Micro Credit and Development

Although many of the broad approaches to economic growth and development are “top-down" in nature – for example an ambitious government strategy to increase productivity or attract foreign direct investment projects – in recent years there has been huge interest in a bottom-up or grassroots approach to enterprise and innovation supported by the micro-finance industry. The world's poor are exposed to irregular income flows, and their needs are irregular too – ranging from unforeseen medical bills to having to pay more when food prices rise unexpectedly.

Microfinance refers to a large number of different financial products, including but not exclusive to

1. Micro-credit - the provision of small-scale loans to the poor for example by credit unions
2. Micro-savings – for example, voluntary local savings clubs provided by charities
3. Micro-insurance- especially for people and businesses not traditionally served by commercial insurance businesses - a safety net to prevent people from falling back into extreme poverty
4. Remittance management – managing remittance payments sent from one country to another including for example transfer payments made through mobile phone solutions

The concept of microcredit was first introduced in Bangladesh by Professor Muhammad Yunus who started the Grameen Bank (GB) more than 30 years ago with the aim of reducing poverty by providing small loans to the country's rural poor. At the end of 2009 in Bangladesh, there were 20.5 million active borrowers and the average loan per borrower was $114.

A key feature of micro-finance has been the targeting of women on the grounds that compared to men, they perform better as clients of microfinance institutions and that their participation has more desirable long-term development outcomes. The Grameen Bank approach initially focused on small groups 'lending circles' of largely female entrepreneurs from the poorest level in the society.

This became the widely accepted view of what microfinance is. In reality there are thousands of commercial microfinance institutions (MFIs) including some large international operators.

1. Commercial micro-credit businesses – profit seeking

2. Not-for-profit micro-credit businesses – social enterprises, reinvesting profits for social purposes

3. Donor-supported micro-credit businesses – perhaps targeted at supporting the very poorest – an example being the savings schemes established by CARE international

• Poverty reduction (this is the original aim of micro credit) - replacing urban money-lenders
• Funding essential spending such as transport, medical bills, investment in animals
• Protection against income volatility (insurance) to help smooth consumption
• Sustainable finance without the need for collateral for new businesses in villages
• Gender empowerment especially in rural families

Criticisms of Micro-Credit

In 2006 the Bangladeshi economist Muhammad Yunus and the Grameen Bank he founded were awarded the Nobel Peace Prize. But micro-finance has come under close scrutiny in recent years and there are many who argue that the positive effects of micro-finance have been exaggerated and that the rapid expansion of micro-credit has caused unintended consequences and limited benefits in reducing extreme poverty. Some of the criticisms are as follows:

Debt

• Many borrowers have been allowed to take on multiple loans - sub-prime style lending in very poor countries - and charged exhorbitant rates of interest for these loans
• Evidence of coercive collection practices by some lenders

Savings

• Credit can help people in difficult times but sustainable saving from in-work income is more important in long run
• For this to happen, real incomes need to rise - this requires higher productivity

Effectiveness of micro-loans

• Direct cash transfers and direct funding of skills training might have bigger effect than micro-loans to entrepreneurs setting up fledgling businesses
• Randomnised control trials by Banerjee and Duflo: Microcredit may not be the miracle claimed on it's behalf but it does allow households to borrow to help fund businesses

Risks

• The poorest countries are vulnerable to external shocks including extreme climate
• When natural disasters happen, interest on debt still needs to be paid
• Focus might need to shift towards micro-insurance rather than micro-credit schemes

Investment

• Credit is often used to finance consumption - the flip side of micro credit is micro debt
• Micro-finance cannot compensate for inadequate healthcare, education or hard and soft infrastructure in promoting sustainable development and poverty reduction