The Role of Microcredit in the Fight Against Poverty

Programmes providing small loans of a few hundred dollars or less to poor households have the capacity to create employment or business opportunities, to introduce women who have been economically and socially marginalized into productive activities and to build self-reliance among the poor, according to the first report from the United Nations Secretary-General on the subject of microcredit. But the report to the UN General Assembly also cautions that such schemes should not be relied upon as an independent or a primary means of poverty reduction.

Informal, small-scale lending arrangements have a long history, thriving especially in rural areas. Examples of these traditional forms of microfinance can still be found in Kenya ("merry-go-rounds"), Ghana (susu), Nigeria (esusu) and Malawi (chiperegani) and, in one form or another, in most parts of the world. Not only do these arrangements suffice in the absence of formal banking facilities; in some cases, they are preferred. Participants gain credit and a certain measure of protection against economic fluctuations or family difficulties in a mutually supportive social setting. Collateral is held jointly, and the groups gather and spread information of economic and social value.

The practice of providing small loans on a large scale as a poverty fighting measure through national and international agencies gained prominence only in the current decade. In an era of lowered expectations for the public sector, and as international development assistance and governmental expenditure fell, microfinance offered the hope of unleashing entrepreneurial capabilities of poor people, and especially of poor women, at modest cost and with a minimum of bureaucracy.

Since the beginning of the decade, about 3,000 microfinance institutions have been established in developing countries. At a "Microcredit Summit" held last year in Washington, DC, donors agreed to a plan that would extend the reach of small-loan programmes to 100 million poor households by 2005. To do this, Summit organizers estimated, there would need to be additional outlays totalling about $26 billion.

Warning on limitations

The Secretary-General's report (A/53/223) finds that "there are limits to the use of credit as an instrument for poverty eradication, including ... the fact that many people, especially the poorest of the poor, are usually not in a position to undertake an economic activity, partly because they lack business skills, and even the motivation for business". Furthermore, many claims of high rates of repayment or of stable improvements in the standard of living of borrowers are not consistently or convincingly substantiated, despite the proliferation of literature in this area.

The report also warns against siphoning scarce development assistance funds away from crucial sectors like agriculture, infrastructure, health, sanitation and education.

The report, which was prepared by the Division for Social Policy and Development of the UN Department of Economic and Social Affairs, specifies some of the difficulties that have been encountered by existing institutions:

* In many developing countries, overall interest rates are relatively high to begin with, and with a stiff risk premium, microfinance interestrates can become quite high.

* Administrative structures are commonly either fragile or rudimentary, and sometimes involve large transaction costs. "If thetransaction costs, combined with high interest rates, require that theoperation in question generate profit margins of the order of 30 per centto 50 per cent, it is not clear that this would be economically verybeneficial", the report says.

* A recent alternative approach to microfinance favours extending loans to anyone with the ability to repay, whether or not they have acredible plan for a small-business or informal-sector enterprise. The risk of this "minimalist" approach, the report indicates, is that borrowers will consume rather than invest their capital.

* Many microcredit schemes have been stand-alone operations, lacking support services or linkage with public sector activities, such as land reform, which may be a necessary condition for success.

To maximize the undoubted success achieved by many microcredit programmes, the report recommends that administrative structures should be strengthened; that loans should be provided in the context of access to land, appropriate technology, markets, self-help solidarity groups and counselling; and that microfinance should be conceived as one component of an overall strategy to foster small business enterprise.

An effective means of ensuring long-term sustainability in microcredit operations, the report suggests, is to include a savings mobilization function, such as a credit union linked to the microfinance institution. Without long-term sustainability, a microcredit institution is in danger of collapsing or of becoming a thinly veiled charity.

The Secretary-General's report welcomes creation by the World Bank (which has a microfinance portfolio of $218 million) of the Consultative Group to Assist the Poorest to coordinate international microcredit efforts, collect reliable data and foster best practices.

"The CGAP process should be strengthened", the report says, and "the UN system also needs to spread a more realistic notion of the potential of microcredit approaches, and to put them in the broader perspective of the fight to eradicate poverty".

Regional surveys

Asia
Microlending has progressed farthest in the Asian region. An innovative approach which has been used successfully by Grameen Bank's credit delivery system is "peer-group monitoring" to reduce lending risk, although some studies have suggested that the reason for the Grameen Bank's high repayment rates is also partly due to the practice of weekly public meetings (at which attendance is compulsory) for the repayment of loan installments and the collection of savings. It is reported that the meetings reinforce a culture of discipline, routine repayments and staff accountability. Not all microfinance institutions use peer-group monitoring. Other institutions, such as the Bank Rakyat in Indonesia,which serves 2.5 million clients and 12 million small savers, rely on character references and locally recruited lending agents in place of physical collateral.

Thailand's Bank of Agriculture and Agricultural Cooperatives (BAAC)serves roughly 1 million micro-borrowers and 3.6 million micro-savers. Newcomers such as the Association for Social Advancement in Bangladesh, with half a million clients, and the People's Credit Funds in Vietnam, with more than 200,000 members/clients, are other examples of the potential for growth in the industry.

Other institutions, such as Cambodia's ACLEDA, Buro-Tangail and SEWA Bank of India and AIMS Ikhtiar Malaysia, are also reported to be making good progress.

Various institutions in Asia are involved in the delivery of microfinance services. They include formal commercial banks, rural banks, cooperative institutions, credit unions and non-governmental organizations. Their methods of doing business range from Grameen Bank ­style solidarity groups and institutions dealing with individual clients to self-managed self-help groups. Reports indicate that some institutions have gone beyond credit to offer insurance and other financial services. Both the Grameen Bank and the Bangladesh Rural Advancement Committee (BRAC) offer non-financial services, such as retail outlet facilities for products of their clients.

Latin America
Accion Internacional, a non-profit development agency, and its affiliates were reported to have disbursed, in the last five years, $1 billion in loans to very poor microentrepreneurs. Its first-time loans are between $100 and $200, and the overall repayment rate is above 98 per cent. Its network of 19 affiliates in Latin America and North America provides $300 million a year in loans to poor entrepreneurs (56 per cent of whom are women). Since 1987, Accion's network has grown from 13,000 to more than 285,000 active borrower clients. The six largest affiliates now provide $1million per month in loans. Banco Sol in Bolivia, which has grown from a credit-providing non-governmental organization to a fully licensed commercial bank, provides financial services to 67,000 people, more than half of the total number of clients in the entire Bolivian banking system. ADEMI in the Dominican Republic and ACP in Peru are reported to have achieved sustainability.

Africa
In West Africa, where microfinance institutions are still in their infancy, a World Bank case study of nine microfinance programmes (the Pride, Crédit Rural, and Crédit Mutuel de Guinée in Guinea; Crédit Mutuel duSénegal, and Village Banks Nganda in Senegal; Réseau des Caisses Populaires and Sahel Action PPPCR in Burkina Faso and Caisses Villageoises du Pays Dogon and Kafo Jiginew in Mali) concluded that all nine of these programmes are very much in the mainstream of best practice in the field of microfinance. In terms of sustainable lending to microentrepreneurs, the study gave high marks to the programmes on the following basis: all nine programmes are located near their clients and in the largest catchment areas possible; they use lending technologies that are simple, well-tailored to the cultural environment and inexpensive for both lender and client; they have employed very effective techniques for obtaining high repayment rates; most include savings which meet a critical need of many people, and they price their loans far above commercial lending rates, though not at full cost recovery.

[Published by the United Nations Department of Public Information - DPI/2011, October 1998]