Microcredit is one of the newest and most popular forms of poverty alleviation. Especially in the last few years, there has been a huge focus on microcredit. Indeed, the United Nations designated 2005 ‘the Year of Microcredit’.

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Microcredit is really a very simple idea, and easy to put into practice. It was developed as a way to fight poverty in the 1970s by two organizations, working separately in different parts of the world: ACCION International in Latin America and Grameen Bank in Bangladesh. While at first microcredit was tried on a small-scale, experimental level, it has developed, mainly through the pioneering work of Muhammad Yunus and Grameen Bank, into an effective poverty-alleviation tool that is used around the globe.

Microcredit involves loaning poor people small amounts of money (usually around $50-$150) for use as capital to start or expand small businesses, sometimes called microenterprises. In many poor countries, thousands, or even millions, of impoverished people develop ideas for starting businesses in what is called the ‘informal market.’ The informal market refers to non-official businesses that have no ties to the government (they are not registered businesses). Businesses in this market might consist of no more than a small stand selling drinks and employing one or two workers.

Though small, these businesses can greatly increase the income of the men and women who run them, and have proven to vastly reduce poverty. Grameen Bank, for example, estimates that 55% of its borrowers and their families in Bangladesh have worked their way out of poverty since the bank first started operations in 1974. Unfortunately, even microenterprises require money to begin operation, though usually a very small amount. This is where many impoverished individuals meet a dead-end. Even if they know how to start a successful business, they often do not have the funds to get the business going. Microcredit operations allow them to borrow capital and start their businesses, then use the profits to pay back their loans. Later, they can take out larger loans, and continue to expand.

Informal barbershops such as this one can be started more easily with the addition of microcredit services.

While microcredit might seem very similar to standard loans made by commercial banks, there are many key differences:

Commercial banks rarely loan money to the poor, because there is a high risk that they will not be repaid. Also, due to the high costs of conducting transactions at commercial banks, loaning the small amounts of money that microcredit operations require is usually unprofitable for these banks. Because standard banks will not loan to the poor, loan sharks often fill in, charging exorbitantly high interest rates, sometimes as much as 3600% per year. Microcredit organizations (also called microfinance institutions or MFIs) have much lower interest rates, though they are often higher than interest rates at commercial banks, and also have very short repayment periods (every week for several months, for example, rather than every month for several years).

Also, most banks require a form of collateral as insurance if the borrower does not repay the loan. Because poor people often do not have collateral, MFIs do not generally require this. Instead, they use ‘solidarity groups’ – small social groups – in their operations. Each group takes out a loan. If one member of the group does not meet repayment obligations (for example, he or she misses weekly payments), the whole group is penalized. Because of this, group members often exert peer pressure on non-paying members, contributing to the high repayment rate of many microcredit organizations. Grameen Bank, for example, records a 99.01% recovery rate for its microcredit program. Many MFIs recognize that in some cases, a borrower cannot repay a loan, and so are willing to write-off the existing debt as a loss, without any punishment to the borrower.

A Qatari man repairs watches in his small business.

Another revolutionary microcredit banking idea that many MFIs embrace is loaning primarily to women. Grameen Bank, which first introduced the idea, now concentrates almost solely on loaning to women; today, 96% of its loans are to women. In the bank’s early days, Professor Yunus, the founder, observed that 1) more women lived in poverty, 2) women, especially in Asian countries such as Bangladesh, were marginalized in society and unable to get good educations and pursue their goals, and 3) women had a better repayment rate on their loans than men.

MFIs differ from standard banks in one final way. As Professor Yunus puts it: “The clients should not go to the bank; it is the bank which should go to the people.” MFIs are generally set up in rural areas where poverty is most acute. Instead of having several large branches in major cities, MFIs concentrate on smaller branches spread across a wide area, and so are much more decentralized than most commercial banks.

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While most microcredit operations today involve monetary loans, a growing number of operations loan other items, such as livestock or supplies, which are then paid back monetarily. For example, Gonoshasthaya Kendra in Bangladesh loans livestock—cows, chicken, and goats—to poor women living in villages. Lending livestock can be very effective because the animals reproduce, help with labor (water oxen, for example, can transport goods), and produce such consumable products as milk and eggs, all of which can improve the financial situation of a borrower. Monetary loans, on the other hand, can be used only once. But there are drawbacks to livestock loans. For example, livestock can get sick or die, creating problems for borrowers and MFIs. And in contrast to livestock loans, monetary loans can be used as start-up capital for small businesses (and more and more often, MFIs concentrate their efforts on poor entrepreneurs who have good business ideas, but a lack of funds), which then, if profitable, become self sustaining.

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Rickshaw-taxis such as the one displayed above provide a livelihood for hundreds of people is developing capitals such as Dhaka, Bangladesh. Unfortunately, the rickshaws are often unaffordable to people who would otherwise make a living operating them. This might be partially relieved through microcredit.

Due to the expansion of microcredit into poverty relief efforts, 2005 was designated the ‘International Year of Microcredit’ by the Economic and Social Council of the United Nations. Much like the Millennium Development Goals, this act serves to heighten public awareness of microcredit, providing information on microcredit activities around the world. Microcredit also is strongly endorsed by a special United Nations organization: the United Nations Capital Development Fund Microfinance, or UNCDF Microfinance. Though it does not actually engage in microcredit activities, UNDF Microfinance helps MFIs expand through technical assistance and grants, called MicroStart grants. This approach has proved very effective. In Guatemala, for example, a $500,000 grant to a commercial bank allowed the bank, Bancafe, to create a microcredit service that allowed 11,000 new borrowers to join.

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While microcredit is overwhelmingly seen as a positive force in alleviating poverty, there is growing concern over the direction many larger MFIs are taking. Because microcredit operations are very similar to businesses (in some cases, due to the interest they receive on loans they make, MFIs such as Grameen Bank no longer take donations), questions arise about how to balance the organizations’ business aspects with their humanitarian aspects.

This man runs microenterprise that sells cotton candy.

MFIs that have been successful are becoming more and more like traditional businesses, and this transformation has created more pressure to engage in standard business practices – working to create higher profits, for example. This issue is extremely important to the future of the poor, who have so far benefited from microcredit. An MFI that becomes too similar to a for-profit company may be unable to respond to the needs of the poor as well as one that has kept its focus on the people it serves.

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Microcredit programs are sometimes better understood through real-life examples. To read actual cases of microcredit in action, see the Economics Case Studies section, or use the links below to access individual case studies.

Microcredit Case Studies:

• The Bangladesh Relief Fund/GK and Cow-lending: read more...



• UNCDF Microfinance and Yemen: read more...



• SKS and Unitus: read more...



• PMM and Unitus: read more...



• ACCION International and PADME: read more...



• Heifer International: read more...

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Wikipedia: Poverty

World Bank: PovertyNet: Overview

UN World Summit on Social Development

Wikipedia: Purchasing Power Parity

Gilbert, Geoffry. World Poverty. Santa Barbara: ABC-CLIO 2004 About ACCION

About Unitus

BRF: Cow-lending

Grameen Micro-Credit & How to End Poverty from the Roots Up

Grameen: What is Microcredit?

Yunus, Muhammad. Telephone Interview. 8 December 2005.

Microfinance Gateway

UNCDF Microcredit

Unitus

Wikipedia: ACCION International

Wikipedia: Muhammad Yunus

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