Do Microcredit Lending Programs Help The Poor? A Comparative Analysis of Programs in Bangladesh and the U.S.A.

Like the right to

food, clothing, shelter, education and health,

credit should also be recognized as a

fundamental human right.

- Muhammad Yunus

Fahima Aziz

Department of Economics

Hamline University

Paper presented at 2011 Second European Conference on Microfinance, Groginnen.

June 16-18, 2011

INTRODUCTION

Micro-credit programs were first introduced in developing countries and have grown rapidly in the United States and in rest of the world. Initially, developing countries began implementing microenterprise programs to bootstrap the poor out of poverty through entrepreneurship, or self-employment, and instilling skills for employment, which would then stimulate economic development in the surrounding communities. The main focus of many microcredit programs is to break the vicious cycle of poverty. Some argue that welfare programs sometime tend to contribute to the dependency and despair of the poor, whereas microfinance programs help the poor rise out of poverty by giving them a sense of dignity and self-respect. Consequently, microenterprise programs also have a social impact on its borrowers by increasing self-confidence and self-worth, which further lead to empowering the poor.

The poor are generally unable to obtain credit for working capital. There are approximately over 1 billion people worldwide who have to live on less than $1 a day and over 2 billion people are malnourished (UNDP report 2010). Therefore, in developing countries, where credit is virtually nonexistent for the poor, microenterprise programs were created to collateral-free credit to low-income people who historically have been considered credit risks by conventional banks (Aziz, 2002). Traditional banks will not consider lending to the poor for a variety of reasons. First of all, traditional banks usually do not make loans to home businesses, which is typically the type of business operated by microentrepreneurs. Second, the poor are considered to be very high credit risks because they lack collateral, credit history and/or previous experience operating a business. Furthermore, microenterprise loans are unattractive to traditional banks because the transactions costs of a small loan are high relative to the interest and fees the loan generates. In other words, it is not profitable for traditional financial institutions to lend such small amounts because the transaction costs are essentially the same as they are for larger loans. Consequently, the poor could only obtain credit from local moneylenders, who charge astronomically high interest rates, leaving the poor with essentially zero profit from their sales. Therefore, microenterprise programs have become a viable and much needed alternative for the poor in developing countries to obtain credit. The estimated market for microloans is an estimated several hundred billion people

Microenterprise programs became a success story for the poor as a result of the Grameen Bank in Bangladesh, the first to introduce micro-credit lending in 1976. Mohammad Yunus, an economics professor who was frustrated with large-scale international programs that had little impact on alleviating poverty, originally established the bank. One of the most phenomenal aspects of Grameen Bank is that is has proved the theory of conventional banks to be wrong. As mentioned previously, conventional banks were skeptic of the idea of lending to the poor, who have no collateral, and many of the poor that Grameen Bank help are illiterate and landless. However, Grameen Bank has proved that the poor can pay back their loans and increase their income by providing working capital necessary for business operations.

Grameen Bank has given the poor the opportunity to build an asset base and use the credit to put to whatever use they choose. The bank not only helps the poor increase their income through self-employment but also enables the poor to have control over their own lives. The poor with financial resources at their disposal have the freedom to build their own fate through self-employment, which gives the poor a sense of empowerment.

Grameen Bank was the first to recognize that the availability of credit is critical for the economic emancipation of the poor, and as a result, the model of Grameen Bank has received international attention and has been replicated in many countries throughout the world. According to Grameen Bank, hundreds of micro-lending programs have replicated the Grameen Bank model in different countries over the last decade (Grameen Bank Dialogue, 2004). Consequently, Grameen Bank has been able to reach thousands of poor borrowers around the world indirectly through their positive influence.

As a result of Grameen Bank’s international fame, there have been many studies conducted on the bank’s micro-lending program. However, there have been very few studies comparing Grameen Bank to other micro-lending institutions that have emerged in other parts of the world. Consequently, this research will undertake a comparative analysis between Grameen Bank and Lakota Fund (LF) in Kyle, South Dakota in the U.S. This research will focus on the similarities and differences between Grameen Bank and the three micro-lending institutions and how they have impacted the lives of the poor both socially and financially. The significance of this research is to determine how successful the a U.S. micro-lending institutions have been in contrast to Grameen Bank in alleviating poverty in their different socioeconomic environments.

Overall, the methods to be employed in this study are intended to be qualitative rather than quantitative, and in order to measure how successful the micro-lending institutions have been in alleviating poverty, the research will examine the following:

Examine how the micro-lending institutions are organized due to their different cultural and socio-political environment

Examine the primary clientele of the micro-lending institutions by studying the demographic characteristics, such as race, age, and income level

Examine how the loan procedures of the micro-lending institutions differ. The requirements for obtaining a loan from the different institutions will be analyzed

Examine the success rate of the micro-lending institutions, which is measured by the repayment rate

Examine the financial and social impact the different micro-lending institutions have had on their borrowers, especially the borrowers’ perception of the management of the microcredit institutions and its role in their financial success.

grameen bank

In 1983, Muhammad Yunus founded Grameen (“of the village”) Bank in Bangladesh, an innovative lending institution that makes small, unsecured loans to the poorest of the poor. Yunus made the discovery that rigid collateral requirements, credit guarantees, and inflexible repayment schedules made it virtually impossible for microenterprise borrowers to obtain credit from commercial banks, which regard microenterprises as too risky and costly to administer. Consequently, the poor were trapped in the vicious cycle of poverty because their only source of credit was from local traders and moneylenders, who would exploit the poor. Since the local commercial banks were reluctant to lend to the poor and the local moneylenders were taking advantage of the poor, Yunus requested and was granted permission to set up an independent bank in 1983, known as Grameen Bank. Yunus has successfully proved his hypothesis that the poor can lift themselves out of poverty through self-employment as long as they are supplied with the correct amount of capital. Furthermore, Yunus has proved that the poor pay back their loans because they have a “greater incentive than the rich to repay their debts: it is their only way out of destitution.” (Yunnus, 2000)

Yunnus established Grameen Bank with the following five objectives in mind:

  • Extend banking facilities to the poor men and women
  • Eliminate the exploitation of the poor by money lenders
  • Create opportunities for self-employment for the vast multitude of unemployed people in rural Bangladesh
  • Bring the disadvantaged, traditionally the women from the poorest households, within the fold of an organizational format, which they can understand and manage by themselves
  • Reverse the age-old vicious circle of “low income, low saving, low investment,” into a virtuous circle of “low income, injection of credit, investment, more income, more savings, more investment, more income”

( Grameen Bank Reports)

As a result of Grameen Bank’s bold and daring goals, it is currently the “largest rural financial institution in the country” (Grameen Bank Report, 2010). Grameen Bank is truly an institution for, and of the poor, because the poor own ninety percent of the shares of the bank, while the government owns the remaining ten percent.

Grameen Bank now has 2,565 branches and serves in 81,378 villages in the country. It has nearly 8.36 million borrowers and the clients of the bank have been predominantly women (97%), who took the opportunity of borrowing in a group of four persons with no collateral (Aziz, 2002). As mentioned previously, Grameen Bank lends out very small amounts of credit to the poor with the average loan of -----(US). Even though Grameen Bank borrows to clientele without any collateral, they have an outstanding repayment rate of97.32 percent, a rate envied by most commercial banks. The commercial banks in Bangladesh have a repayment rate of only seventy percent on agricultural loans and ninety percent for its industrial loans. Part of the difference in the repayment rates is a result of the mindset of the borrowers. For example, the rich can avoid the consequences of non-payment, whereas the poor cannot. The poor value the access to credit so highly because it gives them the opportunity to rise out of the depths of poverty.

Yunus believes credit is a fundamental human right, which the poor are deprived of.

Instead of credit, poor are given charity, which does not help eliminate poverty but helps to sustain poverty. Charity maintains the vicious cycle of poverty because the poor become dependent on it, eroding their will and capacity to help themselves climb out of poverty. Credit, unlike charity, gives the poor the tools they need to break the vicious cycle of poverty they are trapped in.

As a result, the goal of Grameen Bank is to target the poorest of the poor, defined as the bottom twenty-five percent of the population, primarily women because they bear the greatest burden of poverty. Grameen Bank ensures they reach their target market through a simple test they devised: anyone wanting to join Grameen Bank needs to “prove that they own less than half an acre of land and that their total wealth does not exceed the [market] value of one acre of medium-quality land” (Yunus, 20000).

Currently, of the 8.36 million Grameen Bank borrowers, ninety percent are women because they are more likely than men to be poor. The United Nations Development Program reported, “[O]f the 1.3 billion people worldwide who live in extreme poverty, seventy percent our women. [Furthermore,] women earn only ten percent of the world’s income and own less than ten percent of the world’s property” (Grameen Dialogue, 2000-2008). The low status of women reported by the United National Development Program is evident in Bangladesh. Yunus says that the Bangladeshi women experience hunger and poverty more intensely than men. In addition, it is traditionally the responsibility of the woman to stay home and take care of the family with little to no resources, and if anyone in the family has to starve as a result of the dire circumstances, there is an unwritten rule that it has to be the mother.

Yunus also says it is the mother who suffers the traumatic experience of not being able to care for her children properly. It is the woman who is unable to feed her children during times of famine or food scarcity. As a result, if poor women are given the opportunity to fight against hunger and poverty, they are more determined, resourceful, and creative in generating income for the family. The women have an intense drive to move up in society, which is demonstrated by their hard work and willingness to make sacrifices to increase the welfare of their children. In other words, the women are more reliable than men because they not only pay back their loans much more consistently, but the profits from their income-generating activities are more likely to benefit the children. The women are less likely to misuse funds, and more likely to use them to improve the overall welfare of the family or for household and/or capital improvements. According to Yunus, “If being poor is tough, being a poor woman is toughest” (Grameen Bank, 2010).

Also, Grameen Bank discovered that women use the skills they learn from doing household work in their income-generating activities. For example, some of the income-generating activities of the women borrowers involve making handicraft items such as baskets and mats from bamboo and cane, rearing poultry and raising animals, like cows and goats, and growing vegetables and fruits in their gardens. Therefore, it is quite common for women to already have the skills necessary to operate a microenterprise.

There is a recognizable difference between the lives of women who belong to Grameen Bank and those who are non-Grameen Bank members. Independent studies by the World Bank and others indicate that within five years, about half of Grameen Bank’s million borrowers are able to climb out of poverty, and a further quarter linger around the poverty line. Another recent study of Grameen Bank revealed that over fifty percent of the borrowers escaped poverty over a ten-year period, whereas only five percent of non-Grameen members climbed out of poverty. Furthermore, women who are members of Grameen Bank feel a sense of empowerment, which has increased their status within the household. The husband tends to show his wife more respect due to her involvement with Grameen Bank, resulting in lower divorce rates and birth rates (Aziz, 2002, 2003).

Grameen Bank is able to have a financial and social impact on the lives of the women as a result of its lending programs, known as peer group lending. The bank requires the women to form a group of five in order to receive credit. Once the group has been formed, only two group members are eligible for, and receive, a loan. Usually, the first two members to receive loans are the poorest among the group members. However, before eligible borrowers receive loan proceeds, they are required to participate in a one-to-two week intensive training programs on the philosophy of Grameen Bank and its rules. The borrowers are also educated about money management ad small-scale economic development.

Typically, the first loans received by the group are no more than $20 (US). Only if the first two borrowers have repaid the principal and interest over a period of six weeks, do the other members of the group become eligible for a loan. Consequently, the borrowing prospects of the members without a loan are contingent upon the timely repayment of the borrowing members. Therefore, the group members exert peer pressure on one another to keep the loans current. If one member defaults, the entire group will lose its privilege to borrow from Grameen Bank, which is their only option to receive “inexpensive” credit. As a result, the collective responsibility of the group serves as collateral on the loan.

Normally, the repayment schedule is based on 50 weekly installments with an interest rate of sixteen percent. When borrowers of Grameen Bank have repaid their first loan, they become eligible for larger and larger ones. However, the borrowers are allowed to proceed at their own pace and not according to the needs of the lender (Aziz, 2002).

When the members of the group receive their first loans, they meet on a weekly basis to make a loan payment, which takes place in their own village. Unlike traditional banks, the Grameen staff visits all 81,378 villages to do banking with the more than 8.36 million borrowers at the doorsteps. Grameen Bank believes the people should not have to go the bank; instead, the bank should go to the people.

Furthermore, every week at the group meetings, individuals, no matter how poor, must contribute to a savings fund. The members can borrow from the fund, although, it is contingent upon the group’s consent. Also, the group members need to contribute an additional amount of money to an emergency fund, which serves as an insurance policy. It is important to Grameen Bank to instill the concept of savings in the borrowers because it empowers them by allowing them to exert control over their lives (Aziz, 2002).

However, Grameen Bank is not only a financial intermediary, but also a social intermediary. The members of Grameen Bank have to support an array of moral tenets, called the 16 Decisions (Appendix A), which they must abide by in order to continue borrowing from the bank. The 16 Decisions force the borrowers to promise to keep their families small, drink clean water, keep their dwelling in good repair, plant vegetables and seedlings, and carry out other good health practices. In addition, the members pledge to follow the four principles of the Bank: discipline, unity, courage, and hard work. Grameen Bank along with its loan program, encourages birth control, sanitation, and a clean environment, and may the only bank that has this unique characteristic as part of its lending policy. In addition to the 16 Decisions, the bank also holds workshops on health care, nutrition, family planning, and business opportunities (Aziz, 2002)