Microcredits, the ultimate tool to end poverty?

In a paper called “Microfinance is a possible tool to alleviate poverty in developing countries. Case of analysis: the Grameen Bank of Bangladesh”, the social scientist Marban reviews the historical aspects of microfinance, which dates back to the 1996 Millennium Summit in which 189 countries participated, setting out a series of objectives and goals aimed at improving the quality of life of the planet’s inhabitants. Among the objectives that were established at the summit, the most remarkable is to eradicate extreme poverty and hunger. According to data from the Food and Agriculture Organization of the United Nations (FAO) in 2006, extreme poverty continues to be a reality for more than 1 billion human beings who subsist on less than a dollar a day. Faced with this reality, countries are immersed in the need to search for viable alternatives for the reduction or alleviation of poverty in the world.

It is important to mention the origins of this system, which dates to the initiative of Muhammad Yunus, winner of the Nobel Peace Prize in 2006. He found that local people from his country, Bangladesh, didn’t have access to the traditional banking system to get a loan because they didn’t have anything valuable to offer a guarantee of payment. This guarantee was the first thing they were asked for when they went to the banks and if they couldn’t fulfill this requirement, they were openly excluded.

The origin

Due to this situation, Yunus’s idea was to give people “little” amounts of money, without any guarantee, with the sole promise that they would pay and, to ensure the repayment of the loans, the bank uses a system of “solidarity groups ” (small informal groups that apply for loans together and whose members act to guarantee the repayment of the loan and support each other in the effort to improve economically). Interestingly, he got a 98% money back; therefore, it is considered to have a very low default in the payments.

This is the origin of microfinance programs, which can be a strategy to support the fight against poverty in developing countries. A good example of these is the various organizations that promote and create microfinance systems that are having significant success in the international arena. Moreover, in recent decades, some international organizations, such as the World Bank, the International Monetary Fund, or the United Nations Development Program (UNDP), have promoted the microcredit system to solve poverty problems in developing countries.

What is Microfinance and how does it help people?

One definition of microfinance is financial intermediation at the local level. This refers to the provision of financial services such as loans, savings, insurance, or transfers to low-income households or people living in poverty, including consumers and self-employed. Broadly speaking, microfinance refers to a movement that envisions a world in which low-income households have permanent access to a range of high-quality services, (as could be done by large companies that have the necessary solvency to be an excellent credit prospect for financial institutions), to finance their income-generating activities, create assets, stabilize consumption and protect against risks. Derived from the term microfinance, there is another new term called “Microcredit”, which consists of the name assigned to the credit granted by these financial institutions.

According to Marban (2005), in her work called “The microcredit within the Grameen Bank. Comparative analysis between the Classic Microcredit System and the Grameen II System ”(2005), among the definitions of microcredit found there, is the one developed at the International Conference on microcredit in Washington DC, (1997) at the 1997 Microcredit Summit, which establishes microcredits as programs for granting small credits to the neediest of the poor so that they can start small businesses that generate income with which they improve their standard of living and that of their families. Based on the foregoing, it can then be said that microcredits are small loans for all those non-salaried individuals who lack some guarantee, or of a little amount of money and that they are provided of a loan by legally constituted institutions in the country

Most Microfinance Financial Institutions started as non-governmental organizations (NGOs), credit unions and other financial cooperatives, state-owned development banks, and savings banks. A growing number of microfinance institutions are organized as for-profit entities, often because this is a requirement to obtain a license from the banking authorities to offer savings services. For-profit MFIs can be organized as non-bank financial institutions, commercial banks that specialize in microfinance, or microfinance departments of full-service banks.

In recent years, some microfinance institutions (MFIs) have begun the development of a range of products to meet the needs of the most vulnerable sectors of the developing countries. Some MFIs provide services required by their clients that are not necessarily financial services, offering training related to money or credit management, or on business issues, marketing, health or social development, the use of microinsurance, or home insurance.

What are the weaknesses of microfinance’s approach?

Nevertheless, the real number of their impact shows that only half or less of the credit procedures are used for business purposes. The rest support a wide range of money management needs in their homes, ranging from the stabilization of consumption, education, medical expenses, or special events. This is because in these countries there is a lack of financial culture. Microfinance experts observe that loans are not appropriate for all kind of people, since they are not a good option for poor people if they do not have the ability and willingness to meet the repayments of their previously programmed payments and it is necessary to point out that the risk of not recovering these credits is very high. All the above is explained because in the developing countries there is a need for adequate financial education, which helps to understand and avoid getting involved in financial operations that could be harmful.

Adequate financial education will allow people to have bases or tools on how to optimize their financial resources. Likewise, this type of education should begin at secondary levels (in some countries they do it in primary school). Educating in this field will give to the people the power of decision and the capability to obtain monetary resources that will help their growth, to have a better standard of living, and to be able to access every one of the services offered by the financial system, using the resources for what they were requested and not for another kind of concepts. Therefore, the use of microcredits granted by microfinance institutions is and will be an excellent option if they are used for the business purposes they were asked for.

What kind of people benefits most of this system?

The target user of this tool considers all those low-income people who do not have access to other types of financial institutions such as independent workers and some entrepreneurs who work from home. Among them we could find: small shops, street vendors, artisans, and some service providers, but surprisingly, professionals recently graduated from educational institutions, who do not have the capital to be able to start their offices, their businesses, etc., that require financial support, are also considered within this classification. to begin their professional development.

An interesting fact is that, curiously, in the clients of microfinance institutions, the female users predominate, as well as in the Grammer Bank Model. It is important to mention that the model does not have a gender focus, rather it has a focus on the head of the family since it is a bank for the poor and generally the head of the poor family is a woman. Due to the lack of a way to prove their income, because they do not have stable cash flows (they do not have financial statements, bank accounts, etc.) within financial institutions recognized as formal, they are not likely to be considered suitable to exercise credits because they cannot guarantee the repayment.

The female public constitutes most of the clients served by institutions known as microfinance institutions since it is considered an unprotected sector. To corroborate the information previously established, the use of microfinance for women was analyzed. According to the 2001 Report of the Microcredit Summit Campaign, 14.2 million of the world’s poorest women currently have access to financial services through specialized microfinance institutions (MFIs), banks, non-governmental organizations (NGOs), and other non-bank financial institutions. Women make up nearly 74% of the world’s 19.3 million poorest people who now receive services from microfinance institutions.

Helping minorities empower themselves

Most of these women have access to credit to invest in the businesses that they operate. Most of them have an excellent payment record, despite the daily shortages they face. Although women’s access to financial services has increased substantially over the past 10 years, their ability to benefit from this access is often still limited by the disadvantages they suffer due to gender. Some differences in the number of loans may be the result of the greater poverty of women or the more limited capacity of women’s businesses to absorb capital. But they can also indicate broader social discrimination against women, which limits the opportunities available to them, which is why it is questioned whether development programs through microcredit should make more of an effort to address these issues.

The conceptualization of what microfinance represents is based on the provision of a set of financial services to sectors of the population with low-income levels that cannot access the formal circuit of financial intermediation to develop or expand their productive activities.

Likewise, it is important to comment that there are programs focused on entrepreneurship projects and not on individuals who develop entrepreneurship, such is the case of the creation of business incubators, supported by higher-level educational institutions, where projects are supported with financial resources of innovation and improvement as long as these are considered viable. In this case, these programs aim to simplify loan processes and reduce traditional requirements, offering quick credit approval. Finally, the strategy of creating microfinance institutions is an excellent option for growth, if the resource obtained from microcredits is applied for expansion, growth, investment, generation of self-employment, as well as for creating more wealth. Unfortunately, the reality is not always like this, because the loan is sometimes used to pay debts contracted previously, this derived from the scarcity of financial resources and the lack of adequate financial education. It is recommended that financial institutions and educational institutions, at all educational levels, promote and deepen financial education in children, youth, and adults, which will promote savings and investment, to give a better use of the little resource available. A phrase from the director of the pro-development group, Francisco de Hoyo, states that “Microcredits are not going to lift the country out of poverty, but they are an instrument that has allowed many families to improve their situation and keep a job ”.

What are the main threats to the microfinance system?

In Brazil, clients can access their accounts aboard a floating bank on the Amazon River. In Mexico, rural residents find banking services inside stores like Walmart, 7-Eleven, or at their local pharmacy. Mobile technology and regulatory reforms have made it easier and cheaper for private and public companies around the world to offer banking services to the poor, young, women, and rural residents and others.

But in a new report released in 2019, the World Bank warned that while some services, like low-cost accounts, clearly benefit the poor and small businesses, others – like microcredit, microinsurance, and debt relief – can do more harm than good.

The World Bank encourages governments to reduce regulatory barriers, legal hurdles, and other factors that make financial services too expensive for some, such as fostering competition and protecting the rights of creditors.

Access to financial services helps the world’s poorest to save so they can invest in education and improve their standard of living and enables small companies to borrow so they can grow. It also makes it easier for governments to direct subsidies and financial aid to the bank accounts of those most in need.

Microcredit, or small loans to the poor, became fashionable in the late 1990s to provide financial services to the world’s most deprived to combat poverty and foster entrepreneurship. But the World Bank said that India offers a cautionary tale on over-extension of credit, following reports of dozens of suicides by poor debtors in 2010 in the southern state of Andhra Pradesh. India lacks appropriate consumer protection and legal provisions for personal bankruptcy, the bank said.

In general, governments should avoid direct credit and loans through state banks, as these interventions can become politically related, according to the World Bank.