Microcredit

= the extension of very small loans (microloans) to those in poverty designed to spur entrepreneurship. [1]

URL = http://en.wikipedia.org/wiki/Microcredit

Definition

"Microlending is a decentralized activity where the poor manage their own credit risk by saving and borrowing in circles of five people each, who all guarantee each other’s loans. This decentralization of the credit risk not only makes the microlending work, but with real and regular loan repayments, it also teaches the borrowers the responsibility of tight business and financial management." (http://beckstrom.com/kaputei.html)

Description

Microcredit:

"In 1974 Bangladeshi Economics Professor Muhammad Yunus observed a poor countrywoman and calculated that, if she could raise less than thirty cents, she might escape the poverty imposed by middle-men who manipulated the prices at which she bought her raw material and sold her finished furniture. Bemoaning the failure of his American economics Ph.D. to highlight this travesty Yunus founded the `Grameen' (meaning `Community') Bank. But how could it make these loans and get them repaid when its borrowers had no collateral to put up and Bangladeshi culture was shot through with corruption and debt evasion?

The secret was lending to individuals, but doing so within groups of people - particularly women - all of whom went co-guarantor. People might walk away from a loan to themselves, but these `solidarity groups' helped transfer skill and share risk as well as radiating both the financial pain and the social shame of default. These groups, the desire to increase borrowing as businesses grow, and the `training' that borrowers get enable the Grameen Bank inculcate a culture of trust and repayment and a default rate of around one percent.

Group and self-interest coalesce a deft and miraculous new combination." (http://troppoarmadillo.ubersportingpundit.com/archives/009157.html)

Characteristics

Hans Schuhmacher:

"Concise definition: Small-scale credit developed in the global South (Frontrunner: Grameen Bank, Bangladesh), typically employed to finance labour-intensive small-scale trade and industry with minor material costs. Microcredit bridges lack of access to the regular banking sector for the poor and, thus, mobilises economic potential.

• Application for technology cooperation : Financing of small-scale business activities in

threshold and developing countries, for example implementation of technologies in households, maintenance, distribution. Volume: less than 10.000 EUR in case of community projects; consumer credits in the global South, for example for solar cookers or Compact Flourescent Lamps (CLFs).

• Achievement potential: Microcredit is particularly suitable for the financing of very smallscale

entrepreneurial activities, in the context of technology cooperation for example implementation of household technologies, maintenance and distribution.

• Prerequisite for effectiveness : Economically sustainable interest rates which minimize the

risk of project failure due to overindebtedness of borrowers. Microinsurance (analogous conditions) for further risk mitigation. Valid credit assessments and feasibility analyses, valid risk management systems. Collaboration with microfinance institutions (MFIs) that act in a target-aimed manner in the sphere of technology cooperation, when appropriate founding of such MFIs.

• Practical experiences: Microcredit is successful regarding the mobilisation of economic

potential. There are already positive practical experiences in the sphere of technology cooperation. „Grameen Shakti“, for example, offers soft consumer credits for climatefriendly technologies and supports small-scale industry and trade activities geared up to the implementation of these technologies by means of microcredit and training.4

• Possible correlations : The Peer-to-Peer microcredit platform Kiva5 works with MFIs which

transfer non-interest-bearing loans from private individuals and civil society organisations to small-scale entrepreneurs in developing countries as interest-bearing loans. It should be examined whether such a combined instrument would be suitable for technology cooperation."

(SourceClimate Justice as Business Case: Innovative Business Models for the Transfers of Climate-Friendly Technologies. By Hans Schuhmacher, with support from Julio Lambing et al. European Business Council for Sustainable Energy. Preliminary English version. 06 December 2009 [ http://www.e5.org]

History

German and British genealogy of microfinance

"The first Genossenschaften in Germany were founded simultaneously in 1847 by Friedrich-Wilhelm Raiffeisen and Herrman Schulze-Delitzsch as a response to famine. Among other things, they gave credit to small businesses and farmers. In the early 20th century, when the British identified rural poverty and dependence on moneylenders as a serious social problem in Indian colonies, they were inspired by the German successes and sought to tackle the problem via cooperative credit. These credit cooperatives were a “transplant of a German idea, with English characteristics, slightly modified to suit conditions in British India”.

Henry W. Wolff, an ardent British promoter of cooperative credit, compared the cooperative systems around the world in 1910, and specifically applauded the Indian cooperative societies.

In what can only be regarded as historically ironic, he believed their independence and capitalist outlook would make them more advanced and prosperous than the German cooperatives.

- Compare the eagerness and the good practice of the non-State aided Indian rayats with the listless indifference and sluggish backwardness of the French and Italian peasantry now being urged by government officers to array themselves in State-fed banks against their will! You will quickly come to a conclusion which of the two systems is the better. And, large as the results of State-assisted agricultural co-operation in Germany and Austria have been – where people are systematically drilled into obeying State orders – they can still not compare in degree with what has been accomplished, in little more than four brief years, in India…

For complex reasons, in the 1920s and ’30s, the cooperatives in British India went into decline, but they left a heritage in how they influenced the development of the Comilla model cooperatives in post-independence East Pakistan (Bangladesh). That model, in turn, influenced the development of microfinance by Grameen, BRAC, and others." (http://governancexborders.com/2011/09/14/false-histories-microfinance-and-its-non-lineage-of-german-cooperative-banking/, by 'phil'))

Discussion and Critique

For an update on the crisis in microfinance in 2010, see http://www.neweconomics.org/blog/2010/12/20/whatever-happened-to-microfinance

1. Hans Schuhmacher:

"Microfinance attracted considerable attention in recent years, not least due to the conferment of the Nobel Prize to Muhammad Yunus, the founder of the Grameen Bank. Its subsidiary, Grameen Shakti, utilises microcredit for the implementation of solar modules on houses in Bangladesh for years. Meanwhile, a multitude of MFIs throng in the market. The strength of microcredit is its ability to reach those who are classified as unbankable and do not have access to credit under reasonable conditions. The volume of a single microcredit ranges from 1 EUR and 10.000 EUR. MFIs can be specialised finance institutions, but also NGOs.

Interest rates typically range between 15% and 40%, run durations are short. Payback and monitoring are usually organised by groups of borrowers. The Grameen Bank, like many other MFIs, grants new credits when the old ones are repaid. This brings about tight social control which, in turn, results in very few dead losses. Activities financed by means of microcredit are usually labour-intensive and require minor material expenditure.

Microcredit, however, cannot bring about sustainable economic development on its own when infrastructure, healtcare and access to education, training and qualification are deficient or not present at all.6 There is also the problem of, in places, extremely high interest rates (in some cases up to 70%) which are accounted for inflation, high administrative costs and the difficulties involved with aquiring capital by the MFIs in question.

Disproportionate interest rates can affect the application potential of mcrocredit for technology cooperation negatively. Success of technology cooperation also depends on mid-term and longterm solvency of local partner entrepreneurs and companies and on their capability to prosper.

Therefore. technology companies wishing to employ microcredit in technology cooperation projects should choose with care a MFI and collaborate with it. The interest rates of this MFI should be oriented towards sustainability. This applies both to financing of economic activities that are part of the project and to credits in the project's environment. It is advisable to take into account the national or regional rate of inflation when evaluating interest rates, the „real“ interest rate may in fact be lower than the figures indicate. It should be possible that microcredit debtors obtain positive accounts in credit in the long run in order to strengthen local purchasing power. Furthermore, microinsurance for loan loss should be available under advantageous conditions.

In case there is no suitable MFI present in the region, institutional investors may play this role or found special MFIs, so lang as the asset managers of institutional investors are increasingly bound to invest in sustainable projects..

Another possibility would be the founding of special MFIs by already existing MFIs or joint ventures in developing countries. Appropriate education and training of students and interns from developing countries may bring about functioning banking systems in regions where there is a lack of them, led by executives who understand local environments."

2. The danger of Grameenism October 2010, Patrick Bond

Far from being a panacea for fighting rural poverty, microcredit can impose additional burdens on the rural poor, without markedly improving their socio-economic condition:

"Grameen’s origins are sourced to a discussion Yunus had with Sufiya Begum, a young mother who, he recalled, ‘was making a stool made of bamboo. She gets five taka from a business person to buy the bamboo and sells to him for five and a half taka, earning half a taka as her income for the day. She will never own five taka herself and her life will always be steeped into poverty. How about giving her a credit for five taka that she uses to buy the bamboo, sell her product in free market, earn a better profit and slowly pay back the loan?’ Describing Begum and the first 42 borrowers in Jobra village in Bangladesh, Yunus waxed eloquent: ‘Even those who seemingly have no conceptual thought, no ability to think of yesterday or tomorrow, are in fact quite intelligent and expert at the art of survival. Credit is the key that unlocks their humanity.’

But what is the current situation in Jobra? Says Bateman, ‘It’s still trapped in deep poverty, and now debt. And what is the response from Grameen Bank? All research in the village is now banned!’ As for Begum, says Bateman, ‘she actually died in abject poverty in 1998 after all her many tiny income-generating projects came to nothing.’ The reason, Bateman argues, is simple: ‘It turns out that as more and more ‘poverty-push’ micro-enterprises were crowded into the same local economic space, the returns on each micro-enterprise began to fall dramatically. Starting a new trading business or a basket-making operation or driving a rickshaw required few skills and only a tiny amount of capital, but such a project generated very little income indeed because everyone else was pretty much already doing exactly the same things in order to survive.’

Contrary to the carefully cultivated media image, Yunus is not contributing to peace or social justice. In fact, he is an extreme neoliberal ideologue. To quote his philosophy, as expressed in his 1998 autobiography, Banker to the Poor,

- I believe that ‘government’, as we know it today, should pull out of most things except for law enforcement and justice, national defense and foreign policy, and let the private sector, a ‘Grameenized private sector’, a social-consciousness-driven private sector, take over their other functions.

...

Yunus has long argued that ‘credit is a fundamental human right’, not just a privilege for those with access to bank accounts and formal employment. But reflect on this matter and you quickly realise how inappropriate it is to compare bank debt – a liability that can be crushing to so many who do not survive the rigours of neoliberal markets - with crucial political and civil liberties, health care, water, nutrition, education, environment, housing and the other rights guaranteed in the constitutions of countries around the world.

By early 2009, as the financial crisis tightened its grip on the world, Yunus had apparently backed away from his long-held posture. At that time, he told India’s MicroFinance Focus magazine the very opposite of what he had been saying: ‘If somebody wants to do microcredit – fine. I wouldn’t say this is something everybody should have’ (emphasis added). Indeed, the predatory way that credit was introduced to vulnerable US communities in recent years means that Yunus must now distinguish his Grameen Bank’s strategy of ‘real’ microcredit from microcredit ‘which has a different motivation’. As Yunus told MicroFinance Focus, ‘Whenever something gets popular, there are people who take advantage of that and misuse it.’

To be sure, Yunus also unveiled a more radical edge in that interview, interpreting the crisis in the following terms. ‘The root causes are the wrong structure, the capitalism structure that we have,’ he said. ‘We have to redesign the structure we are operating in. Wrong, unsustainable lifestyle.’ Fair enough. But in the next breath, Yunus was back to neoliberalism, arguing that state microfinance regulation ‘should be promotional, a cheerleader.’

For Yunus, regulators are apparently anathema, especially if they clamp down on what are, quite frankly, high-risk banking practices, such as hiding bad debts. As the Wall Street Journal conceded in late 2001, a fifth of the Grameen Bank’s loans were more than a year past their due date: ‘Grameen would be showing steep losses if the bank followed the accounting practices recommended by institutions that help finance microlenders through low-interest loans and private investments.’ A typical financial sleight-of-hand resorted to by Grameen is to reschedule short-term loans that are unpaid after as long as two years; thus, instead of writing them off, it lets borrowers accumulate interest through new loans simply to keep alive the fiction of repayments on the old loans. Not even extreme pressure techniques – such as removing tin roofs from delinquent women’s houses, according to the Journal report – improved repayment rates in the most crucial areas, where Grameen had earlier won its global reputation among neoliberals who consider credit and entrepreneurship as central prerequisites for development.

By the early 2000s, even the huckster-rich microfinance industry had felt betrayed by Yunus’ tricks. ‘Grameen Bank had been at best lax, and more likely at worst, deceptive in reporting its financial performance,’ wrote leading microfinance promoter J D Von Pischke of the World Bank in reaction to the Journal’s revelations. ‘Most of us in the trade probably had long suspected that something was fishy.’ Agreed Ross Croulet of the African Development Bank, ‘I myself have been suspicious for a long time about the true situation of Grameen so often disguised by Dr Yunus’s global stellar status.’ Several years earlier, Yunus was weaned off the bulk of his international donor support, reportedly USD 5 million a year, which until then had reduced the interest rate he needed to charge borrowers and still make a profit. Grameen had allegedly become ‘sustainable’ and self-financing, with costs to be fully borne by borrowers.

To his credit, Yunus had also battled backward patriarchal and religious attitudes in Bangladesh, and his hard work extended credit to millions of people. Today there are around 20,000 Grameen staffers servicing 6.6 million borrowers in 45,000 Bangladeshi villages, lending an average of USD 160 per borrower (about USD 100 million/month in new credits), without collateral, an impressive accomplishment by any standards. The secret to such high turnover was that poor women were typically arranged in groups of five: two got the first tranche of credit, leaving the other three as ‘chasers’ to pressure repayment, so that they could in turn get the next loans.

At a time of new competitors, adverse weather conditions (especially the 1998 floods) and a backlash by borrowers who used the collective power of non-payment, Grameen imposed dramatic increases in the price of repaying loans. That Grameen was gaining leverage over women – instead of giving them economic liberation – is a familiar accusation. In 1995, New Internationalist magazine probed Yunus about the 16 ‘resolutions’ he required his borrowers to accept, including ‘smaller families’. When New Internationalist suggested this ‘smacked of population control’, Yunus replied, ‘No, it is very easy to convince people to have fewer children. Now that the women are earners, having more children means losing money.’ The long history of forced sterilisation in the Third World is often justified in such narrow economic terms.

In the same spirit of commodifying everything, Yunus set up a relationship with the biotechnology giant Monsanto to promote biotech and agrochemical products in 1998, which, New Internationalist reported, ‘was cancelled due to public pressure.’ (http://www.himalmag.com/The-danger-of-Grameenism_nw4752.html)

3. David Harvey: microfinance as extreme exploitation of the poorest

"The violent neoliberal attacks on the rights and power of organized labor that, from Chile to Britain, began in the 1970s are now being augmented by a dra- conian global austerity plan that, from California to Greece, entails losses in asset values, rights, and entitlements for the mass of the population, coupled with the predatory absorption of hitherto marginalized populations into capitalism’s dynam- ics. Living on less than $2 a day, this population of more than 2 billion or so is now being taken in by microfinance as the “subprime of all subprime forms of lending,” so as to extract wealth from them — ­ s happened in U.S. housing markets through subprime predatory lending, which was then followed by foreclosures — ­ to gild the McMansions of the rich. The environmental commons are no less threatened, while the proposed answers such as carbon trading and new environmental technologies merely propose that we seek to exit the impasse using the same tools of capital accu- mulation and speculative market exchange that got us into the difficulties in the first place. Unfortunately, this is an old, old story: every major initiative to solve the problem of global poverty since 1945 has insisted on exclusive use of the means — ­ capital accumulation and market exchange — ­ that produce relative and sometimes absolute poverty." (Radical History Review, Winter 2011)

Microfinance doesn't work

Jason Hickel:

"What’s so fascinating about the microfinance craze is that it persists in the face of one unfortunate fact: microfinance doesn’t work. Of course, there are some lovely anecdotes out there about the transformative power of micro-loans, but as David Roodman from the Center for Global Development put it in his recent book, “The best estimate of the average impact of microcredit on the poverty of clients is zero.” This is not a fringe opinion. A comprehensive DFID-funded review of extant data comes to the same conclusion: the microfinance craze has been built on “foundations of sand” because “no clear evidence yet exists that microfinance programmes have positive impacts.”

In fact, it turns out that microfinance usually ends up making poverty worse. The reasons for this are fairly simple. Most microfinance loans are used to fund consumption – to help people buy the basic necessities they need to survive. In South Africa, for example, consumption accounts for 94% of microfinance use. As a result, borrowers don’t generate any new income that they can use to repay their loans so they end up taking out new loans to repay the old ones, wrapping themselves in layers of debt.

When micro-loans are used to fund new businesses, budding entrepreneurs tend to encounter a lack of consumer demand. After all, their potential customers are poor and low on cash, and what little money they do have gets spent on basic goods that tend already to be available. In this context, new businesses end up displacing already-existing ones, yielding no net increase in employment and incomes. And that’s the best of the likely outcomes. The worst – and much more likely – is that the new businesses fail, which then leads, once again, to vicious cycles of over-indebtedness that drive borrowers even further into poverty.

This demand-side problem can be stated quite simply: poor people don’t have enough money. Apparently we need expensive research studies to point this out.

The only consistent winners in the microfinance game are the lenders, many of whom charge exorbitant interest rates that sometimes reach up to 200% per annum (as in the case of Banco Compartamos). In the past we would have called such people loan sharks, but today they’re called microfinance providers, and they crown themselves with the moral halo that this term carries. Microfinance has become a socially acceptable mechanism for extracting wealth and resources from poor people.

The failure of microfinance is recognised at even the highest levels, and yet for some reason it retains its staying power, like a zombie that refuses to die. Why is microfinance such a resilient idea? Because it promises an elegant, win-win solution to the problem of poverty. It assures us that we – the rich world – can eradicate poverty in the global South without any cost to us, and without any threat to existing arrangements of political and economic power. In other words, it promises revolution without the messiness of class struggle. And, what is more, it promises that we can help save the poor while making money from it. It’s an irresistible tale. It’s also a very effective tool of political control. Milford Bateman, one of the most compelling critics of microfinance, points out that the movement had its roots in the US government’s “containment strategy” in Latin America. The idea was to prevent people from subscribing to leftist movements by reframing poverty not as a political problem, but as a private problem. Microfinance became a powerful way of casting the poor as responsible for bootstrapping themselves out of poverty: all you need is a bit of gumption and some credit, and you should do just fine – if you fail, you have no one to blame but yourself.

It’s the neoliberal development strategy par excellence. Forget about colonialism, structural adjustment, austerity, financial crises, land grabs, tax evasion, and climate change. Forget about challenging the concentration of power and wealth. And, above all, forget about collective mobilisation. Bankers shall be our new heroes and debt our salvation. Debt, incidentally, is a great way to keep people docile.

If we expand our view to encompass the actual causes of poverty, it becomes clear that microfinance just won’t do. Structural problems require structural solutions. What might this look like? We could start by democratising the World Bank and the IMF, renegotiating trade agreements, clamping down on capital flight, rebuilding labour rights, and so on. If we want to eliminate poverty, rich countries and rich individuals are going to have to feel the pinch – there’s no way around it. Unfortunately, the missionaries of microfinance are unlikely to be happy about this.

This is not to say that we should abolish microfinance altogether, but simply that microfinance will never work until we address the background conditions that produce poverty in the first place. We also need to set up the right systems for small businesses to succeed, such as strong subsidies, state assistance, and welfare support to prop up entrepreneurs when they fail – the very systems that neoliberalism has convinced us to abandon.

There’s also a much more immediate solution we could try. Why not just give money to the poor, for free? A growing body of evidence suggests that direct cash transfers, with no strings attached, not only deliver success where microfinance fails, they appear to be the single most impactful anti-poverty intervention available. Experiments with basic income grants have been conducted in Namibia, Mexico, South Africa, Indonesia, and elsewhere, all with astonishingly good results. They smooth out consumption deficits, improve health indicators, and allow people to start small businesses that are successful because they can take advantage of increased local demand.

The beauty of this approach is not just that it actually works; it also brings about a fundamental change of attitude toward the poor. It treats them not as hopeless victims to be pitied with charity, nor as sources of potential value for a rapacious financial sector, but rather as human beings with an innate right to the wealth that we draw from our planet’s common resources." (http://therules.org/microfinance-usually-ends-up-making-poverty-worse/)

Differences between microfinance and the (German) cooperative model

"The commonalities between the Raiffeisen model and the standard microfinance model are very few, and the specific strengths of the German cooperative financial institutions were never taken on board by the microfinance industry. The group aspect is perhaps where the closest resemblance between MFIs and the German cooperatives could be imagined, since borrower groups and “centers” (as Grameen Bank and its replicators call their groupings of groups) could perhaps be misunderstood as something like a cooperative. But the groups and centers in microfinance do not assume an organisational and legal identity, like German cooperatives.

As Seibel himself outlines, from the outset, the Raiffeisen cooperatives did far more than organise credit: for instance, setting up purchasing and sales cooperatives for inputs and produce, transmitting technological changes, and organising famine relief.

A full list of differences between modern microfinance and Raiffeisen’s/Schulze-Delitzsch’s cooperatives (later Volksbanken) would be extensive, but some key divergences are easy to note:

• German cooperatives, from their inception, provided longer-term and much larger loans (relative to clients’ incomes) at lower interest rates than MFIs. Both were based on local savings, rather than on foreign investment, commercial borrowing, or donations. The German cooperatives were structured through regional supervision and auditing associations, which the cooperatives themselves owned, which smoothed seasonal fluctuations and acted as “lender of last resort”.

• MFIs, on the other hand, often operate on a credit-only basis. They sometimes sell products through affiliates, but never organise consumers or producers. They make far smaller loans – average loan size in South Asia is only 15% of GNI – and charge interest rates aimed at more than simple cost recovery. MFIs are controlled top-down, most have only recently begun to focus on savings, and are usually owned by shareholders instead of cooperative members. Their profits can be extracted.

Ownership & control matter:

These differences are highly relevant. Who owns and controls a financial institution takes the decision on the type of lending it should make, and in turn the relations of production it promotes. Longer-term larger loans from cooperative banks – which were owned and controlled by local small and medium-sized businesspeople – contributed to the making of today’s German Mittelstand. The small short term loans from today’s MFIs – owned and controlled by a potpourri of philanthrocapitalists, Wall Street bankers and development finance organisations – on the other hand are contributing to the establishment of bazaar economies, full of business activity but hollow in terms of job-creation, innovation and capital accumulation.

The cooperatives in Germany (and elsewhere) in time became formal local banks; microfinance groups still meet for the sole purpose of accessing loans from the external MFI source, for whom they represent little more than a risk management tool. This group structure compels them to share losses on the downside, but not gains on the upside. (One rare exception to this pattern is the route taken in recent years by India’s SHGs, which Prof. Seibel has been involved in, where SHGs are registering as independent cooperatives.)

Thus it becomes clear, at the level of organisational philosophy and culture, that the motto which became synonymous with the Raiffeisen movement “one for all – all for one” has never applied to microfinance. Expecting one to perform like the other is a mistake." (http://governancexborders.com/2011/09/14/false-histories-microfinance-and-its-non-lineage-of-german-cooperative-banking/, by 'phil'))

Key Book to Read

• Why Doesn't Microfinance Work? by Milford Bateman. Zed Books

• Lamia Karim, 2011: Microfinance and Its Discontents: Women in Debt in Bangladesh. Minneapolis: University of Minnesota Press. [2]

More Information

• What is the evidence of the impact of microfinance on the well-being of poor people? By Maren Duvendack, Richard Palmer-Jones, James G Copestake, Lee Hooper, Yoon Loke, Nitya Rao. London: EPPI-Centre, Social Science Research Unit, Institute of Education, University of London, August 2011 [3]:

"A new systematic review of the evidence on microfinance, published last week, is dynamite for the world’s most popular development policy. Madeleine Bunting of the Guardian has already referred to it as “microfinance’s sober reckoning”, likening the findings to a “hangover after a big party”. Bangladeshi news calls it a “damning report”."

1. Microcredit lending models
2. Here's a critique of the microfinance movement and the bottom of the pyramid movement by Paul Hawken, author of The Ecology of Commerce and Natural Capitalism, athttp://valuenewsnetwork.com/article.cfm?id=12
3. Networks and networking in microfinance
4. Spotlight on the Grameen Bank

See also: Social Lending