27, this is the sum which laid the foundation to what is now a 34 Billion dollar industry, the 27 which brought together the bankers and the social workers. Who could have predicted that such a small sum changed the outlook for thousands of communities, shifting them away from the back-breaking poverty prevalent in the developing nations. Microcredit for the poor allowed them social mobility and move away from the back breaking poverty they were trapped in, this was the vision of Muhammad Yunus the founder of modern day microfinance.
This philosophy of credit to the poor seems counterproductive, why would any institutionalized bank give credit to those which are financially poor? When a bank normally gives loans, it provides credits to those who can pay it meaning those who are financially sound enough to give interests on the loan taken. But providing credits to the riskiest of its customers seems counterproductive to a bank, while for the credits takers jumping through hoops of complex paperwork’s seems like a waste of time.
Beginnings of microcredit
While Muhammad Yunus may be regarded the father of modern day microfinance, the general idea of microcredit to support the poor has been put into practice in various forms throughout the centuries. The basic idea of microcredit is to support the poor while slowly move people out of extreme poverty, Lysander Spooner is the first notable theorist to propose this heretical idea and many were not convinced. While moving into the 20th century many newly formed nation’s pondered ways to help their nation’s ultra-poor communities, with microcredits being introduced and somewhat successful in countries such as Indonesia and Venezuela. Then in 1976, the foundation of Gareem bank is laid when $27 is given to 42 families by Yunus and later on in 1983 Gareem Bank is formalized into a proper microfinance bank.
The idea of what microfinance banks can and cannot be has varied throughout the early year’s of this industry with various implementations floating around. These early days many found success while a inappropriately large group found an opportunity to abuse said vulnerable poor communities. The worse of these crimes have been committed in Cambodia and India, where crude lending practices and harassment have led to divergence of the declared goal of poverty reduction mission.
The microcredit model took off in the 1990s with thousands of microfinance banks forming around the world. Today, there are around 10,000 microfinance institutions around the world catering to millions of poor and vulnerable communities.
Microcredit and how it works
Microfinance institutions basically work on the same principals of conventional banking, where the borrowers are provided credit on a certain interest rate and most importantly collateral put down by the borrowers in case they loan cannot be paid. The collateral can be in the form of any physical assets such as land or house; this is where most of the successful microfinance institutions diverge.
If we look at one of the most successful microfinance programs, the Gareem Bank it diverges in many policies in respect to conventional banks which we will discuss in detail. Gareem Bank is a pioneer in what is call a non-collateral loans a stark opposite to conventional and informal lending’s, rather a system of binding rules for productive use of credit i.e. planting of more seedlings is implemented and the amazing thing is that this enforcement is done by peer monitoring system where the community itself enforces said rules. But when the borrower defaults on his loan the policy of “consume less and invest more” is enforced and a social sanction employed onto the borrower. In essence the system has been built on the principal on “social collateral’ which ensures repayment is done by the borrower.
Microfinance and the battle against informal lending
The class of informal contracts is represented by suppliers and merchants, landlords, relatives and friends microfinance was in essence formed to provide an alternative to informal borrowing, microcredits would provide a much safer alternative to informal lender, well that was what microfinance institutions were supposed to do. In countries like Cambodia, microfinance essentially legalized crude practices from informal lending systems, coercive land sale, child labor, family members migrate due to debt became prevalent due to unpaid debts to these pseudo-welfare programs. Cambodia has 2.4 million borrowers with an $8 billion in outstanding microloans, which is one third of the whole countries GDP. Most of these borrowers have been forced to sell their properties in order to repay their loans.
Microfinance banks were formed with their mission being to support fragile communities and when divergence is seen, results for the poor are inadmissible and damaging.
Why it became successful
This does not necessarily mean that microcredit programs are inherently bad, those countries that have implemented effective policies to steer microcredit programs are present, and countries like Bangladesh and Kenya are great examples.
One of the most important parts in its success has been microfinance institutions dual target philosophy of social uplift and profits in order to internally generate capital and supporting the poor populations. Balancing both targets has been a tough goal to achieve and while there has been great success in growth of this sector and supporting the poor another part of this industry has been wholly inept in balancing their goal leading to undesirable outcomes.
To achieve this dual target mission microfinance institutions have taken progressive methods to ensure that they meet their goals. The “one size fits all” does not work in this industry countries and their populations vary and in order to meet the goal of financial inclusion each credit policy differs from region to region. A good example is Kenya where the introduction of “commitment savings” where borrowers are encouraged to save money in their “safe box” increased the achievement of health savings by 14 percent.
Microfinance a goal hard to achieve
Globally, microfinance is hailed as a revolutionary platform in bringing people out of poverty but the hard truth is that a total 5% of the total beneficiaries exit poverty each year. Even this is a more optimistic outlook and only few counties have accomplished said result, nonetheless, microfinance institutions have become an integral part of poverty reduction programs around the world and their role will only increase. The battle against poverty is a long and cumbersome one, eventually our combined efforts can only succeed in riding the world of this menace.