The Rise and Fall of Microcredit

Leonardo Conte

Leonardo Conte

Laureato MSc in Economics and International Politics presso l'Università della Svizzera Italiana di Lugano e l'Università Cattolica del Sacro Cuore di Milano
Leonardo Conte
Bamboo product making unit in Dumka, Jharkhand.

Bamboo product making unit in Dumka, Jharkhand.

An overview of the Results and Criticisms of the Financial Instrument that has Revolutionised Development 

 

Of the Millennium Development Goals (MDGs) established in 2000 by the United Nations, that of halving the number of poor on the planet within 2015, an objective that was proposed again last year in the Sustainable Development Goals (SDGs), stood out for its importance. The North American, European and Japanese economies have been lead to unprecedented developments by the triumphal march of capitalism, allowing millions to reach a high level of wellbeing. At the same time, however, the gap widens and billions of people worldwide have been left out of this wave of development.  To further aggravate the situation, the overlapping of various global economic, financial, environmental, agricultural and social crises has caused a drop of the ranks of social class into extreme poverty. From the viewpoint of the world’s poorest countries, the 2008 crisis was born from a crisis of food resources. The constant growth of world population, accompanied by a reduction in the cultivable land available – to recall the old Malthusian principle – has created tragic developments. Speculators then inflamed the situation, betting on the rise of primary material and foodstuff prices, without considering that, when the financial markets crash and the banks close the credit channels, when shops go bankrupt and governments lose power and have no resources, it is upon the poor that is lain the heaviest burden.

 

Of the Millennium Development Goals (MDGs) established in 2000 by the United Nations, that of halving the number of poor on the planet within 2015, an objective that was proposed again last year in the Sustainable Development Goals (SDGs), stood out for its importance.

 

Almost to compensate for these tendencies, one the principle innovations of our times seemed to propose solutions to credit related problems. Born in the village of Jobra, in Bangladesh, the idea of microcredit has spread most heavily in Asia, Africa, South America, the Middle East and many First World countries. Nearly every nation has a program inspired by such idea; some directly follow the Grameen Bank experience, whilst others distance themselves from such, choosing instead to follow some of their variants. The number of ‘clients’ reached by the end of 2006 amount to one hundred million. The objective proposed, continuing in this direction, comes from that of permanently liberation nearly half a billion people from poverty, in line with the MDGs primary goal.

Of all of the participants whose mission follows this direction, the Grameen Bank and all microcredit institutes operate by providing small loans without physical guarantees. In general, it is actually the guarantee, in most cases, that hinders individuals, artisans, small businesses, micro-entrepreneurs, families and groups from access to bank loans. Microcredit offers such parties the opportunity to liberate themselves from such exploitation, to enlarge their base economy and take their own destiny in their hands, or at least allow them to organise them, starting and developing productive activities that are fundamental to escape the conditions of poverty. From here a virtuous circle is entered, a true revolution that sees worldwide changes, even influencing the World Bank’s ideas, changes that begin to initiate projects similar to those of Grameen. Microcredit has become one of the globally used financial tools for the promotion of economic and social development, to the point of being included in the first SDG point, within financial services to which every individual should have right of access.

 

Microcredit institutes operate by providing small loans without physical guarantees.

 

But is it possible to make it a concrete and definitive reality? Would it work the same way in other contexts, even those completely different to that of Bangladesh? How many and which changes would be needed to reach such a goal? These are the questions that are looked at by scholars and professionals on the global spread of microcredit.

 

Is it possible to make it a concrete and definitive reality? Would it work the same way in other contexts? How many and which changes would be needed to reach such a goal?

 

Before even trying to respond to these questions, it is useful to analyse, on a theoretical level, the main questions connected to the specific benefits and the effective use of microcredit. First of all, we need to keep in mind that, for various reasons, the traditional banking method is not made to lend money to the poorer classes. Some of these are, theoretically, both “justifiable” and understandable. However, others are simply a taking advantage of the inherited prejudices of the predominant economic mindset. An intrinsic part of the modern banking system, for example, is the idea that providing loans to the poor would not be prudent as there is a lack of the guarantee that ensure a good finish to the operation. Yes, even though it is easily fixable. In any case, there are other, deeper motives, among which is the low profitability and the typically economic convenience of supplying huge loans to few middle-upper class people, rather than small amounts to a large, but poorer group. In these conditions, it is difficult to imagine being able to overcome such a situation. It is about one of the huge holes in the traditional banking system, that has, over time, created institutional barriers that segregate and imprison the poverty-stricken classes on an economic and social level. This problem, though, also regards industrialised countries, within which there are some social categories that are arbitrarily excluded from credit access. The phenomenon is known as credit rationing, and is comes back to the modern financial system’s theoretical anomalies.

 

One of the huge holes in the traditional banking system is credit rationing.

 

 Added to that are some of the typical traits of contemporary economic theory, such as the deep-rooted certainty that it is necessary to create jobs for everyone to combat poverty. In fact, according to the traditional system, the poor help themselves by getting themselves a job. All of the economic policies lead in this direction, making people invest private capital in large businesses that we expect to trigger a virtuous circle on a local scale, which would be able to create new jobs: “Economists have grown fond of this strategy because for the most part, books on economy do not take into account work that is not given a salary”, remarks Muhammad Yunus, “There is no space within those pages for those who live by creating their own goods or giving services to then sell them to those who need them. In the real world however, it is exactly this type of autonomous work that allows the poor everywhere to survive”. What these people are missing, rather, are the economic instruments necessary to increase their work productivity.

 

According to contemporary economy the poor only help themselves by getting work.

 

Going back to these ideas, the microfinance institutes that are more faithful to the ‘original’ mandate try to mend the deficits of the traditional banking system in various ways. According to a distinction made by the Fondazione Pangea, which actively uses programs aimed at the empowerment of women, ‘true’ microcredit workers can be distinguished in archetypes. The first, and larger, of these categories is those that use microcredit with the aim of the financial sustainability of the supplier, those being banks or microfinance institutes. In this case, the social relapse generated by the operation represents a positive externality, but not its main objective. Another common approach is that of microfinance becoming a tool in a poverty reduction program. The objective of the operation in these programs is not that of repaying the loan, in fact it often concerns organisations supported by public institutions or international agencies. The final archetype is empowerment, which has the objective of a social and cultural bettering through the economic participation of women.

In spite of the discord between the various ways do using microfinance, the difficulties that these organistions come across are almost the same. Firstly, the limited money available that is necessary in the program’s start-up phase up until the break-even point, the balance between entering and leaving. Asking for foreign finance could be dangerous, in particular in the case of economies with high inflation such as in developing countries: The real interest paid on international loans would be notably higher than the established nominal value. The solution to this problem is fixed by seeking various solutions. Firstly, national or international bodies can substitute microfinance organisations that cannot receive loans from the national banking system as they are not able to offer the necessary guarantees. Secondly, microcredit institutions may simply take deposits from their own savings: An tactic that paradoxically, however, is not allowed by law if they part of non-state organisations. A third solution is the establishment of so-called wholesale funds, funds allocated to businesses or organisations that direct the contributions towards the start-up and the management of loan programs. As Yunus discussed in 2010, using this tool a larger sum of money arrives in the hands of the poor, without thinning out the advantages to officials and consultants in the form of salaries,

percentuals and various spendings. This way, we don’t only save on the long application process for contribution approval, but a continuous financial flow can be supplied, until the microcredit programs have reached a sufficient level of institutional autonomy. All of this allows the credit programs to develop from an initiative based on generosity, subject to the variable income of donations, to real businesses with a fully auto-sufficient social end on the financial level.

After the specific difficulties that the microfinance institutions can come across in their business, the idea has had success from the beginning; both for its simplicity and its relative ease in use. Since its appearance, microcredit has drawn the attention of numerous economists, philosophers, historians and intellectuals alike that have put the spotlight on the implications of this revolutionary initiative. It’s natural nevertheless, that there be, among these, convinced backers and, likewise, critics. Of the latter, some claim that microcredit does not make a significant contribution to economic development. Situations may exist where parts of society may contribute and benefit from the effects of the development, whilst other parts of society remain excluded. According to traditional theory, inequalities are often inevitable consequences of economic development, even calling this “development”. It would not be, however, the same for microcredit’s orthodox doctrine, according to which the essence of development is found in the change of the quality of life in the poorest fraction of the population. From this perspective, it is evident that the two positions can not coincide: that in classical theory of identifying as a clear economic development process can not be so according the fundamentals of microcredit.

Secondly, the difficulties of expanding the reality of microcredit in contexts completely different to those in which the idea was conceived are often underlined. The projects would, in fact, be moulded in such a way that attention would be brought to other types of poor, such as those that live in developed countries. In the USA, for example, it is difficult to attain the same results that could be found in underdeveloped or developing countries. The main reason for this difficulty would be in the endogenous differences between the two target groups: the lower class in a rich country has very different characteristics to the lower class in a poor country. Furthermore, many policy-makers consider poverty to be a mere problem of individual behaviour rather than a phenomenon originating from structural problems. Acting in this manner, they therefore reject the need to turn to state measures aimed at increasing employment or distributing revenue transfers: helping the poor could be dangerous as it could undermine work incentive, an ideology historically derived from neoliberal thinking. Differences will, then, emerge relevant in terms of results also attainable in reasoning behind the economic, political and social planning of a country. To this end, some American academics sustain Muhammad Yunus won the Nobel prize as “The approach linked to the banking sector reinforces the neoliberal vision that focus on the cause of the origin of poverty in individual behaviour”. It was, rather, more neoliberal institutions that from the beginning sustained the microcredit structure: World Bank and the US Agency for International Development (USAID), first and foremost. In reality, the idea behind the structure of microcredit would lead in another direction: Poverty is not due to the characteristics of a person, be it ignorance or laziness, but a lack of support from the country’s economic and financial systems.

Finally, between those that criticise the system put in place by the Bengalese economist, there are also those that look to offer explanations to support the other great area of initiative in the field of microcredit; that is, those orientated towards profit. These programs have larger interests, positioning themselves over the 15 percent increase of bank rates. Many, for example, sustain that the effectiveness of these projects is in the operating in the interest of the poor rather than in the interest of the general economy. Microfinance businesses would benefit from the implementation of higher interest rates that would allow them to achieve financial independence much faster. In doing this, they would more effectively exchange the attention of private investors coming from richer countries, definitively helping to better develop financial services offered to the poor. Yunus points out, however, that such theory works perfectly only in the context in which its supporters reason. That is, where loans are given to middle-high class individuals. Yet microcredit “is a system of loan grants without the guarantee that is able to start activities that create a revenue that is sufficient enough to liberate borrowers from their poverty”. Financial institutions that this clearly defined are those that, to formally claim to be “microcredit”, offer loans to the middle class, those that use these resources to finance consumption rather than create new means of income. Not only this, but accomplishing the task calls for regular guarantees as well, similar to those that are asked by the traditional banking system, or they may have up to 100% interest, which generates enormous profits for the investors. The purely speculative goals of these programs have certain, devastating effects in the respective parts of the world in which they have been carried out: India, Bosnia, Nicaragua and Morocco are the scenes of dozens of suicides due to the psychological pressure caused by false microcredit agencies. Stories of Compartamos in Mexico and SKS Microfinance in India teach us that the effects that abusive interest rates systems have important repercussions on a social and psychological level. It is direct proof, on a minor scale, of how much financial speculation represents the most lethal virus to the contemporary economic system.

 

The lower class in a rich country has very different characteristics to the poorest class in a poor country.

 

Milford Bateman, professor at the University of Juraj Dobrila Pula in Croatia, attributes the ‘failure’ of microcredit in the local economies of some territories on the fake microfinance institutions. According to Bateman, microfinance constitutes without a doubt a sustainable reduction in poverty within developed countries, but there is no evidence that it has a positive effect on the welfare of the poor themselves. With this in mind, the success of microfinance is nothing but the result of disproportionate publicity campaigns, public relations and show-business. More specifically, Professor Bateman points out three factors that determine the limits of microcredit. First of all, there was the certainty that the local demand for goods and services produced by small business would increase with the increment of the offer. However, an increase of the offer in the informal local market without a relative rise in real demand does not create any change in jobs or other added bonuses. Furthermore, the fact that more and more small enterprises are launching their own businesses in the same market quickly saturates the levels of offers, leading to an inevitable reduction in prices and income from sales, and therefore lower margins and lower salaries. Additionally, this would have a negative effect on employment rate, and could, in the long term, lead to the bankruptcy of said small businesses. It is exactly this that happened in Bosnia-Herzegovina, where more than 50 percent of small businesses established were forced to close within a year. The increase in informal small business ‘caught out’ the medium-small businesses already in the area. That happened because the sheer amount of small businesses in the informal sector is not able to collaborate with the businesses in the formal sector to better the processes that produce economies of scale. A final, surprising aspect is that the large part of microcredit, unlike how it is usually instructed, is not used to create small business, but rather to finance family consumption and cover health and school fees. These do not generate resources to repay the debts, but force the families into a situation of over-indebtedness. In such an instance, microcredit does nothing but bring benefits to market financiaries, becoming a totally counterproductive practice, bearing in mind its original aim: of a miraculous solution to the real snare of poverty.

In the future, we hope that commercial microfinance institutions are not supported. And that the others become regulated. According to prof. Bateman, we need to put an end to the idea of neoliberal donations, control the cheats and focus attention of the bad examples of microfinance. This way we can avoid other organisations following these models. Finally, for the principle mission for which microcredit was originally idealized, we need to support microfinance with other forms of support for the poor: introducing a minimum wage or adopting so-called microsavings. These would be efficient and intelligent solutions.

 

We need to put an end to the idea of neoliberal donations, control the cheats and focus attention of the bad examples of microfinance and finally support microfinance with other forms of support for the poor (such as a minimum wage and microsavings).

 

Readapting a statement by Robert Buron, Director-in-Chief of the Centre for the Development of the OCSE, remembering that the aim of microcredit should be the end of microcredit.

 

The aim of microcredit should be the end of microcredit.

 

Bibliography

  • Bateman, M. (2010), Why Doesn’t Microfinance Work? The Destructive Rise of Local Neoliberalism, Zed Books;
  • Bosi, P. (2012), Corso di scienza delle finanze, il Mulino, Bologna;
  • Feiner, F. S. e Barker, K. D. (2006), Microcredit and Women’s Poverty, Granting this year’s Nobel Peace Prize to microcredit guru Muhammad Yunus affirms neoliberalism;
  • Fondazione Pangea, Report 2014;
  • Yunus, M. (2013), Il banchiere dei poveri, Feltrinelli, Milano;
  • Yunus, M. (2010), Un mondo senza povertà, Feltrinelli, Milano;
  • United Nations Non-Governmental Liaison Service (UNNGLS), The Microfinance Illusion: The post-2015 development agenda should rethink its development approach for local financing, News Archive 2013.

 

Sitography

 

Foto: Bamboo product making unit in Dumka, Jharkhand. (CC BY-SA 3.0) by Jaimoen87

Leonardo Conte

About Leonardo Conte

Laureato MSc in Economics and International Politics presso l'Università della Svizzera Italiana di Lugano e l'Università Cattolica del Sacro Cuore di Milano. Ha conseguito una Laurea in Metodi quantitativi per le Scienze Economiche all’Università Cattolica di Milano e specializzato in Economia e Politiche Internazionali, perfezionando gli studi in Australia e nel Regno Unito e approfondendo temi legati all’Economia dello Sviluppo, Economia Comportamentale, Storia del Pensiero Economico, Geografia e Politica Economica. Sì è formato presso l’Istituto per gli studi di politica internazionale (ISPI) e ha collaborato con l’ONG AIESEC.

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