Microcredit 101: Definition, Benefits, and Impact

Microcredit is a type of small loan that helps people in need access capital to start or grow a business. It's often used by individuals who don't have the collateral or credit history to secure a traditional bank loan.

The benefits of microcredit are numerous, including increased economic opportunities and improved living standards for borrowers. For example, a study found that microcredit borrowers in Bangladesh saw a 15% increase in income.

Microcredit can have a significant impact on the lives of individuals and communities. In fact, the Grameen Bank, a pioneer in microcredit, has reported a repayment rate of 98% for its loans.

Microloans are designed for individuals not served by traditional banks and are generally offered by specialized financial services providers often called Microfinance Institutions (MFIs).

The "micro" part refers to the amount of money lent to these individuals, which is usually anywhere from a few hundred to a few thousand dollars.

Microloans aim to provide enough money to make a difference to an individual's life, while still being manageable to pay back.

The sum may be small, but the impact can be big, allowing people to grow businesses, expand farms, and fund educational pursuits.

Kiva funds microloans by allowing individual lenders to contribute small amounts, with as little as $25.

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Microcredit has been a game-changer for millions of people worldwide, providing them with access to financial services and credit that they would otherwise not have. Over 174 million people have directly or indirectly benefited from microfinance-related operations.

The benefits of microcredit are numerous, but one of the most significant is its ability to increase household wealth. For example, a loan used to purchase higher quality seeds for farming can lead to a more successful harvest and increased earnings, which can then be reinvested in the farm. This is exactly what happened with Peter, a maize farmer in Kenya, who borrowed USD$125 through Kiva and was able to purchase and plant higher quality seeds, leading to an increased harvest and higher earnings.

Microcredit also creates opportunities for others, as entrepreneurs who create successful businesses can offer jobs and trade to help improve their community. In fact, the International Finance Corp. (IFC) has helped establish or improve credit reporting bureaus in 30 developing nations, making it easier for entrepreneurs to access credit and create jobs.

Some of the most common uses of microcredit include savings accounts, like those set up by Kiva Field Partner Xacbank for students in Mongolia. These accounts provide a safe and secure way for students to save their money and plan for the future.

Here are some examples of how microcredit is used:

Microcredit has also been shown to promote better health and education, as families who utilize microcredit are less likely to pull their children from school for economic reasons and have more resources available to pay for healthcare. Additionally, microcredit has helped close the gender gap, with over 80 percent of Kiva microloans going to women, funding businesses, enterprises, and education in countries where social norms do not support gender equality.

Microcredit has been shown to have a positive effect on financial inclusion, offering millions of people in impoverished communities loans and services to improve their livelihoods. Kiva, a non-profit microfinance organization, has seen borrowers increase their incomes by 40-50 percent in East Africa and 92 percent in other countries.

However, critics argue that high interest rates and predatory lending practices can trap vulnerable people in debt. Compartamos Banco, a for-profit microfinance institution, has been criticized for charging high interest rates that can create a debt trap for low-income borrowers.

Despite these concerns, some studies have shown that microfinance can be transformative when designed around customer needs and circumstances. A study in India found that microloan borrowers who were given a two-month grace period saw a 41 percent increase in weekly profits.

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Microfinance has indeed had a positive effect on financial inclusion, offering millions of people in impoverished communities loans and services to improve their livelihoods.

Studies show that if microfinance is designed around customer needs and circumstances, it can be transformative. For example, a study in India found that when microloan borrowers were given a two-month grace period before repaying their loans, they saw a 41 percent increase in weekly profits.

Critics of microfinance cite high interest rates and predatory lending practices, but Kiva remains vigilant in ensuring responsible and fair lending practices.

Rural farmers in East Africa who received microloans through the One Acre Fund have shown to increase their incomes 40-50 percent compared to a control group.

With a repayment rate of 96.4 percent, microlending through Kiva provides a sustainable flow of cash which can be lent again to additional individuals once it has been repaid.

Positive impact can also mean better quality of life: In Madagascar, 92 percent of customers of Boabab+, a provider of off-grid solar energy systems, reported that they feel safer in their homes because of the increased light, and that children have been able to study 75 percent more in these households.

Here are some specific examples of the benefits of microfinance:

Microfinance has been criticized for making money off people with low incomes due to higher interest rates compared to conventional banks.

Banco Compartamos, a Mexican bank, started as a nonprofit but converted to a for-profit company in 2000, and its initial public offering raised over $400 million in 2007.

Critics, including Dr. Yunus, the founder of microfinance, argue that for-profit microfinance institutions prioritize making money over poverty alleviation.

Compartamos and other for-profit microfinanciers counter that commercialization allows them to operate more efficiently and attract more capital.

This approach has led to concerns that large microfinance bankers will charge higher interest rates, creating a debt trap for low-income borrowers.

Some critics argue that individual microloans of $100 aren't enough to provide independence and instead keep recipients working in subsistence-level trades.

The presence of interest payments can also be a burden, as some borrowers may not be able to repay loans due to venture failure or personal catastrophe.

Microcredit has its roots in the 18th and 19th centuries in Ireland, where Jonathan Swift's ideas inspired the Irish Loan Funds.

John Wesley began a microcredit scheme in 1746, lending small amounts to the poor who repaid weekly.

In the mid-19th century, Lysander Spooner and Friedrich Wilhelm Raiffeisen independently worked on cooperative lending banks to support farmers in rural Germany.

The concept of microcredit was reimagined in the 1970s and 1980s, with Muhammad Yunus playing a key role in shaping the vision.

Yunus opened the Grameen Bank in 1983, which received funding and created a microcredit model that was successful in Bangladesh.

The first example of microcredit originated with a group of women who created bamboo stools, earning a minimal profit due to supplier repayment.

These women were loaned $27, allowing them to sustain their business and pay off the loan.

Muhammad Yunus found that providing credit to the poor could help them escape poverty, as seen in his work with destitute basketweavers in Bangladesh.

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Dr. Yunus founded the Grameen Bank in 1983, which became a model for similar lending institutions around the world.

The Grameen Bank was followed by organizations such as BRAC in 1972 and ASA in 1978, both in Bangladesh.

Microcredit reached Latin America with the establishment of PRODEM in Bolivia in 1986, which later transformed into the for-profit BancoSol.

The Grameen Bank, initially a non-profit organization, later became a corporate entity and was renamed Grameen II in 2002.

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Kiva, Zidisha, and the Microloan Foundation are platforms that connect lenders to micro-entrepreneurs via the Internet.

These platforms facilitate a modified form of peer-to-peer lending, aggregating smaller loans at a negligible interest rate.

United Prosperity, a now-defunct microlender, used a variation on the usual microlending model, providing a guarantee to a local bank which then lent back double the amount to the micro-entrepreneur.

This approach allowed the micro-entrepreneur to develop a credit history with their local bank for future loans.

Zidisha became the first peer-to-peer microlending platform to link lenders and borrowers directly across international borders without local intermediaries in 2009.

Vittana allowed peer-to-peer lending for student loans in developing countries from 2008 through 2014.

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Microcredit originated in Bangladesh in the 1970s to address poverty and lack of access to financial services in rural areas.

The Grameen Bank, founded by Muhammad Yunus, was the first to offer microcredit to women in rural Bangladesh, providing loans of up to 5,000 takas (approximately $60 USD) for small businesses and income-generating activities.

The bank's model was based on the idea that women, who were often excluded from traditional banking systems, could be successful entrepreneurs with the right support and resources.

In India, the National Bank for Agriculture and Rural Development (NABARD) finances more than 500 banks that on-lend funds to self-help groups (SHGs), which typically comprise twenty or fewer members, mostly women from the poorest castes and tribes.

These SHGs save small amounts of money, as little as a few rupees a month in a group fund, which members can borrow from for various purposes like household emergencies or school fees.

Banks typically lend up to four rupees for every rupee in the group fund, and nearly 1.4 million SHGs comprising approximately 20 million women now borrow from banks, making the Indian SHG-Bank Linkage model the largest microfinance program in the world.

In Asia, borrowers generally pay interest rates that range from 30% to 70% without commission and fees.

Bangladesh is home to Grameen Bank, the oldest and probably best-known microfinance institution in the world. It launched its US operations in New York in April 2008.

Grameen Bank has been successful in providing microloans with an impressive 90% repayment rate, thanks to its unique solidarity lending model. This model values the relationship between the bank and the borrower, making poorer individuals safer borrowers.

The Grameen model has been studied extensively, and its success can be attributed to the strong relationships built between the bank and its clients. Even so, efforts to replicate this model in developed countries have generally not succeeded.

In Canada, the Calmeadow Foundation tested an analogous peer-lending model in the 1990s, but it ultimately concluded that solidarity lending was unviable without subsidies.

The United States has a significant microcredit industry, with the Accion U.S. Network being the largest and only nationwide nonprofit microfinance network in the US.

Accion U.S. Network is headquartered in New York, New York, and is part of the global nonprofit organization, Accion International.

The Accion U.S. Network has helped many poor but ambitious borrowers to improve their lot, with over half of loan recipients escaping poverty within five years.

On average, household assets of these borrowers grew by nearly $16,000 during this period, and their reliance on public assistance dropped by more than 60%.

Grameen America, launched by corporate sponsors including Citi Foundation and Capital One, has facilitated loans to over 9,000 borrowers valued at over $35 million in just four years.

Grameen America has achieved a remarkable 99 percent repayment rate, according to its CEO, Stephen Vogel.

Financial inclusion is a significant challenge, with an estimated 1.7 billion people lacking access to basic financial accounts.

More than 174 million people have directly or indirectly benefited from microfinance-related operations, but this is only a small fraction of those who need it.

Microfinance has been shown to create jobs, trade, and overall economic improvement within a community, making it a crucial tool for economic growth.

However, the impact of microcredit is a subject of controversy, with critics arguing that it may not increase incomes and may drive poor households into a debt trap.

Some studies suggest that microcredit has not generally empowered women, and its negative impacts have not been as drastic as some critics have argued.

The success of small businesses is influenced by various factors, including the economy and market growth, rather than just microcredit.

Here are some of the unintended consequences of microfinance:

More than 174 million people have directly or indirectly benefited from microfinance-related operations, but an estimated 1.7 billion people still lack access to basic financial accounts.

Microfinance has been shown to create successful businesses, jobs, and economic improvement within a community. Entrepreneurs who create successful businesses in turn create jobs, trade, and overall economic improvement.

However, the impact of microcredit is a subject of controversy, with some arguing that it may not increase incomes and may drive poor households into a debt trap.

The available evidence indicates that in many cases microcredit has facilitated the creation and growth of businesses, but it has not necessarily increased incomes after interest payments.

Microcredit has achieved much less than what its proponents said it would achieve, but its negative impacts have not been as drastic as some critics have argued.

Some studies suggest that microcredit has not generally empowered women, and that it may be used for durable consumer goods or consumption instead of productive investments.

Here are some key statistics on the impact of microfinance:

Financial education is a crucial step in achieving financial inclusion. It helps individuals understand basic money-management concepts.

People seeking help from microfinance organizations are often required to take a basic money-management class. These classes cover essential topics like understanding interest rates and cash flow.

A typical loan from a microfinance organization may be as little as $100. This may not seem like much, but for many impoverished people, it's often enough to start or sustain a business.

The global microfinance market was valued at an estimated $224.6 billion in 2023. It's expected to exceed $506 billion by 2030, highlighting the significant impact of microfinance on the global economy.

Microcredit is a powerful tool for individuals in developing countries to start or expand small businesses. Microcredit borrowers tend to be low-income individuals living in parts of the developing world, where the practice originated in its modern form in Bangladesh.

Microfinanciers charge interest on loans and institute specific repayment plans with payments due at regular intervals. Some lenders require loan recipients to set aside some of their income in a savings account, which can be used as insurance if the customer defaults.

Repayment rates on microloans are often surprisingly high, with some institutions reporting rates of up to 98.9% in 2016. This is likely due to the group borrowing model, where borrowers pool together as a buffer and repay debts together.

The group borrowing model creates a form of peer pressure that can help ensure repayment. If an individual is having trouble using their money to start a business, they can seek help from other group members or the loan officer.

Developing a good credit history through repayment allows borrowers to obtain larger loans in the future. This can be a game-changer for individuals who may have previously been unable to access traditional forms of financing.

Here are some key terms to know: