Microcredit
Microcredit is a financial practice that involves providing small loans to individuals and small businesses who typically lack access to traditional banking services due to inadequate credit history or insufficient income. This model, which includes terms like microfinance, peer-to-peer lending, and crowdfunding, aims to empower low-income entrepreneurs, primarily in developing countries. Pioneered by Muhammad Yunus and the Grameen Bank in the 1970s in Bangladesh, microcredit gained global recognition, leading to Yunus and the bank being awarded the Nobel Peace Prize in 2006.
Microcredit has since expanded to regions like North America and Europe, especially after the 2008 financial crisis, which left many unable to obtain conventional credit. Organizations involved in microcredit often focus not just on lending but also on providing financial literacy and business mentorship. While the repayment rates for microloans are reported to be high, critics have raised concerns about the sustainability of microcredit in effectively alleviating poverty and the potential for borrowers to become trapped in cycles of debt. Despite these challenges, advocates emphasize the positive impacts of microcredit, including job creation and income generation for marginalized groups, such as immigrants and women, while also beginning to incorporate environmental considerations into lending practices.
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Microcredit
Microcredit refers to the practice of making small loans to individuals and small businesses that would not typically get credit because the size of the loan is smaller than what traditional banks would finance and the borrower might not have the financial history to qualify for a traditional loan. Microcredit, also practiced under the names microfinance, peer-to-peer lending, and crowdfunding, was pioneered by Grameen Bank under Muhammad Yunus in the 1970s in Bangladesh; Yunus won the 2006 Nobel Peace Prize jointly with Grameen Bank for this work. While microcredit originated to help entrepreneurs work their way out of poverty in developing countries, it has since grown in popularity in the United States, Canada, and Western Europe. Microcrediters most often operate as nonprofit organizations with individual and government investors, though there are also for-profit microcredit organizations. While microcredit organizations typically have high repayment rates for their loans, critics have questioned whether this approach can alleviate poverty.
Brief History
Microcredit provides small loans to people who might not otherwise qualify because of income or credit history. Loans are used to start or expand a business or to (re)train for work. The continuous recent history of microcredit began in 1972 when a nongovernment organization called the Bangladesh Rural Advancement Committee (BRAC) was started to spur was rural development and women’s empowerment. By 1974, BRAC was providing collateral free loans to poor people, becoming the new model of microcredit after the Kaligram Krishi Bank, started in 1905 in Bangladesh, ceased to exist. In 1976 the Grameen Bank, funded with government support, began to offer small loans with the aim of eliminating poverty; typical borrowers used loans to purchase livestock, repair vehicles, or expand the output of their business. Grameen Bank and Muhammad Yunus shared the 2006 Nobel Prize for their microcredit work. Growing awareness of microcredit led to the model being replicated in other nations in development as well as in North America and western Europe.
Microcredit became especially popular in North America after the financial crisis of 2008 created thousands of potential clients who could not qualify for traditional credit sources; the number of microcredit clients tripled from 2008 to 2011 in the United States alone. Many nonprofit microcredit operations in the United States and Canada also teach loan recipients financial literacy and business planning and offer mentorship to foster long-term success. The Grameen Foundation’s US operation has headquarters in Washington, D.C., and Davis, California, as well as twenty-four branches around the country. Their small loans start at no more than $2,500. Notable North American microcredit organizations include Accion USA and the Ottowa Community Loan Fund (Canada). Accion USA has been active since 1991 with lending offices in thirty cities across the country and offers small business loans as low as $5,000 and up to $250,000. The Ottawa Community Loan Fund has been active since 2000 and has focused on helping youth entrepreneurs and new immigrants. US business leaders Alan Greenspan and Ben Bernanke, both former Federal Reserve chairmen, have advocated for the microcredit model.
Grameen America does less borrower counseling and offers smaller loans in a way that stays close to its Bangladeshi model. In this model, borrowers are put in groups of five to approve one another’s loans and make weekly payments at 15 percent annually; this is comparable to other nonprofits and well below payday lenders rates of 400 percent or more. If everyone in the group repays on time, then everyone is entitled to a larger loan next cycle. Grameen’s clients must be below the federal poverty line when they join and the money must go toward entrepreneurial projects; citizenship is not a requirement for clients. US clients typically use funds to purchase supplies to sell food, cosmetics, or clothing/accessories from home, small shops, or in their native countries.
The microcredit sector cites a repayment rate between 95 and 99 percent on average with funding. Microcredit is funded through governments, foundations, and individual donors (also called angel donors) or lenders (also called peer lenders) as the industry is primarily not-for-profit. For-profit microcredit organizations include microcredit brokers, who provide the connection between lenders and borrowers, usually though an online or social media platform, for a small fee. Such brokers include the United Kingcom’s Prosper.com and Funding Circle, the latter of which now operates a US branch. US based Kiva also connects lenders to borrowers, is not-for-profit, and has overseen 2.2 million lenders who have facilitated over $2 billion in loans to over 5 million people from 2005 to 2023.
Impact
Borrowers of microcredit might continue to face economic and other challenges. In countries like South Africa, where microcredit was introduced after apartheid to help lift individuals out of poverty it has created new problems such as locking the poor into a cycle of repaying microdebt and funding low income generating enterprises (e.g., small convenience shops called spaza shops) at the expense of more sustainable development programs. Finance professor Gregor Dorfleitner et al., in "What Determines Microcredit Interest Rates?" (2013) also argues that there is evidence to suggest that female borrowers are charged higher interest rates, especially in African region microcredit organizations. European studies of microcredit similarly argue that women face more life challenges that can make securing microcredit more difficult. Microcredit is also criticized as infeasible for technology projects, which can take longer to develop and reach profitability.
Microcredit’s advocates cite loan recipients increased income and decreased government social benefits spending and increased tax income; this is in addition to the already noted high repayment rate of loans. Microcredit is described as character-based lending, meaning that the personal commitment, experience, and/or skills of the client are weighed along with the business idea. Microloans have greatly helped immigrants and the poor develop jobs and often help such individuals overcome language, cultural, and bureaucratic barriers to employment with support programs and mentoring.
Microcredit is increasingly taking a so-called green perspective, which takes the environmental impact of microfunded businesses into account. Many microcredit rating agencies now also look at an organization’s environmental performance. Countries like Burkina Faso have introduced regulations to promote green microcredit projects while Bangladesh promotes them using incentives.
Bibliography
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