Microcredit Essay

A range of financial services, that provide the help for poor people, in order to help them to manage their small business initiatives are referred as microfinance. Microfinance consists of such sub-elements as microinsurance, microsavings, and microcredit.
Microcredit means providing the financial support (small loans or so called microloans) to poor individuals, for a range of various entrepreneurship purposes.
A number of obstacles for these individuals like no steady employment or a verifiable credit history should be demonstrated that will not allow them to meet the basic requirements for the traditional credit policy.
Microcredit gives an opportunity for entrepreneurs to initiate their own small businesses that they couldn’t afford to start in the other case. Why is it seen as an important tool in the fight against poverty? The main argument is that, when microcredit works in the way it should, it provides an opportunity for poor households to make purchases, start or expand a business. This tendency allows poor people to escape out of poverty and be more productive.
Currently millions of dollars are given to the microcredit programs by wealthy philanthropists (for example, among active supporters of microcredit such people as George Soros and eBay co-founder Pierre Omidyar can be found).
Besides it, microfinance funds are established by world known banks, such as Citigroup Inc.
Taking in account all facts mentioned in the introduction, I should make a note that without a doubt, microcredit can’t be perceived as universal panacea and there are many options of abuses; various problems with microcredit happen frequently.
Microcredit origin and current investment situation
Microcredit innovation has considered having an origin in Bangladesh, when it was presented by a Bangladeshi economist Muhammad Yunus. Nobel Peace Prize was granted to Yunus and Grameen Bank for this excellent economic initiative in 2006. (Morduch 1998)
Bangladesh has a good experience in helping its impoverished citizens to start self-employment projects and to escape poverty this way. The credibility of finance industry to the microcredit issue is constantly increasing, and many of traditional finance organizations consider microcredit as a perspective source nowadays, although they experienced big doubts in the beginning. Bangladeshi Grameen Bank has 2,500 branches in Bangladesh nowadays and it borrows more than $100 million a month (it presents wide range of loans starting with less than $10 to $1,000 microcredit). These bank branches depend only on deposits from ordinary Bangladeshis, i.e. they are financially successful. Savings accounts are opened by the borrowers at the bank and the balances of many accounts are actually larger than their loans. Therefore Grameen Bank, also return the profits in the form of dividends to it’s clients (most of them are microcredit customers at the same time).
In Yunus’s opinion, this model has to be adopted by more microcredit institutions. The original definition of microcredit must be reaffirmed and it has to serve the poorest first of all.
Yunus believes that the cost of the fund hasn’t to be exceeded by the maximum interest rate and it needs to be strictly regulated by government. The current cost of fund is 10 percent according to Grameen Bank’s official information, and they believe that the maximum possible interest could be as high as 25 percent. They charge the interest rate of 20 percent for the lenders and absolutely sure that the ideal difference of the cost of the fund and the interest rate should be about 10 percent. To keep this kind of combination every state where microloans are popular needs to provide professional regulatory authorities. (Bangladesh Will Send Poverty to Museum by 2030: Yunus 2007).
In the case of Bangladesh, the country that has the highest concentration of the microcredit customers in the whole world, this kind of regulator has been successfully operating for a number of years. It’s goals are the lending transparency guarantees and avoiding of excessive interest rates and control over practices. Other states, like India, that has an emerging microloans activity, desperately need this kind of regulating authority.
Yunus also comments on the social side of the microloan’s programs. Financial organizations should not seek an advantage of the vulnerable people in a desperate life situations, therefore the definition of ‘microcredit” should not be mentioned in the case of credit opportunities that are specifically aimed to gain the profit from the poorest people. Owners of this kind of credit organizations in fact should not be allowed to use the positive image and advantages of real microcredit banks that have earned the real thrust of the population. And this is a state’s responsibility to find the way to prevent this kind of abuse.
Generally speaking, the whole community benefits from the development of economic climate, and it usually helps to improve the living standards and to provide employment and decrease poverty. (Bangladesh Will Send Poverty to Museum by 2030: Yunus 2007),
Despite it, some analysts note that individuals that will get the most benefits from the microcredit trend are land owners. The improvement of living standards influence the rise of land’s cost. The countries that initiate the microcredit usage should first of all adjust its laws, in order to regulate the situation with land; this is very substantial for poverty regulation.
According to the latest information, investments in microfinance institutions have a tendency to increase. There are two opportunities for investors: first is a direct investment in a microfinance investment vehicle and the other is indirect investment via a fund-of-funds.
It is important that investments are done in local currency because it helps to support the growth of the industry.
Speaking regarding the microcredit effects on the economic development, we must remember, that to single out just microcredit is a one-sided view. Other services indeed influence the economic situation too.
Microcredit promises to help recipients achieve economic self-sufficiency and break cycles of poverty by providing cash infusions necessary to purchase productive assets.
The microcredit issue is very controversial, because financial policy’s instrument has a list of pros and contras. While we share the belief that access to credit is a human rights issue, we also suggest that its delivery has become a human rights concern. If microcredit is to play a constructive role in breaking cycles of poverty in rural areas, it must be rethought with and from the perspective of recipients and communities.
In contemporary microcredit, “sustainability” has come to refer to the financial viability of MFIs. If microcredit is to contribute to poverty alleviation, donors and practitioners must:
Reevaluate metrics for success
Ensure that other critical services (such as health care, food security programs, and schools) are in place in communities where MFIs operate
Engage in sustained dialogues and build partnerships with communities to better address the needs of recipients.
These are critical first steps in moving beyond the idea that market-oriented policies help in poverty’s reduction and provide the positive change in social life. It’s not only microcredit organizations should change their measurement of efficiency (such measurements as interest percentage), the elimination of poverty also depends on correct social state policies.
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Advantages of microcredit:
In 2011 a new study (Microcredit Summit Campaign) has stated that microcredit has helped 1.8 million Bangladeshi households to escape from the poverty. Among the advantages of microcredit programs are following could be mentioned^:Microcredit provides a high level of investments return;
Microcredit is a part of poverty problem solution and additional help to poor people is a victory in any case, no matter what the other factors are;
The freedom that gives self-employment assures that workers will be more confident in their future and are likely to take the initiatives.
Economic diversity is a positive factor as well and studies show that diverse economy has better long-term prospects.
Disadvantages and possible risk of microcredit
Many borrowers don’t use microcredit solely for business purposes.
Microfinance is dangerous without education
Microcredit might be helpful just when interest rates are relatively low. Unfortunately, financial organizations sometimes can’t determine the line between constructive microfinance and exploitative money lending.
The markets for production that was increased in a result of microloans are demanded by farmers.
Microloans can’t cure poverty, only stable jobs can. Some experts are confident that in order of helping the poor people, investments in microfinance should be stopped and on the opposite, industries with large scale of employed labour should be started. Besides, other sources confirm that Microloans do not significantly decrease poverty and in some cases microcredit can make a life of the poorest even worse.
Multiple loans and big sums of debt have emerged as the important problem. There are also cases of coercive collection practices managed by microfinance staff, and series of suicides of lenders that couldn’t meet their payments.
Microcredit theory’s concepts
The main argument of the microcredit’s creation is it’s availability for poor households that are not able to get a loan from traditional banks due to the banks’ unwillingness to bear risks and finance small microcredit loans. But there is no possibility for impoverished population to rise above subsistence without these loans. They just can’t pull themselves out of poverty without this additional capital.
In order to reduce the risks and costs some financiers use innovative contractual practices and organizational forms (for example, lending to groups,). Some finance organizations (most of them are owned by investors that have a more concern of economic and social development, than willingness of gaining profits) offer education, training, healthcare, other social services, and more loans. Targeting women is another innovation that nonprofit microfinance organizations have developed. The studies show that women spend more capital on the health, security, and welfare of their families in comparison with men lenders. Women’s bargaining power, personal interest and participation in social and political matters, and also their mobility are increased as a result of lending a microcredit. Although it just can’t overcome patriarchal means of control in developing economies. For example, a woman may have a formal access to a microcredit, but in reality they can’t have any control over received loans or the generated income. So we can make a conclusion that loans mostly encourage women in a social, but unfortunately not in an economic way.
On the opposite, commercial finance organizations usually provide only financial services and they provide no additional services to their clients. (Rahman, 1999)
Some of them do not have a direct cooperation with individual clients (for example, Indian bank ICICI), but they cooperate via small microfinance organizations instead.
Controversy of microcredits
Among the definite controversial facts about microloans the following could be named:
Lenders that have living standards above the poverty line, get more benefits from microloans, than lenders with living standards below the poverty line. The risks, for example like investing in new technologies, that will definitely increase income are willingly taken by microcredit lenders with more income. Poorer lenders are more conservative and usually do not pay any interest to a new technology, or labor hiring investments.
Microcredit appears to do more harm than good for the poorest lenders. In accordance with Vijay Mahajan’s opinion (the chief executive of Basix, an Indian rural finance institution), microcredit may sometimes even reduce the cash flow for the poorest population. The reason is simple – if a greater return on investment in comparison than the microloan interest cannot be earned by poor lenders, eventually they are not going to become wealthier as a result of a loan operation
The kind of business supported by microloans is another controversial issue. These poor lenders are not entrepreneurs. What are their actions regarding the funded business? They raise capital, manage the business, take the profit, but these poor microloans customers frequently do not have specialized skills that are required for success. Successful business models depend on entrepreneurs – heroes that convert new ideas. The majorities of these poor people have no recourses like staff, business assets, etc., and deal at small and inefficient scale; therefore their earnings are not sufficient. They do not have entrepreneurial skills such as vision, creativity, and persistence. The majority of funded microenterprises are small. Many of them unfortunately fail and this fact contradicts the United Nations’ conclusion that ‘micro-credit programs will impact the businesses that lead to developing economies.’ (Dichter 2006)
The most critical issue with microcredit is a question if it really helps decrease poverty. In general, the idea of microcredit is perceived as a noble and also as genuine innovation, which have made a positive impact to lenders (particularly to women), but the answer for that question is disputable.
Countries such as China, Vietnam, and South Korea have substantially decreased the level of poverty with low usage of microcredit. For example, a big part of Chinese population is employed and the poverty has declined greatly in the recent years. On the other hand a relatively small percentage of African population is employed, while the poverty has remain constant. And finally the number of employed people in India has a little bit increased and poverty has become slightly less obvious.
Conclusions
According to the analyzed controversies of microcredit, the best solution for a developing country is a combination of investment both in microenterprises and larger business, especially industry.
A problem with insufficiently developed public sector is crucial for many developing markets. Microcredit refers to a market-based approach of decreasing poverty. But the state has to bare the social responsibilities, build a proper social support for poor; it also should provide at least a basic education.
Nevertheless, microcredit is a very important tool for poor people living rural areas or small towns that otherwise would have no opportunity to start small, home-based businesses. In other words, I believe that a helping hand of small microloans is vital. (Sabharwal 2000)
But these loans have to be easily available, and there should be a large number of financial organizations that support the lenders on the local level and also provide some informational and consulting support. (Tripathi 2006)
At the end of this essay I would like to cite the successful results of microcredit policy in Bangladesh, stated by the Microcredit Summit Campaign. During many years it has been one of the poorest countries and although the mentioned report doesn’t insist on a direct cause-and-effect between microcredit and the progress with a poverty level, the results are surprisingly good anyway. (Pros and Cons of a new Microcredit Summit Campaign report 2011)
Almost 2 million Bangladeshi households take part in microcredit programs and according this survey a great dramatic number of families have escaped the poverty.
These are the good news for the microloans sector, taking into account it has been heavily criticized in recent years.
Two famous institutions of Bangladesh were studied and their groundbreaking efforts to end rural poverty were examined. This survey states that a real major progress in the fight with poverty can be made with microcredit policy’s support