Microcredit is an important poverty alleviation tool which is based on providing small loans without collateral to the impoverished, who otherwise would be dependent on local moneylenders who charge very high interest rates for capital. The debate over the effectiveness of micro credit has been going on for quite a while with no sign of ending soon. This blogpost seeks to provide a brief introduction to microcredit by specifically focussing on Grameen Bank, we lay out its model in brief and finally list out the major criticisms against microcredit.
The Grameen Bank
The Grameen Bank, which is generally considered the first modern microcredit institution, was founded in 1983 in Bangladesh that has succeeded in providing credit, without collateral, to millions of poor people and recording very low default rates along with very high recovery rates. Grameen Bank creates a market niche for the low income groups who do not have alternative sources of credit at the rate of interest charged. Grameen’s creation of market niche is also due to its implicit targeting of women amongst the poor. This is not just because women form the majority of poor people in rural areas but also because they are seen as having the biggest influence in attempting to reduce poverty and are more reliable in making repayments. Lending to women has become a core principle for most microcredit organizations – indeed, some lend exclusively to women.
The Model: Group Lending
The Grameen Bank operates in a credit market that is characterized by imperfect information and imperfect enforcement. Lending entails high risk of loan default, but formal lenders are not part of the community and hence, do not have ability as well as means to collect information about the borrowers and their activities.
The Grameen Bank tackles this problem by offering group-based credit as opposed to traditional individual lending, where an individual’s access to credit is tied to group responsibility and repayment behaviour. It uses peer pressure to monitor and enforce contracts, provides an incentive structure for the borrowers to repay, and helps screen good borrowers from bad ones, all of which would be costly for the bank to accomplish otherwise.
Criticisms of Microcredit
- Microcredit has not had a positive impact on gender relationships.
- Microcredit imposes interest rates that are too high.
- Microcredit has driven poor households into a debt trap.
- Microcredit does not alleviate poverty or improve health and education.
- Microcredit constitutes “privatization of welfare”.
The first randomized evaluation of microcredit, however showed mixed results: there was no effect on household expenditure, gender equity, education or health, but the number of new businesses increased by one third compared to a control group.
The arguments about the effectiveness of micro-finance in alleviating global poverty will continue. They often reflect the different political values brought to bear on the whole field of world development.
Useful Links for further reading:
- Wikipedia article on microcredit: en.wikipedia.org/wiki/Microcredit
- A more detailed blog on Microcredit and the Grameen Bank: http://newint.org/books/reference/world-development/case-studies/poverty-microcredit-grameen-bank/
- Article by David Roodman from The Washington Post explaining the limits of microfinance in helping people out of poverty :washingtonpost.com/opinions/microcredit-doesnt-end-poverty-despite-all-the-hype/2012/01/20/gIQAtrfqzR_story.html