Microcredit is a potent financial innovation designed to boost self-employment and small business growth among low-income individuals, primarily in less developed countries (LDCs). This powerful tool is also known as “microlending” or “microloan.”
Key Takeaways
- Microcredit provides very small sums to individuals to start or expand a small business.
- Borrowers are usually low-income individuals in developing parts of the world; modern microcredit practices began in Bangladesh.
- It predominantly functions on a group borrowing model, pioneered by Nobel laureate Muhammad Yunus and his Grameen Bank.
How Microcredit Works
The foundation of microcredit lies in empowering skilled individuals in underdeveloped regions who are typically excluded from traditional banking systems. Many people who benefit from microcredit belong to barter economies with no direct access to currency.
The modern era of microcredit credits its origins to the Grameen Bank model, conceived by economist Muhammad Yunus. This pioneering system was first implemented in 1976 in Bangladesh, where a group of women borrowed $27 for their small businesses. The collective repayment of the loan enabled them to sustain their operations.
Take the example of the women making bamboo stools in Bangladesh. Individually, the women couldn’t afford the materials or secure credit due to high individual lending risk. However, collective borrowing provided them the necessary resources, with the agreement that the loan would be repaid gradually as they sold their products.
Microloans can be as small as $10 and generally do not exceed $2,000. This contrasts sharply with traditional banking loans, which typically require collateral and adhere to stringent repayment terms. Often, microcredit arrangements eliminate the need for written agreements altogether.
Micro-Loan Terms
Though akin to conventional lenders, micro-financiers levy interest and establish set repayment plans. Some require borrowers to reserve a portion of their income into a savings account, which serves as a safety net should they default on the loan. Successful repayment increases their savings, thus creating a financial cushion.
Collateral is often absent in microcredit schemes. Borrowers are pooled together as a safety measure, repaying their debts collaboratively. This collective arrangement imposes peer pressure, promoting consistent repayment.
For instance, if a borrower faces struggles in their business venture, they can turn to other group members or the loan officer for guidance. Through consistent repayment, borrowers cultivate a favorable credit history, paving the way for accessing larger loans in the future.
Interestingly, despite their financial straits, microcredit repayment rates often surpass those of conventional financing. For example, Opportunity International reported a remarkable 98.9% repayment rate in 2016.
Critiques of Microcredit
Microcredit has met with some criticism, particularly concerning misuse and unsustainable debt accumulation. In South Africa, microcredit introduced to spur self-employment in impoverished areas sometimes led to funds being spent on consumption rather than business creation.
Borrowers may also amass debt they struggle to repay, lacking a stable income or viable business to provide revenue for loan repayment. This situation can drive them to liquidate personal assets or seek further loans, trapping them in a cycle of debt.
In conclusion, while microcredit offers significant potential for fostering entrepreneurship and economic development, it is not without its pitfalls. Careful implementation and oversight are crucial to ensure it serves its purpose effectively.
Related Terms: Microfinance, Loan, Muhammad Yunus, Repayment, Default, Credit History.
