In discussions of international development, microcredit is viewed as a silver bullet. It ticks all the right boxes – microcredit keeps money in the communities, it empowers individuals to create their own income and become independent of handouts, and it places women at the forefront of the development agenda.
The benefits of microcredit are often told in anecdotal stories. For example, a woman in Zambia receives a $5 loan to start her own embroidery shop. The shop then takes off, and she employs 20 local women. As a result of the increase in income, the women send their children to school, they eat well and receive quality medical care – ultimately pulling that family from the cycle of poverty.
While success stories such as these may be true, they are the exception. There are a lot of challenges that microcredit as a development tool poses that are often overlooked. As stated by Milford Bateman, author of the book Why Doesn’t Microfinance Work, focusing on these anecdotes is similar to focusing on a few trees left standing after having helped the entire forest to burn down.
Firstly though – let’s go back to basics.
What is Microcredit: Microcredit is the process of providing small loans to individuals usually living in rural areas who are not eligible for loans from traditional banking institutions. The motivation behind providing the loans is that the individual will use the money to start a business venture to increase their household income
The history of Microcredit: The concept of microcredit was first developed in 1976 by Muhammad Yunus who lent $27 to a group of 42 Bangladeshi villagers. The villagers used the money to start small businesses and improve the quality of their lives. After the success of his experiment, Yunus established the Grameen Bank, which to date has dispersed $11.8 billion US dollars to over eight million members.The initial achievement of Yunus and the Grameen Bank lead to the rapid growth of the microcredit industry, with non-governmental organisations, intergovernmental organisations, and international donors pledging their support of the new development. By the late 1980s, microcredit became the international community’s development model of choice, and has evolved to include other financial services such as micro-savings and micro-insurance. Today, there are more than 3600 microcredit organisations worldwide, the majority of which follow a similar model as developed by Grameen Bank.
How microcredit works: The Grameen Bank model features microcredit agents who travel to the countryside to distribute loans and collect repayments. The lenders make small loan repayments each week with interest, usually over a 52 week period. The Grameen Bank has a 96.65 percent repayment rate, a figure that is common to most microcredit organisations. The Grameen Bank’s high repayment rate can be attributed to the loan circles, which every lender must be apart of. The loan circles are composed of approximately 20 members who meet once a week. If one member of the loan circle is unable to meet their obligations, no one in the group is eligible to borrow. The Grameen Bank’s microcredit program also features additional training provided in the weekly meeting, which cover areas such as skill development, literacy, bank rules, investment strategies, health and civil responsibilities.
MICROCREDIT CHALLENGE NUMBER ONE – The informal sector
In many underdeveloped areas, the belief is held that men should be paid for work outside the house, and women should be unpaid for work inside the house. Therefore, female lenders generally engage in microenterprise involving sewing, weaving, building toys or electronics. This creates two problems:
- These restrictions mean that a lot of women conduct enterprise in the same area, and the more people specialising the same activity the lower the return will be as the local economy becomes saturated with almost no further productivity-driven gains to be made.
- Enterprises such as these exist in the unregulated informal sector, providing the female lenders with no legal protection. These realities result in the lender being unable to pay back their loan, and it becomes common for women to become trapped in debt cycles. A 95 percent loan recovery rate does not give any indication of whether individuals were able to pay back their loans without additional suffering, such as selling family assets, diverting other income into repayment, or taking out addition loans.
MICROCREDIT CHALLENGE NUMBER TWO – Ignoring the ‘hardcore poor’
This fear of failure to repay a loan has repercussions for both the microcredit program and the potential lender. Microcredit programs are often criticized for not offering loans to the ‘hardcore poor’, the poorest of the poor. This occurs as microcredit organisations feel accountable to their donors, so in order to maintain high repayment rates tend to move up the poverty scale, away from the poorest borrowers, a finding that has been supported by many studies. On the other hand, the ‘hardcore poor’ often discount microcredit as an option, as the fear of being unable to repay is too extreme.
MICROCREDIT CHALLENGE NUMBER THREE – Non-productive use of microcredit loans
When desperately poor individuals are offered a loan, they are generally going to favour buying food over starting a microenterprise. This assertion has been supported by many academics. One of the first in depth studies of Garmeen Bank in the 1990s found that up to 70 percent of microloans were being used for purposes other than income-generating activities.
The societal conditions that restrict microcredit’s ability to succeed as a development model combine to produce an overall disappointing reality. Studies are continually finding that microcredit has limited or no impact on the level of poverty of lenders:
- A study conducted by Karlan and Zinman in the Philippines discovered that access to a microcredit loan created no changes in household income, spending or diet of the lender.
- A study in India by Jameel Poverty Action Lab discovered that microcredit had “no impact on total income, spending, health, or school enrollment rates”.
- A study in Bolivia found that after receiving a microcredit loan 65 percent of lenders poverty level stayed the same and 15 percent of lenders poverty level deteriorated.
- Finally, an analysis of Grameen Bank concluded that 77 percent of client’s poverty levels “stayed more or less the same” after the receiving the loan.
Bateman and Chang in their paper The Microfinance Illusion compared microcredit to a bad medicine – it has created some temporary feel-good effects for the patients (the lenders), and the doctors (the microcredit organisations and international development agencies). Yet over the longer term, the bad medicine has been debilitating not curing the patient.