. .



Micro-credit is a way of banking which claims to be more effective in the alleviation of poverty

By HUSSEIN HAERI
Jun 26 - Jul 02, 2000

Capital tends to be a relatively scarce factor of production in the 'developing world'. The role played by supranational credit agencies (i.e. the IMF and the World Bank) is testimony to this predicament, as is the burgeoning debt crisis. Increased accessibility to credit (albeit conditional to the implementation of 'liberal' economic policies) does not seem, however, to have had a 'significant' impact on poverty alleviation. In fact, the poorest billion people on earth earned 2.3% of world income in 1960. Today they earn 1.1%. The World Bank asserts that "sustainable poverty reduction is the overarching objective....and the benchmark by which our performance as a development institution will be measured."1 Its success in this capacity has clearly been limited.

Micro-credit is a way of banking which claims to be more effective in the alleviation of poverty than the loans of supranational credit agencies and conventional banks. This form of credit can target the self-employed and in cities such as Dakar and Lagos (where the 'informal sector' accounts for about 50% of employment) it has tremendous potential as a mechanism for economic development. This paper is not intended to be an exhaustive study of the particularities of Micro Credit. It is rather an examination of some of the more interesting dynamics of the Grameen Bank (whose policies in Bangladesh have arguably become the prototype of Micro Credit.) This paper will examine the areas in which such banks can function effectively, as well as some of the limitations of Micro Credit (as depicted by the Grameen Bank)

The proponents of Micro Credit argue that 'conventional' forms of credit can often have counterproductive consequences in terms of the economic development of the recipient country. Credit is often gratefully accepted by the governments of developing countries, in spite of the strain which high interest rates places on their respective economies. The escalation of the debt crisis is an example of this phenomenon as well as of the quantitative, rather than qualitative approach, which many institutions adopt to the issue of credit. In 1981, LDC debt amounted to US$ 739 billion. By 1995, the accumulated debts of LDC countries had risen to US$ 2 trillion. Ironically "All the assistance Africa receives from the international aid agencies, the United Nations, and the big industrial nation governments, some $10 billion a year, just about covers the payments African countries owe on their foreign debts."2 Increased 'conventional' loans may facilitate, rather than undermine the process of economic development, but this is often not the case. International aid amounts to $50 - $55 billion a year but a significant amount of this money supports huge bureaucracies which become corrupt and inefficient, quickly incurring losses. It is perhaps ironic to note that "In a world which trumpets the superiority of the market economy and free enterprise, aid money still goes to expand government spending, often acting against the interests of the market economy."3

Muhammad Yunus (founder of the Grameen Bank) notes that as long as collateral is a prerequisite for 'private' loans, the poor will not be deemed credit-worthy. Nevertheless he argues that loans are viable in the absence of collateral. Remarkably, his contention has been vindicated by the fact that 98% of Grameen's 'uninsured' loans are paid back. This recovery rate contrasts starkly with the repayment rate of Bangladesh as a whole (which is between 30 to 40%.) Grameen relies on the "collateral of peer pressure" for the high recovery rate on its loans. To qualify for these loans potential borrowers must first form a group of five. Members are required to undergo a two-week training session before any loans are made. The first loan will be made to one individual from the group, and other members of the group are not allowed to borrow money until a regular repayment record has been established. Once this has been established other members of the group are allowed access to credit. They are obliged however, to meet once a week with a "bank officer" to make loan payments and to critique each other's business plans. This is crucial because members will not obtain approval for repeat loans if one of the borrowers defaults on his debt. This accountability is one of the fundamental dynamics that underlies Grameen's success in Bangladesh. Individuals are not just responsible for their own economic welfare, but in accepting loans from the Grameen Bank, they become at least partially responsible for the economic welfare of their group members. This is at once the greatest strength and weakness of the Grameen system of banking. It is effective in communities (such as those found in rural Bangladesh) where group members are likely to know one another well. This will facilitate the effectiveness of "peer pressure" as well as augmenting mutual trust and accountability. However, Micro Credit projects have run into considerable difficulties in cities such as London and Paris. By Muhammad Yunus's own admission "The social solidarity was not strong enough to create the effect of peer pressure and peer support which is the linchpin of Grameen's micro-credit loans."4

Another factor, which has characterized the Grameen system of banking, is the adoption of incremental, as opposed to lump sum, repayment of loans. Borrowers are obliged to repay their loans in weekly installments and this may be a contributing factor to Grameen's high rate of repayment, for two reasons. The first is that borrowers are not faced with the psychological barrier of having to repay a relatively large sum of money in 'one go' (i.e. the average loan size in 1994 was $140 and this figure is over half the annual income of many borrowers.) The second advantage is that a system of incremental repayment is, in itself, a confidence-building measure. An individual who has already repaid part of his loan may be less likely to forfeit on that loan. Mr. Yunus believes that this system will "enhance self-discipline among people who have never borrowed before in their lives, and will give them the confidence that they can manage it."5

One of the most fundamental and contentious aspects of Grameen's system of banking relates to the fact that 94% of its borrowers are women. This policy of targeting women as the principal credit beneficiaries can help to facilitate the alleviation of poverty (i.e. Todaro notes that "the poorest segments of Third World populations live in households headed by women."6) Women also tend to have fewer opportunities (i.e. with regard to both education and employment) than men. According to a survey conducted by Mahmoub Hossain, approximately half of Grameen's women borrowers said that they were unemployed at the time they became Grameen members (compared with less than 7% of the men.) Women tend to have higher repayment rates than men, and are more likely to spend a larger proportion of 'new earnings' on their children's welfare. Studies have also shown that where women's share of income within the family is relatively high, there is less discrimination against girls. This relates to the fact that where women are able to contribute economically to family income, they are viewed more as an economic asset rather than as a burden. Targeting women with regard to credit therefore serves a variety of functions, ranging from granting them financial empowerment to increasing the productivity of home-based production (which occupies many women in the developing world.) As well as encouraging confidence and independence in women, access to credit whereby they can obtain gainful employment, increases the opportunity cost of having 'many' children. As incomes improve and the incidence of poverty decreases, population growth rates also tend to decrease.

In many contexts, this policy of targeting women for loans challenges the 'status quo' and precipitates social mobility. Alan Jolis argues that one of the consequences of the 'financial empowerment' of women is that "suddenly the old repressive, patriarchal ways become less relevant." 7It is important to note, however, that sudden challenges to the socio-cultural fabric of a society can produce 'backlash effects.' For example, Grameen has experienced only limited 'success' in India and Pakistan, despite the fact that both countries share cultural similarities with Bangladesh. Social and cultural factors often determine the respective roles that men and women can play in the economies of developing countries (and elsewhere.) Traditions in Bangladesh, for example, may inhibit a woman's ability to gain employment outside the home (i.e. the role of 'purdah.') Grameen loans facilitate self-employment, however, and women may be able to work from home while respecting traditional conventions. Other traditional conventions may be less easy to reconcile, and in certain cases it may be deemed inappropriate for women to be earning income at all. As UNRISD (United Nations Research Institute for Social Development) notes, women's effective control of the loaned money should be the focus of attention (in evaluating the success of such a policy) rather than simply analyzing access to that money, given the high rate of male 'appropriation' of the loans. This is a significant point as this 'appropriation' characterizes many of the loans made to women in Bangladesh.

Micro-credit's potential as a means of economic development is especially pertinent in the current global climate of privatization. Governments of developing countries are often subjected to pressure (from organizations such as the World Bank and the IMF) to privatize (or at least to 'downsize') public-sector enterprises which are deemed inefficient. They must therefore significantly decrease the public-sector wage bill while at the same time trying to control rising unemployment rates (by creating enough jobs to offset 'burgeoning' labor forces.) The 'informal sector' is one means, albeit an imperfect one, of accomplishing this. As Karl Maier contends, "the lack of a secure environment in which to work, crumbling infrastructures and educational institutions, and the dearth of confidence that investments today will bring rewards tomorrow have pushed the bulk of Africa's economic activity underground into the so-called informal sector."8 This phenomenon is not exclusive to Africa, and characterizes, to a greater or lesser extent, the economies of many developing countries. Although it may not be registered in the annual calculations of gross national product, the 'informal sector' is the source of livelihood for many of the poorest people across much of the developing world. The informal sector tends to be particularly significant in urban areas and accounts for approximately 30% of employment in Abidjan, 50% in Dakar and Lagos, and 80% in Accra. It must be noted that there are limitations associated with the informal sector, namely the inability of governments to tax generated revenue and the existence of illegal activity such as the 'black market.' Nevertheless, governments of developing countries often 'tolerate' aspects of the 'informal sector.' Failure to do so would exacerbate problems of poverty, income inequality, and 'real' unemployment and would hinder an important source of initiative and enterprise. Micro credit can effectively target the self-employed and where the 'informal sector' accounts for a significant proportion of employment, it has tremendous potential as a mechanism for economic development.

Muhammad Yunus argues that although training and education will facilitate the use of credit, they are not necessarily prerequisites. He contends that all human beings have a skill — the survival skill. He believes that "the poor are poor not because they are untrained, or illiterate, they are poor because they cannot retain the returns of their labor. This reason for this is obvious — they have no control over capital."9 Yunus refutes the contention that credit alone is useless and that it must be packaged with training, marketing, transportation facilities, technology and education. Grameen's results in Bangladesh go some way towards vindicating this belief. Although Grameen does offer some 'support facilities', many borrowers do not receive technical assistance. Nevertheless, it is estimated that one-third of Grameen's two million borrowers have crossed the poverty line and that another third are 'close.' Grameen has not only succeeded in reducing poverty by the headcount measure but it has also significantly reduced poverty by the income shortfall measure.

The economic multiplier effects of micro lending can potentially be quite significant. One of the reasons for this is that the 'poor' tend to spend most of their money in the local economy on basic things such as food, clothing and shelter. Micro Credit is also a relatively inexpensive means of combating poverty. As Muhammad Yunus notes, "we have no legal instrument between the lender and the borrower in Grameen."10 This allows Grameen to 'cut costs' in a way that 'conventional banks' are not able to. In addition, Grameen's annualized interest rate on loans is 16% and this challenges the 'monopolistic' power that moneylenders (whose interest rates are often as high as 200%) frequently have in developing countries (particularly in the Indian subcontinent.) However, Grameen's costs are relatively high by commercial bank standards. It is estimated that they stand at 26.5% of the value of loans and advances. This is approximately 10% higher than the nominal interest rate charged. Approximately 39% of the costs of lending are therefore subsidized. However, it is important to note that "about half of the excess of costs over interest receipts are attributable to the expense of opening new branches, which should be treated as a capital cost."11

The significance of the Grameen Bank relates to whether or not Micro Credit can be replicated "an successfully in other parts of the world. It was estimated in 1998 that a total of 223 Grameen replication programs were being carried out in 58 different countries and that approximately eight million people are now getting Micro Credit globally. The success of these projects has varied tremendously and Micro Credit has, perhaps surprisingly, made relatively little impact in India and Pakistan (where cultural and traditional practices resist the policy of loans to women.) However, there are several impediments to Micro credit other then the forces, which stand to lose from its implementation (i.e. the moneylenders.) For example, Micro Credit faces a significant obstacle in many 'developed' countries as a consequence of the social welfare system. Potential borrowers may be reluctant to lose the welfare checks and insurance coverage, which they otherwise receive, by becoming self-employed. Even if individuals do accept the 'risk' associated with taking a loan, self-employed people in many developed countries must file documents, petition bureaucracies and keep books, in order to remain within the framework of the law. It may be unrealistic to expect individuals, who are essentially 'provided for', to incur these risks.

The system of "peer pressure collateral' is also less likely to work in urban settings where borrowers may be less 'accountable' to one another. In England and France, for example, Micro lending has thus far failed to emerge as a significant phenomenon. To reiterate Muhammad Yunus's own assessment of the situation "The social solidarity was not strong enough to create the effect of peer pressure and peer support which is the linchpin of Micro Credit loans."12 Part of the reason for the tremendous success, which Grameen enjoys in Bangladesh, can be explained in terms of 'accountability.' Someone who borrows money in London, for example, may not have the same incentives to repay the loan as someone that lives in a small village. The villager may be more reluctant to default on the loan as he or she is likely to encounter, and have to deal with, members of his or her 'borrowing group', perhaps on a daily basis. It is therefore perhaps surprising to note that Micro Credit has reached 150,000 Americans in inner cities like Chicago and Washington. Borrowers can begin with a $500 or $1000 loan, which is enough money to purchase gardening or hair styling tools, for example. Indeed Micro Credit projects are being implemented in countries as diverse as South Africa and Sweden. The key to the success of Micro Credit lies in its ability to adapt to local environments, while adhering to the basic Grameen principles. For example, the governor of the State of Illinois gave a special exemption to welfare recipients who took out micro-loans, which ensured that they would be covered by welfare in the interim period, until they could get their personal 'businesses' off the ground.

Since its founding in 1983 as "an innovative lending institution that makes small, uninsured loans to poor self-employed individuals in Bangladesh" the Grameen Bank has evolved remarkably. It has diversified in the nature of its loans (i.e. the inclusion of housing loans) and embarked on several projects in the field of technology (i.e. the launching of a cellular service in Bangladesh.) Having embarked on this journey with a capitalization of $30, Muhammad Yunus can now reflect on the fact that on any working day Grameen collects an average of $1.5 million in weekly installments. There can be little doubt, given the evidence, that credit is a cost-effective weapon with which to fight poverty. It can serve, as the case of Bangladesh illustrates, as a catalyst in the process of economic development. Approximately 1.3 billion people suffer extreme poverty and this figure is exacerbated by burgeoning population growth in much of the developing world. It should be noted that Micro Credit is not a panacea for global poverty. Nevertheless, as the Grameen example illustrates, with commitment and innovation the core principles of Micro Credit can be used to tackle some of development's most pressing issues.

1'Faith and Credit: The World's Bank's Secular Empire. Susan George and Fabrizio Sabelli.

2'Into the house of the ancestors: Inside the new Africa.' Karl Maier

3'Banker to the poor.' The autobiography of Muhammad Yunus.

4'Banker to the poor' Muhammad Yunus

5'Banker to the poor' Muhammad Yunus

6'Economic Development' Michael Todaro

7www.grameen-info.org

8'Into the house of the ancestors' Karl Maier

9'Banker to the poor' Muhammad Yunus

10'Banker to the poor' Muhammad Yunus

11'Case studies in economic development' Stephen Smith

12'Banker to the poor' Muhammad Yunus

The author is studying in an honours program in International Development and Economics at McGill University in Canada. He is currently working on a paper, which focuses on the barriers to trade which hinder economic development in the 'third world' / LDC's. Please contact info@pak-economist.com for further information.