2001).
Another argument in favor of microcredit as a solution to poverty in third world countries is based on the argument that encouraging the availability of small scale to the poor, it promotes the latent capacity of the entrepreneurs to utilize this credit in the small enterprise sector. This effort would further create employment opportunities, endorse a feeling of self-reliance among them, and most importantly since microcredit in the Grameen model lends out mostly to the poor women, his exercise helps to include women in productive activities in the poor countries where the women population accounts for more than or equal to half of the total population.
Another reason why lending out small sums, as much as $25 to women groups is that women are more likely to use any additional income to feed and clothe their children, while men might just blow the extra income on booze, as seen in certain parts of Otim in Africa (Kampala, 2001).
Thus, by empowering the majority of the population, microcredit can serve as an important factor to alleviate poverty among third world countries (World Summit for Social Development, 1995). According to the World Summit Report, the impact of these microcredit programs on the overall incomes of households showed that these households reported higher and more stable incomes after receiving loans through these programs (World Summit for Social Development, 1995)
A characteristic as observed in third world countries is that the poor people are so empty-handed that they have no money to invest in their children. As a result, the future of the nation remains illiterate and is unable to improve its standard of living or contribute towards the growth of the nation. Thus, The third argument in favor of microcredit for the poor of the third world countries is that putting capital in the hands of these poor people allows them to invest in small businesses, reduce dependency, earn profits, although small in the beginning but they grow as the business expands, and invest in their children with the extra money they have earned. As a result, the provision of small loans creates enormous benefits for the future of both the nation and the poor people. This education will open up various choices and opportunities for the upcoming generation for better employment and a better standard of living (Krieger, 2004).
According to a report by the Australian Bureau of Statistics, in 2003-2004, micro-credit facilities provided by the Agency for International Development helped around 143,000 people to take advantage of microloans, and further pass on the benefits to approximately 410,000 dependants. An example of such a household is that of Ms. Nguyen Thi Hoang who lives in Vietnam in Ho Chi Minh City. Three mentally ill brothers and two old parents are dependent on Ms. Nguyen. Their household income came by peeling cashews for which Ms. Nguyen’s mother was paid only, 4,000 Vietnamese dollars ($AUS 0.34 for every kilogram of peeled cashews. Ms. Nguyen applied for a microloan of $2,000,000 Vietnamese ($AUS 170.00) which was granted by an Australian government microcredit project. Ms. Nguyen used the money from the loan to buy a sewing machine and earns as much as $30,000 Vietnamese or $AUS 170.00 per day making her the bread earner of the family. This money also suffices to the basic needs of Ms. Nguyen and her family members who are dependent on her (Australian Bureau of Statistics, 2005).
The limitations of microcredit are greatly overlooked because of various underlying assumptions the economists have incorporated into their studies on the subject. Firstly it is assumed that the poorest wish to be self-employed when most seek fixed income steady wage jobs. Secondly, it is assumed that credit is the main financial service that the very poor of society needs. However in reality there is a need for a sense of security which can be derived from emphasizing savings and insurance to protect the marginalized and the very poor of the society against any unexpected crisis.
Thirdly providing easy access to credit is not sufficient for successful micro-enterprises but other factors mainly identifying opportunities, training, and establishing market linkages are equally important.
The fourth assumption is that people falling just above the poverty line don’t need micro-credit. However, it is this segment that will benefit this segment more. David Holme and Paul Mosley have discussed and proved in their book titled “Finance against poverty” that the increase in income of the borrowers under the micro-credit scheme is directly proportional to their starting income. Hence the vast majority of the population lying below the poverty line does not benefit from the microcredit and they end up with less incremental income even after getting the loan (Roth, 1997).
According to David Holme and Paul Mosley, the upper and middle-income poor tended to benefit more than the ‘poorest of the poor. This according to them can be attributed to factors such as the wealthy individuals and households have a wider range of investment avenues as opposed to the poorest households with limited and less lucrative investment options.
Secondly the richer poor could take some risk without putting their survival at stake and venture into riskier investments in pursuit of higher gains. Thirdly if the purpose of the loan is not specified, the very poor will spend a significant proportion of the loan on consumption as compared to the middle and the upper segment of the poor.
Under the micro-credit programs, a lot of effort has been directed towards uplifting the economic well-being of women. Hence female micro-credit borrowers hold a pivotal position as far as the elimination of poverty from society is concerned. Women were specifically focused because they make up the major portion of the poorest of the poor residing in the rural areas and are responsible for the economic welfare of the family. Ideally, most of the microcredit schemes aim to increase the economic independence of women and thus increasing their status in society. However, there is a lack of evidence to support if these micro-credit programs will empower women to release them from the clutches of poverty.
The size of the loans is not significant enough to enable women to make any long-lasting income change for the household. Moreover increased access to easy credit in the same geographical area leads to market saturation of the products made mostly by women. This is primarily because poor women generally tend to get involved in similar businesses, such as food vending and petty trading, etc. This leads to more competition in an already limited market and decreases the overall share of income for each woman.
Conclusion
Thus we conclude that although microcredit programs due to their underlying assumptions come with certain criticism, the over benefits to the third world countries out with these criticisms. There are concerns that credit is only one element necessary for the establishment of a successful enterprise. To respond to potential demand for a good or service, an entrepreneur will need easy access and support in terms of transport, communications, power, water and storage facilities, etc. Moreover to the poor high-interest rates of 2 to 4.5 percent per month hardly give them any chance of improving their economic conditions. ‘Nevertheless, microcredit has proved to be an effective and popular measure in helping to alleviate poverty, enabling those without any collateral to borrow at bank rates from various financial institutions and start small businesses.
References
- Australian Bureau of Statistics. (2005). Web.
- Hollis, A. (1999, September). Women and Microcredit in History: Women and Microcredit in History.
- Jolis., A. (1998). Banker to the Poor.
- Kampala, O. (2001). How to lend small sums to poor Africans to set up small businesses. 358 (8204).
- Krieger, R. (2004). The Evolution of Microfinance. Web.
- McKernan, S.-M. (2002). The impact of microcredit programs on self-employment profits: do noncredit program aspects matter. 84.
- Roth, J. (1997). The limits of micro credit as a rural development intervention. Institute for development policy and management manchester university.
- Sandals to suits. (1997). The Economist.
- Shuffling off the buffalo. (2004). The Economist , p. 71.
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- World Summit for Social Development. (1995). Role of microcredit in the eradication of poverty .