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 the unemployed, to poor entrepreneurs and to others living in poverty who are not considered bankable. 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.

Microcredit is a financial innovation which originated in Bangladesh where 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. Although almost everyone in larger development organizations discounted the likelihood of success of microcredit when it was begun. Dr. Akhtar Hameed Khan's idea was later picked up by Prof.Yunus and others. The United Nations declared 2005 the International Year of Microcredit.

Contents 1 History 2 Fundamental Principles 3 Strengths 4 The Internet and Microfinance Merger 5 Microlending in the developed world 6 Criticism 7 Role of Developing Country, a recent Forbes ranking 8 See also 9 References 10 Bibliography 11 External links

[edit] History

Microcredit has been practiced at various times in modern history; Jonathan Swift inspired the Irish Loan Funds of the 18th and 19th centuries[1], in the mid-1800s abolitionist/legal theorist Lysander Spooner wrote about the benefits of numerous small loans for entrepreneurial activities to the poor as a way to alleviate poverty,[2], and microcredit was included in portions of the Marshall Plan at the end of World War II. However, in its most recent incarnation, with attention paid by economists and politicians worldwide, it can be linked to several organizations starting in Bangladesh in the 1970s and onward.

[edit] Fundamental Principles

Microcredit is based on a separate set of principles, which are distinguished from general financing or credit. [3] Microcredit emphasizes building capacity of a micro entrepreneur, [4] employment generation, trust building [5] and help to the micro entrepreneur on initiation and during difficult times. Microcredit is a tool for socioeconomic development ^[1] Sapovadia, Vrajlal K., "Micro Finance: The Pillars of a Tool to Socio-Economic Development" . Development Gateway, 2006

[edit] 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 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 pay an annual interest rate of 11 to 12 percent. 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.

[edit] The Internet and Microfinance Merger

Kiva.org, is a micro-lending Website that enables an individual to lend money to a microfinance institution in the developing world which will then lend the money to a micro-entrepreneur. Inspired by Mohammad Yunus and Grameen Bank, microcredit was taken online.

MicroPlace.com, a wholly-owned subsidiary of eBay, was launched on October 2007. This website also caters to the micro-borrower with a little difference from Kiva.org: lenders will earn interest. Therefore, MicroPlace is tapping into the socially responsible investment world and can attract larger capital to microcredit. Deutsche Bank estimates that $250B [6]is needed to raise enough capital to get it into the hands of the 1 billion working poor who could benefit from microcredit. While the US gave $303B[7] in charity to all causes, they invested $2.4T in socially responsible investments.[8] This is therefore a much bigger lever that can be used to invest in microcredit. Kiva is a non-profit and as it's very difficult to become an SEC-registered broker/dealer (a requirement for being able to offer a financial return), has not been able to offer interest returns to investors. MicroPlace, on the other hand, had the institutional and financial backing of eBay, allowing it to go through the complex regulatory application process and to put up the necessary money for the SEC to sign off.

Both Kiva and MicroPlace invest in microcredit institutions around the world. MFIs, in turn, solicit clients, make loans and collect payments - they do their normal day-to-day business. Once client payments are in, the institutional investors receive their loan (plus interest in the case of MicroPlace) who can then pay back their investors - people who purchased those original securities.

[edit] Microlending 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. [9] Among other organizations that provide microloans in the US[10][11], 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 too difficult to escape poverty through private enterprise.

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. ^[2] 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.

[edit] Criticism

Gina Neff of the Left Business Observer has described the microcredit movement as a privatization of public safety-net programs.^[3] Enthusiasm for microcredit among government officials as an anti-poverty program can motivate cuts in public health, welfare, and education spending.^{[citation needed]} 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, and have become dependent on loans for household expenditures rather than capital investments.^{[citation needed]} 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.^[4] As a result, borrowers are kept out of waged work and pushed into the informal economy.^{[citation needed]}

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.^[5] Global data tables from The Microbanking Bulletin show that savings represent a small source of funds for microcredit institutions in most developing nations.

Bangladesh's Finance and Planning Minister M. Saifur Rahman charges that some microfinance institutions use excessive interest rates.^[6]

There are other related criticisms, in the corresponding section, within the article on microfinance.

[edit] Role of Developing Country, a recent Forbes ranking

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After billionaires and household names like Ambanis and Mittals, it is the turn of little-known microfinance institutions from India to hit the pages of famed magazine Forbes, which has named seven such entities in the list of world's top 50 -- highest for a country. In its first ever list of World's Top 50 Microfinance Institutions, the US business magazine has named Kolkata-based Bandhan at the second position. Bandhan, as well as two other Indian MFIs -- Microcredit Foundation of India (ranked 13th) and Saadhana Microfin Society (15th) -- have been placed even above Bangladesh-based Grameen Bank, which along with its founder Mohammed Yunus was awarded Nobel Prize in 2006. Grameen Bank has been ranked 17th in the list topped by another Bangladesh-based institution, ASA. India, along with Bangladesh, are jointly home to the maximum number of MFIs to be featured in the list. Among others, there are five from Bosnia and Herzegovina, four each from Morocco and Peru, three from Colombia and two each from Ecuador, Ethiopia and Serbia. One each from 15 other countries, including Russia, Pakistan, Mexico and Brazil have also been named in the list. Besides Bandhan, Microcredit Foundation of India and Saadhana Microfin Society, other Indian entries include Grameen Koota (19th), Sharada's Women's Association for Weaker Section (23rd), SKS Microfinance Private Ltd (44th) and Asmitha Microfin Ltd (29th). Interestingly, two of the Indian MFIs featured in the list -- Grameen Koota and SKS Microfinance -- are working on the same model adopted by Grameen Bank. 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 noted. The magazine said that the list was made after going through data available with 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 expenses divided by the average number of active borrowers as a percentage of gross national income per capita, the outstanding balance of loans overdue by more than 30 days as a per cent 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".

[edit] See also

• FINCA International, a major US-based, global microfinance institution
• Freedom from Hunger, US charity promoting Credit with Education
• Cooperative banking
• Friends of Women's World Banking, a major Indian apex Microfinance Institution.

[edit] References

[edit] 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.
• Elizabeth Rhyne. 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 VyakarnamRural 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.

[edit] 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
• Innovative BRAC Microcredit Securitization Honored in Bangladesh
• Alleviation and poverty and enpowerment of the poor, BRAC Bangladesh