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Introduction
In 1998 the General Assembly of the United Nations requested to the Secretary General
to submit to it a report on the role of microcredit in the eradication of poverty. It was the
first time that has been requested to the Secretary General to report on microcredit.
Decades away from the birth of this useful tool, the economic and social results
obtained by the main microfinance institutions are controversy, and they are object of
many debates.
One of the hottest topics is the relationship between social and financial performance. In
particular, the problem stems from the fact that the primary object of microfinance is to
provide access to financial services to millions of disadvantaged people, and help them
to improve their living conditions. This social objective is often in contrast with
financial sustainability, especially when it arises as a constraint in the process of target
selection, in the decision of the amount of loans to grant and in the determination of the
interest rates.
Is there a possibility of coexistence between social and financial goals? Microfinance
institutions must aim at financial efficiency or is it also profitable an institution which
aims at social performance? Can exist a balance between social and financial
objectives?
The purpose of the essay is to analyze the connection between social and financial
goals, trying to understand if it is possible reach equilibrium between these two
dimensions. To this end, the following study has been divided in three chapters.
The first chapter analyzes the phenomenon of microcredit, starting from its definition
and its origin, in the village of Jobra. Then the essay focuses on the reasons of the birth
of this phenomenon with particular attention to the analysis of the institutions that have
paved the way for the development of microcredit. Finally the chapter concludes with
some considerations about the financial access and the informal market in the
developing countries.
The second chapter analyzes the financial and social dimension, trying to explain deeper
the existent dualism between these two aspects. Moreover, the analysis focuses on tools
and indicators for the assessment of the performances of the institutions. Finally there
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are made some considerations about competition and the role of the interest rates in the
microcredit market.
The last chapter analyzes the case of India. After an introduction of the Indian
microfinance sector, the essay focuses on the study of the performances of three
institutions, which differ for the nature of the organization, trying to understand if there
is a possibility to reach equilibrium between sustainability and outreach and if the
nature of the institution influences the achievement of this goal.
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CHAPTER I
MICROCREDIT. ORIGIN AND DEVELOPMENT
1. Definition
At the beginning of the twenty-first century, United Nations (UN) members recognized
the need to assist impoverished countries in their development, adopting some targets.
In the UN Millennium Summit, held in New York in September 2000, 191 states agreed
to help citizens in the world's poorest countries to achieve a better life standards in key
areas such as poverty, education, health care and employment by the year 2015. The
structure for this progress is outlined in the Millennium Development Goals (MDGs),
which derived from the Millennium Declaration.
The first point face in this document is poverty. According to the UN figures, people
living on less than $1 a day were 980 million in 2004, down from 1.25 billion in 1990.
The goal of the UN members is to halving the population living at this level by 2015.
Table 1.1 Numbers of poor (millions) in the world
1981 1984 1987 1990 1993 1996 1999 2002 2005
Aggregate for developing world
• Past Estimate using 1993 ICP (number in millions below $ 1.08 a day at 1993 PPP)
1488.5 1281.4 1178.5 1247.5 1172.4 1092.9 1119.8 1067.1 931.3
• New estimate using 2005 ICP (number in millions below each line at 2005 PPP)
$ 1 1535.3 1359.1 1228.3 1303.2 1235.6 1132.8 1146.4 1087.0 879.0
$ 1.25 1913.3 1827.1 1718.2 1817.5 1785.1 1672.0 1695.4 1672.1 1399.6
$1.45 2149.1 2125.1 2048.5 2159.1 2153.8 2060.4 2093.5 2021.5 1716.8
$2.00 2545.7 2625.4 2638.1 2753.6 2815.6 2807.2 2871.9 2808.4 2597.8
$ 2.50 2738.8 2872.1 2948.6 3075.9 3178.8 3235.7 3315.1 3276.3 3140.2
Source: Shaohua Chen and Martin Ravallion, 1998, The Developing World is Poorer than we Thought,
but not Less Successful in the Fight Against Poverty.
In this context, microcredit has generated in the institutional and public opinion strong
expectations in fighting the poverty, thanks to the recognition of the contribution it can
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makes to achieving the Millennium Development Goals. Before analyzing this tool, it is
useful and necessary clarify what microcredit means.
According to the UN Millennium Project microcredit is “one of the development
strategies … that should be implemented and supported to attain the bold ambition of
reducing world poverty by half.”
This definition clarify that microcredit is one of the strategy that can be implemented to
reduce poverty. Many people in fact confuse microcredit and microfinance. Generally,
microfinance can be define as a process which aims at promoting banking services, such
as credit, savings, money transfer services and micro-insurance, to the unbankables.
Traditionally banks have not considered that poor people can be a potential market but
in the latest decades various financial services providers for poor have emerged (Non
Governmental Organization, cooperatives, insurance and credit card companies, post
offices, ..), offering new opportunities.
Currently there are thousands of microfinance institutions (MFIs) in developing
countries trying to create a deeper and efficient financial market for poor. In fact, in
many countries commercial banks are reluctant to lend to the poor because of the high
transaction costs, of the lack of collaterals and high administrative outlays. A research
made by International Fund for Agricultural Development (IFAD) confirmed that the
poor access to formal source of credit is limited by complicated loan procedures and
lack of accounting experience.
The most important success between the microfinance institutions is the Grameen Bank
of Bangladesh, founded by the Nobel peace prize of 2006, Mr. Yunus Muhammad.
Since its inception, over thirty years ago, it has disbursed more than $9 billion with an
average recovery rate of 97%. Other success stories are Banco Solidario in Bolivia and
the Kenya Rural Enterprise Programme.
At the beginning, microfinance consisted in offering small money loans to the poor
families to give them the possibility to run their business. In this context microcredit
and microfinance can be interchangeable because microcredit is a tool for economic
development of the unbankables through offering new opportunities to access to
different types of financing.
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Table 1.2 Growth of microfinance coverage as reported to the Microcredit Summit Campaign
End of year
Total number of
institutions
Total number of clients
reached (millions)
Number of “poorest”
clients reported (millions)
1997 655 16.5 9.0
1998 705 18.7 10.7
1999 964 21.8 13.0
2000 1477 38.2 21.6
2001 2033 57.3 29.5
2002 2334 67.8 41.6
2003 2577 81.3 55.0
2004 2814 99.7 72.7
2005 3056 135.2 96.2
2006 3244 138.7 96.2
2007 3352 154.8 106.6
Source: Daley Harris S., 2007, State of the Microcredit Summit Campaign Report,
Over the years this simple tool has evolved, incorporating a wide range of services. This
has led to serve an increasing number of people. As we can understand nowadays
microcredit is only a part of this strategy.
General Assembly in its resolution 50/107 of 20th December 1995 proclaimed the “
First United Decade for the Eradication of Poverty (1997 – 2006)” and the main goal
was to eradicating absolute poverty through national and international actions. This led
to consider the problem of the poverty as one of the hottest topic discussed at the
institutional level.
The UN General Assembly noted that in many countries microcredit was a useful tool
in freeing people from poverty. In this context, the Assembly requested to the Secretary
General to submit to it a report on the role of microcredit in the eradication of poverty.
It was the first time that has been requested to the Secretary General to report on
microcredit.
Having understood the difference between microfinance and microcredit, it is helpful
now analyze the characteristics of microcredit.
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There are at least seven features
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:
1. Small loans: this is the main characteristic. The size of the loans is different and
it depends on the institution’s strategies, but usually it doesn’t exceed few
hundred dollars.
2. Loans for entrepreneurial activity: generally MFIs target microentrepreneurs
because of the higher possibility to repay.
3. Short repayment period: usually borrowers repay weekly or monthly.
4. Collateral free loans: the target of many microcredit programs are the poor and
often happens that the borrowers don’t have any collateral to offer for the loans.
5. Focus on poor clients: this is almost universal, with different definitions of
“poor”. Some believe that it is important to focus on the “economically active
poor”, or those at or below the poverty line (Robinson 2001). Others argue that
microcredit should reach the indigents (Daley, Harris 2005).
6. Focus on female clients: most of the MFIs programs focus on women. They
demonstrated to be more reliable and to destine a higher share of enterprise
profits to their families
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. Moreover women are risk averse and therefore are
more likely to initiate activities less risky.
7. Market level interest rates: micro loans should be offered at market rates of
interest such that give the possibility to the MFIs to recover their costs.
It is debatable which of these points are necessary, but generally microcredit is
characterized by these points.
From a certain point of view there are some criticism about microcredit and its
effectiveness. The facts criticized are the following:
1. High interest rates: in many developing countries interest rates are very high.
This happens because interests are the main resource for the MFIs. The rates are
a consequence of the cost of fund, the MFI’s expenses and of the possible loan
losses.
1
Karlan D. and Goldberg N., 2006, The Impact of Microfinance: A Review of Methodological Issues, p.
5.
2
Higher repayment rates for females is commonly believed but not well documented. In evidence from
consumer loans in South Africa (Karlan, D. and Zinman J., 2006, Observing Unobservables: Identifying
Information Asymmetries with a Consumer Credit Field Experiment) women are three percentage points
less likely to default on their loans, from a mean of fifteen percent default.
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2. Dualism between social and financial performance: microcredit is characterized
by two aspects, social dimension, which aims to reach the highest number of
poor people, and the financial sustainability, which pursues the efficiency. This
is a problem of coexistence of two aspects often in contrast.
3. Doubts about the effectiveness: the scientific testing of the impact of microcredit
is very difficult. So far the randomized controlled trials (RCTs) published have
been able to track short-term results only. The results in the long period are
controversy.
In the second and in the third chapter of the research these problems will be deeply
faced.
After having understood what is microcredit and which are the features, it is possible
now classify some microcredit methodologies.
There are three basic models employed by MFIs
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:
• Solidarity groups: this is the classic microcredit model, used also by the
“Grameen Bank”. In a group of at most 10 people, each participant is
responsible for the credit of the other members in proportion of his credit. Thus,
each member guarantees the other members’ repayments or he losing access to
future credit. Generally group members should come from the same community,
the loan size is small and the repayment is spread over a short period. Loans can
be granted with different procedures: rolling, in which the next member receive
the money only when the previous one has completely repaid his debt,
contemporary, in which loans are granted at the same time for each member and
nobody can receive a second loan until all the participants have repaid the debts.
In this case, the activities implemented by the members must be different to
avoid productions subject to the same risks.
• Village Banking: it’s a credit and lending association at community level, which
generally consists of 20 - 30 members, for most women. It is financed by the
loans provided by the MFI (the external account) and through making and
collecting loans to and from each other members (the internal account). The
latter, composed of members’ savings and accumulated interests, should become
3
Karlan D and Goldberg N., 2006, The Impact of Microfinance: A Review of Methodological Issues, p. 6.
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gradually more consistent so it is not long dependent from the external account.
An example of this format is Self – Help Groups (SHGs), in India.
• Individual Lending: it is the provision of microcredit to individuals instead of
group. It’s the oldest way of micro lending and it’s the closest methodology used
by banks. There are more contacts with the clients and the total amount of loans
is greater than in the other models. This means that it requires a detailed analysis
of the risks. In this case, MFIs can request collateral from borrowers.
In addition to these, there are other methodologies. There are the Community Managed
Revolving Loan Funds (CMRLF), which are informal financial groups composed by
30-100 members. They are similar to small banks which managed their funds. The
initial funds come from outside in forms of loans or grants. Another typology is the
Saving and Loan Associations, which are sustainable institutions, financed by local
savings. They play a very important role of financial intermediaries between the rural
and the urban areas.
As we can see from above, in the last years microcredit has become a tool for economic
development that allows poor people to access to financial services. This was
recognized also by the UN, which designated 2005 the International Year of
Microcredit, adopting the goal of creating inclusive financial systems. During this year
more than 100 millions of poor received micro loans.
According to the figures of the Microcredit Summit Campaign report of 2007, 3 billion
of people live on less than $2 a day and about one billion live on less than $1 a day. In
addition this billion produce only 1% of the world savings and receive just the 0.2 % of
the credit. The goal of microcredit is to interrupt this vicious circle that prevents the
poor, who cannot offer guarantees, to access to credit.
One of the goals of microcredit campaign is to reach 175 million of the poorest families
by the end of 2015. An ambitious project which can help poor to improve their
conditions.
2. Origin of microcredit: the village of Jobra
The origin of microcredit was in the early seventies. In particular, in 1972 Bangladesh
became independent from Pakistan after a fierce war. Thanks to the international aids,
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the country received $30 billion for the reconstruction, but it wasn’t enough to reach the
poorest population. In addition, two years later floods cause the death of thousands of
people. A government survey showed that over 80% of the population lived in poverty
in the 1973-1974
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.
In these years Muhammad Yunus, the head of the economics department of the
University of Chittagong in the southeast of Bangladesh, started some experiments
lending to poor households in the village of Jobra. He believed that lending to poor
would have a positive impact on the rural poverty in Bangladesh. He tried to lend $27 to
some villagers and after studied the results. Despite the few money landed, this was
enough for the people of the village to run their simple activities. Yunus found that
borrowers were able to obtain profits from their activities and they also repaid on time
and reliably, even without asking collaterals.
In 1976 he started a research project on a new credit system for the poor of the rural
areas of Bangladesh. The aims of the plan were:
• Give access to the poor to bank services.
• Eliminate the local usurers, providing services at better conditions.
• Create job opportunities for the thousand of unemployed.
• Alleviate poverty, through a new tool which allows poor to understand how
manage their activities.
It was here that the idea of microcredit was born as a tool for economic development. It
has given the opportunity to the poor to run their activities, giving them new
perspectives for the future and the possibility to escape from prejudice and unfounded
ideas about their potentiality.
2.1. The Grameen Bank
Microcredit began to spread to neighboring villages, but the resources weren’t enough
to start new funding. Therefore Yunus convinced the Bangladesh Bank to help him set
up a new branch within the bank, which deals with the grant of loans to the villages.
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Bangladesh Bureau of Statistics, 1992.
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Thanks to the central bank and the other national commercial banks, the Grameen Bank
project began its work throughout all the country.
In the early years many foundations and governments (International Fund for
Agriculture and Development, Ford Foundation, Governments of Bangladesh, Sweden,
Norway and Netherlands) gave their support through funds which permitted to grow up
rapidly.
The figure 1.1 shows the rise of member since the birth of the bank. As we can see, at
the beginning the growth went slowly until 1986, but then there was a rapid rise of the
members. Starting from 10.000 people the bank reached over 2 millions of people in the
1996. Then, between 2001 and 2006, there was a great success and tripled the number
of members. At present, Grameen Bank has about 8 millions of owners.
Figure 1.1 Growth of Grameen Bank’s members
Source: Grameen Bank Historical Data Series
The project started in the 1976, but only in the 1983 became effectively Grameen Bank
(in Bengali means the rural bank), through a special law.
The main innovation which allowed Grameen to grow rapidly was group lending, in
which the borrowers were guarantors for each other. In a contract made by standard
banking, the borrower gives the collateral to the bank as security, receives the loan,
0
1000000
2000000
3000000
4000000
5000000
6000000
7000000
8000000
9000000
Growth of GB's members
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