Over the past two decades, the use of microfinance as a strategy to alleviate poverty has risen at an astonishing rate. In fact, the very term has become a buzz-word in the fields of economic and even social development. Generally speaking, microfinance is a term used to describe “financial services to low-income individuals or to those who do not have access to typical banking services” (Kiva 2011). More specifically, microfinance is the “supply of loans, savings, and other basic financial services to the poor” (CGAP 2011a). This is built on the belief that the impoverished, like everyone else, require financial services to run their businesses, acquire assets, and manage risks.
The genesis of modern microfinance is most commonly attributed to Mohammad Yunus, a former professor of economics who began experimenting with poor women in Jobra, Bangladesh in the mid 1970s. His experiment aimed to design “a credit delivery system to provide banking services targeted at the rural poor” (Grameen Bank 2011). In 1983 Yunus founded Grameen Bank, a bank that seeks to offer financial services to the poor. His efforts met with tremendous success. In light of the successes of Grameen Bank, many nongovernmental organizations transformed themselves into formal financial institutions throughout the 1980s and 1990s. This period witnessed mounting enthusiasm for the use of microfinance as a strategy to alleviate poverty (Global Envision 2006). Realizing the vast entrepreneurial potential of the poor, hundreds of microfinance institutions have since followed in Grameen’s footsteps.
The emergence of microfinance institutions (MFIs) occurred as a response to the demand for financial services by the poor. Traditionally, poor people have been unable to obtain loans from commercial banks because they are not considered a viable market. The poor are generally undereducated or uneducated, have very little income, and live in areas with poor health conditions, factors all contributing to a perceived sense by banks that loaning to the poor is too risky. To be sure, commercial banks were originally designed to help those with financial assets. For example, a bank earns much more interest on a large loan than it does a small loan. Consequently, the poor have historically had little or no access to financial services. Yet, through the emergence of Grameen and other MFIs, the poor have gained access to financial resources. Moreover, they have repeatedly demonstrated their ability to repay loans, granting merit to such financial institutions as sustainable enterprises. Repayment rates are high because, due to a system of peer support and pressure used in many micro-credit models, borrowers are responsible for each other’s success and thus ensure that every member of the group is able to pay back the loans (The Microcredit Summit Campaign 2009).
The use of credit in market economies is not new. A bank or lender grants a line of credit, which can then be used on an as-needed basis. The borrower pays interest on the outstanding balance, typically on a monthly basis. When the principal is repaid, money is made available for future loans. The model of micro-credit is built off of this credit model. The success of this model is based off of four assumptions (Campbell 2010). First, it assumes that micro-credit reaches “the poorest of the poor.” Second, it assumes that the borrower will fund his/her enterprise with the loan he/she received for that specific purpose. Third, it assumes that the borrower will reinvest its profits in the business. Fourth, it assumes that as profits increase, the borrower will invest his/her discretionary income in other services, thereby breaking the cycle of poverty.
Statistics show that the use of microfinance, and micro-credit more specifically, has expanded drastically in recent years. In fact, more than 128 million of the world’s poorest families received a micro-loan in 2009, an all-time high (PR Newswire 2011). Not only has the number of micro-credit loans increased, they have also made a positive impact on loan recipients. Empirical evidence suggest that “those participating in microfinance programs who had access to financial services were able to improve their well-being-both at the individual and household level-much more than those who did not have access to financial services” (Kiva 2011).
Furthermore, microfinance has proven to be a useful tool for empowering women, commonly identified as one of the most vulnerable demographics in the world (Kristof 2011; Inter Press Service 2011). Women’s access to micro-credit has increased their self-reliance, their right to make choices, and their ability to influence the direction of change (Drolet 2010). Additionally, women have become more active in economic activity, play a larger role in decision making, and take on leadership positions within their respective communities (Sanyal 2009).
Yet, for all of these benefits, many have been quick to point out the deficiencies in MFIs and microfinance more broadly. The most notable criticism is that micro-credit does not necessarily reach “the poorest of the poor,” therefore not serving its purpose. For instance, many MFIs have dropped their non-profit model and instead adopted a for-profit model. This shift includes charging high interest rates on loans. Mohammad Yunus, the father of modern microfinance, has called this trend a “wrong turn” and a worrying “mission drift” in the motivation of lending to the poor (Islam 2011). Similar criticism charges that the for-profit model creates opportunities to exploit the poor. MFIs, however, have claimed that, due to higher administrative costs, interest rates must be high in order to return the cost on the loan. Lending out one million dollars in 100,000 loans of $100 each will obviously require a lot more in staff salaries than making a single loan for the total amount. As a result, the interest rates of MFIs are significantly higher than the rates charged by commercial banks (CGAP 2011b).
On the whole, however, microfinance and MFIs have been well received by the international community. MFIs have proven to be an effective instrument for reducing poverty by allowing poor people to build assets, increase their incomes, and manage risks. The United Nations has lent its support for the promotion of microfinance as a strategy to alleviate poverty. In fact, the UN declared 2005 the “International Year of Microcredit” (Ahlin 2007, 2). Today, micro-credit is regarded as a viable and effective method to help achieve the first and most prominent of the Millennium Development Goals, the eradication of poverty. The UN’s insistence on the usefulness of micro-credit lends support to its practice of being both economically and socially beneficial to underdeveloped and developing societies. Although microfinance remains imperfect, it is nevertheless a proven method which has demonstrably improved the plight of impoverished peoples around the world.
Works Cited
Ahlin, Christian. 2007. “How does Micro-Credit Work?: Risk-Matching, Diversification, and Borrower Selection.” Preliminary Draft. February 2007. Accessed September 26, 2011 from: http://www.stanford.edu/group/SITE/archive/SITE_2007/segment_2/ahlin_groupsorting.pdf.
Campbell, Gregor. 2010. “Microfinancing the Developing World: how small loans empower local economies and catalyse neoliberalism’s endgame.” Third World Quarterly 31 (7), 1081-90. Accessed September 26, 2011 from: http://www.tandfonline.com/doi/full/10.1080/01436597.2010.518785.
CGAP. 2011. “About Microfinance.” Consultative Group to Assist the Poor. Accessed September 26, 2011 from: http://cgap.org/p/site/c/about/.
CGAP. 2011. “Why Do MFIs Charge High Interest Rates?” Consultative Group to Assist the Poor. Accessed September 26, 2011 from: http://www.cgap.org/p/site/c/template.rc/1.26.1309/.
Drolet, Julie. 2010. “Feminist Perspectives in Development: Implications for Women and Microcredit.” Journal of Women and Social Work 25 (3) (August 2010), 212-23. Accessed September 26, 2011 from: http://aff.sagepub.com/content/25/3/212.abstract?rss=1.
Global Envision. 2006. “The History of Microfinance.” Mercy Corps. 14 April 2006. Accessed September 26, 2011 from: http://www.globalenvision.org/library/4/1051/.
Grameen Bank. 2011. “A Short History of Grameen Bank.” Grameen Bank. Accessed September 26, 2011 from: http://www.grameen-info.org/index.php?option=com_content&task=view&id=19&Itemid=114.
Inter Press Service. 2011. “Accessible Micro-Loans Help Poor Women in Rural South Africa.” Inter Press Service. 19 September 2011. Accessed September 26, 2011 from: http://www.ipsnews.net/news.asp?idnews=105158.
Islam, M. Shahidul. 2011. “Save Grameen as an institution.” The Financial Express. 16 March 2011. Accessed September 26, 2011 from: http://www.thefinancialexpress-bd.com/more.php?news_id=129313&date=2011-03-16.
Kiva. 2011. “About Microfinance.” Kiva. Accessed September 26, 2011 from: http://www.kiva.org/about/microfinance.
Kristof, Nicholas D. 2011. “Sewing Her Way Out of Poverty.” The New York Times. 14 September 2011. Accessed September 26, 2011 from: http://www.nytimes.com/2011/09/15/opinion/kristof-sewing-her-way-out-of-poverty.html.
Microcredit Summit Campaign. 2009. “What is Microcredit?” RESULTS Educational Fund. Accessed September 26, 2011 from: http://www.microcreditsummit.org/about/what_is_microcredit/.
PR Newswire. 2011. “Record 128 Million of World’s Poorest Received a Microloan in 2009.” PR Newswire Association LLC. 7 May 2011. Accessed September 26, 2011 from: http://www.prnewswire.com/news-releases/record-128-million-of-worlds-poorest-received-a-microloan-in-2009-117528093.html.
Sanyal, Paromita. 2009. “From Credit to Collective Action: The Role of Microfinance in Promoting Women’s Social Capital and Normative Influence.” American Sociological Review 74 (4) (August 2009), 529-50. Accessed September 26, 2011 from; http://asr.sagepub.com/content/74/4/529.short?rss=1&ssource=mfc.
Questions
1. Is micro-credit a good basis for promoting development? Are there factors that might be necessary for micro-credit to produce desired results?
2. Is there a place for the for-profit model of micro-credit or should it always be a non-profit venture?
3. What does the social progression on the role of women using micro-credit say about the ties between economic independence and political development? What about the benefits of economic security to societal development?