Microcredit in the world

Microfinance is an area of finance concentrated around people in poverty. It consists of microcredit – loans and other debt facilities, savings, and checking accounts, payment processing, and microinsurance.

About 1.5 billion people are unbanked or underbanked and have to rely on alternative financial services. One of those is microcredit institutions, savings collectives, or mPESA payment system.

Savings facilities are usually not accessible to poor people (recent rise in fintech might be able to change it for at least a portion of them), the same goes for any insurance products that are not government-mandated. And even then there is no guarantee of access.

Microcredit – dripping in small amounts

Microcredit provides money for entrepreneurial ventures, their sole purpose is income generation. They do not require any collateral, provide only low amounts (that could still be life-changing liquidity). In the US companies provide microcredit of up to $50 000, or up to a median yearly income. But that is just an upper limit, most of those loans are lower.

In the current environment, microcredit is considered one of the tools to help with the development of a country or an area by providing liquidity. Entrepreneurs are then able to invest in capital, increase their productivity and enlarge their stock and offerings in a shop. Those loans are usually short-tenured, which makes them less risky and volatile. Therefore more attractive to potential financiers.

History of microloans

A true predecessor of our modern microfinancing and microlending industry are loan funds, saving collectives and savings banks. In the 18th and the 19th century Irish loan funds and lending societies.

In 18th century Ireland banking (and lending) was available only to higher classes, peasants, workers, and most of the middle class were effectively excluded. That resulted in most of the deposits collected in Ireland being deployed in England, where there was a higher concentration of industrious need for credit. Ireland being mainly poor and agrarian at the time wasn’t an interesting enough market. The fact that even Irish lower classes did see an advantage in credit is suggested by a proliferation of pawnshops and other small and local institutions.

In the late 18th century Loan funds with charitable status started gaining more traction. They were locally operating, provided credit for low-income classes, and were recognized as a tool for alleviating poverty. Their loans were capped at £10 per debtor, which would be about £1000 (give or take, between 800 and 2000 British pounds in 2020 or 860-2400 €. Depending on exchange rates and precise year, see inflation calculator).

Those funds were recognized as important institutions in the fight against poverty, because they provided capital for further investments in agriculture (for example farm animals, from which a worker can derive another income) and insurance for consumption, in case of sickness. A somewhat revolutionary view in An Act for Incorporating the Charitable Musical Society for Lending out Money Interest Free to Indigent and Industrious Tradesmen from 1778 summarises it well: industrious tradesmen, who from their extreme poverty are unable to support themselves and their families, when visited by sickness or any other calamity, and are often incapable of earning to themselves a livelihood for want of money to buy materials and other necessaries for carrying on their respective trades; whereby several of that useful class of men have perished, and their families reduced to beggary and become a burthen to the publick.

After the Irish Famine in the 1840s, the population diminished and became richer, which resulted in a slow enlargement of the market served by banks. After the 1920s and the separation of Ireland, the loan funds lost their significance as most of the population gained access to banking. But from the period before, we can surmise the net benefit for a society of these microcredit institutions, which operated locally and were able to provide funds in necessary situations:

The loan fund at Tyrrell’s Pass (Co. Westmeath) boasted that as “collateral operations” in 1840, it: (1) acted as a savings bank; (2) supported an infants’ school of 120 students; (3) established a platting school; (4) employed a Scottish agriculturist to train local farmers; (5) furnished new seed varieties to farmers and sold fertilizers at “Dublin price”; (6) “worked the machinery of a Ladies’ Society for the improvement of the female peasantry” (with 417 female peasants assisted); (7) laid in stores of coal and meal to sell at cost during times of scarcity; (8) employed an average of 82 distressed laborers per day on public works; and (9) exercised “an extensive moral influence by the encouragement of habits of temperance
Further read in Microcredit in Prefamine Ireland

It is important to say that in the early 19th century Germany and Austrian Empire enjoyed improvements in finance thanks to credit unions in their rural areas (the result of the work of Friedrich Wilhelm Raiffeisen and others). There was also significant use of bonds of association, which tend to lower costs of providing capital to borrowers, therefore making it profitable to lend even small amounts. A technique used in microfinance to this day.

Nobel development in South-east Asia

The modern reincarnation of Microcredit is mainly associated with Grameen Bank and Mohammed Yunnus. Dr. Yunus was a researcher at Chittagong University in the 1970s where he developed the idea of microcredit as a way to help struggling poor entrepreneurs. According to the BBC he has lent US$27 to a group of 42 women in the poorest region near the university. Their ventures (bamboo furniture making) then returned a profit of US$0.02 for each of those women, which created the original idea of paving the way from poverty through credit-supported entrepreneurship. It should be noted that in this case, those furniture makers would have borrowed from loansharks paying high interest rates, so the help wasn’t necessarily in the credit available, but in profits to be retained (after paying off the loan).

Mohammed Yunnus established a research project acting as a “bank for poor” where he studied the feasibility and effects of operating such an institution in nearby villages. In 1979 this project expanded to the whole region with support from the central bank and in 1984 Grameen Bank was established as a fully functional financial institution. With assets over US$3 billion, Grameen Bank is probably the largest microfinancing institution. Funding to this project is provided with issued bonds, grants, and government subsidies and guarantees, and the cost of capital is therefore low.

Grameen Bank also expanded from simple microcredit to housing loans and supporting larger schemes such as Village Phone (payphone enterprises). Grameen Bank also established numerous funds, grant schemes, and foundations to further their work in economic development seeing that poverty isn’t only a lack of money but also of other resources (technology, processes, knowledge). Mohammed Yunus received Nobel Peace Prize for his efforts in the fight against poverty in 2006 along with several other awards. He was removed (partly for political reasons) from board of directors in 2011 at the age 70.

Similar projects were started around east Asia. In 1984, a state-owned bank (BRI) established Unit Desa or Village Bank. This BRI-UD was an independent profit center specialized in rural areas and small loans. They charged interest and actually were profitable and not dependent on subsidies. On the contrary, the surplus income was used to subsidize urban activities and lending to richer classes. The nominal interest rate reached 32.9 % in 1994 (real rate would be around 21 %) whereas, according to Jacob Yaron, BRI-UD could offer a nominal rate of 18.7 and still be financially sustainable. (The Global Development Research Center).

It could be argued that this high interest rate – and in light of the surplus generated we could assume it is high – is a result of existing infrastructure, where Village Bank used system already in place for serving richer clients, economies of scale where BRI-UD had 2.2 million customers in loans and 12.2 million depositors, and lack of competition.

In India, modern microfinance was introduced by the Self-Employed Women’s Association which established SEWA Bank in 1974. The SEWA is a trade union for women and their bank specialized in serving poor women who were able to pay Rs. 10 as share capital. This effort impacts especially women who might be unable to access credit in any other way since other credit issuers might require the permission of a male member of the family. SEWA thus fights not only with poverty but also for women empowerment.

From the mid-80s the Indian government started promoting microfinancing opportunities and in 2004 the Reserve Bank of India recognized microfinance institutions (MFIs) as a priority sector for the economy and a tool for battling oppression, poverty and promote growth. Around 2007 the sector experienced growth through the presence of private equity companies, which resulted in unprecedented growth and lacking infrastructure. After series of defaults and societal crises, the sector is now strictly regulated. In recognition of the importance (and financial strength), RBI gave a universal banking license to Bandhan, the largest Indian MFI currently in operation.

The Internet revolution

After the dot-com bubble crashed and internet companies started evolving again, many non-profit and for-profit organizations saw an opportunity to bring finance closer to people. Matt Flannery and Jessica Jackley established Kiva in 2005, MicroLoan Foundation (from the United Kingdom) was established by Peter Ryan after his visit to Malawi in 1997 and Zidisha started in 2009. French Babyloan was started by Arnaud Poissonnier in 2008, although the origin story goes back to 2004 and his visit to Tajikistan, and Indian Rang De was inspired by Grameen Bank’s Nobel Peace Prize and established in 2006.

There are three distinct models that run in web-based microcredit organizations: The refinancing market, the fund, and crowdlending. All of those have the advantage of accessing money of all philanthropic investors in the world, therefore they do not have to charge interest. (Rang De does, but they have also a large pool of investors willing to give them their money)
1) Refinancing is used by Babyloan and Kiva. Both of those organizations use local MFIs as partners, who lend money and then offer those loans to potential philanthropic investors. If they buy them, it servers as an incentive to MFIs to focus more on similar borrowers, but does not directly impact the availability of cash to others. They collect investments (you can get your money back) but don’t offer any interest.
2) The fund method is used by the MicroLoan Foundation. They focus on the education and training of locals in poor regions and offer loans to start their own business. These loans come from the foundation and donors have no direct involvement in the distribution. Also, the money flowing through are real donations, you do not get your investment back.
3) Crowdlending or P2P in microfinance is presented by Zidisha and Rang De. Investors can connect directly with a person seeking loans and chooses who gets funded. Zidisha doesn’t charge any interest and doesn’t provide interest to the philanthropists. Rang De, on the other hand, does both.

Closing quote

Microcredit is often offered with an interest rate, that’s considered high by western/European standards. But as Lysander Spooner, a famous anarchist from the USA, remarked: The reason given for usury laws is, that they protect the poor from the extortions of the rich. But this reason is a false one-for there is no more extortion in loaning capital to the best bidder, than in selling a horse, or renting a house to the best bidder. (…) And those who falsely pretend to be interested to prevent the rich extorting money from the poor, in the shape of interest on capital, arc the very men who want nothing but an opportunity for themselves both to extort capital from the rich, and labor from the poor, that they may thus fill their own pockets at the expense of other men’s rights.

Or as he wrote in the next paragraph, in defense of entrepreneurship and bidding defiance to employers and employment:
Of all the frauds, by which labor is cheated out of its earnings by legislation, and of all the monopolies established by legislation, probably no one is more purely tyrannical in its character, or more destructive at once of the natural right of individuals to make their own contracts, and of the just distribution of wealth, than that monopoly of the right of borrowing money, which forbids the mass of men to obtain capital, on which to bestow their labor, and thus compels them to sell their labor at a price far below the amount of its actual products.

Further reading

Lysander Spooner on Poverty – critique of banking from individualist anarchist, where he encourages small scale lending to alleviate poverty and no interest caps, which are essentially meant to shackle all poor workers to infinite employment.

Virtual Library on Microcredit

The role of Microcredit in India

Grace Levin: Critique of Microcredit as a Development Model Investigation of microfinance crisis in Andhra Pradesh, India. Grace Levin showcases on a crises where are the flaws in using microcredit as a development model. But to quote his last thought: “Most critics agree that micro-finance is an extremely valuable tool for alleviating poverty around the world; however, they also conclude that lending institutions must be run very carefully to avoid such sudden disasters as the one that occurred in India.”

Bridge India: The story of microfinance in India

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