Benefits Of Micro Credit Economics Essay

One of the main reasons that developing economies remain poor is the fact that they cannot have access to credit. This is due to the insufficient collateral that poor have or because the monitoring cost of the banks is too high so lending in such groups is not profitable for the banks. Therefore poor do not have access to the loans from the banking system. However since the late 1970s a revolutionary change occurred and the poor in the developing economies started to have access to small loans. These loans are called microcredit programmes. The first that established them was in 1976, Mohammad Yunus the founder of Grameen Bank in Bangladesh. Also Mohammad Yunus received the Nobel peace prize in 2006 because of the element that microcredit helps people to get away from poverty. There is not only Grameen Bank, in fact many other followed Mohammad’s example and there are nowadays many institutes around the Globe that provide microcredit loans to poor people. Some well-known examples are, Bank Rakyat in Indonesia, Banco Sol in Bolivia and many others that serve the same goal. Too have a better view about the amount of people that leave in extreme poverty in 2002 according to United Nations this amount was the one fifth of the world population (1.3 billion people), and they agreed to a plan of halving the above amount into half by 2015. (Hermes and Lensink, 2007)

So apparently there are many people that can use a help from microcredit, this is the main reason why there is such a growing attention from the policy makers and from the academics. There are two main debates among the academics, one of them is the search of how and why microcredit works from theoretical prospective. The second biggest debate is about the trade-off that might exist between sustainability of the bank providing the loans and the outreach of the microcredit programmes. There will exist advantages and disadvantages of microcredit as in every aspect and we will try to identify and discuss both of them in the upcoming sections.

Benefits of Micro-Credit

There are three types of borrowers, the first one are the individual borrowers, the second one are the group borrowers and the third one are the village banks. Each one of the have different types of liabilities and the bank or institute that lend them have different types of risk so expectations to get their money back and also different interest rates.

First we will start with group lending because it is the most common way that microcredit borrowers can have access to loans. According to (Lapenu and Zeller, 2001) only the 16% of microcredit programmes use the group lending mechanism so poor have access to credit, but they found out that there where the two thirds of the borrowers that where included in their survey. The group lending programmes are groups of customers that are self-formed and they have a jointly liability to repay the loan that was given to the group members. Thus if one member fails to repay the loan then the other members have to contribute. Also it will mean that all group members will be denied any future requests for additional loans. Thus group lending creates high incentives for the individual group members to monitor the rest of the members of the group so they will reduce the potential risk of contributing in a potential failure of even worst lose the access to future microcredit loans. So with this way of lending agency cost of the lender is reduced to a minimum or even vanish it, because the procedure now takes place among the borrowers. Also group lending structure is based to the fact that groups are formed by people that live close one to each other and might have social ties so they are much better informed about each other’s activities and they can assess the risk better than the lender that cannot have access too such in depth information. There are some controversial evidence that if relatives for the group then the repayment is not so secure and other state that as stronger the ties are the more secure it is to repay the loan. Another important factor that helps the repayment security is that if there are written down procedures that they have to follow so the loan is repaid then moral hazard is reduced. Also a leader in the group is very helpful to make sure that everyone will repay their part of the loan and keep monitoring their activities to make sure that they will repay, and as better the leader quality the better the monitoring and the enforcement within a group.

The second type of borrowers is the individual ones. They have two-sided relationship with the institute as normal lenders do. The liability for repaying the loan stands along with the individual borrower only, in some cases a guarantor might be needed but those cases are rare. In other cases that the borrower owns a small land it might be used as collateral but because of the fact that the borrowers are poor it is not an ordinary procedure. In individual borrowing the monitoring cost is high but from studies in Bangladesh sawn that individual lenders have the highest average profit for the bank. One reason for that is that individuals find the group methods become unwieldy for the individuals that seeking for larger loans so they will be able to invest in larger businesses. (Cull et al, 2007)

The third type of borrowers is the village banks. They are kind of a branch of the bank, they form a large group and has a degree of self-governance. Sometimes village bank can be held by an individual that is wealthier that the others so he can borrow from the institute and then lend the amounts to the rest of the people. Majority of the customers of village banks are women and also the amounts that village bank lend are small.

No one can deny that micro-credit is beneficial for the participants and also for the non-financial active people. Many can argue that it might not be available for everyone but even so the overall effects are positive for all. In Bangladesh it was found (Khandker, 2005) that microcredit had a large positive impact on the welfare of the households that used this type of borrowing and consumption was raised among the participants. Also it was found that there was a spill over effect that was helping even the non-participants to have some benefits. Another factor is that because the borrowing households where able to perform better in their businesses they were upgrading their living facilities to higher standards, proper shower, better bathroom fixtures and even plan to send their children to school or college.

The downside is that microcredit programmes and institutes most of the times cannot self-fund the loans so most of them are not sustainable. They depend a lot in donation and on to Governmental subsidies. This is due to the high costs of monitoring that these loans have to have. So as long as there are not sustainable they have to try and make more profit out of the loans, this means higher interest rates. It might not affect so much the overall demand but after a certain point the demand on such high interest rates drop dramatically. This is where microcredit institutes have to find a balance so the following disadvantages have the least impact at it is possible.

Drawbacks of Micro-Credit

Because of the fact that microcredit institutes have to use Government subsidies or donations to be able to remain sustainable and due to the worldwide economic crisis that reduces the amount of funds that are available. So to be able to become self-sustainable institutes have to raise the interest rates of the loans that they give away. Here is where problems start to occur, because as the interest rates getting higher the quality of the portfolio will drop and also the risk of moral hazard will rise. Also because of the low credit limits of the group based methods institutes will have to get more individuals as clients and there is where information problems will occur because the institutes will have to self-monitor the individuals. Researchers (Cull et al, 2007) found that as interest raises the more profitable a loan gets but up to a certain level, after 60% interest rate per year the profitability is not increasing anymore and this is due to the lower demand because of the very high interest rate. This sifts created a puzzle, why the individual approach is favoured from the two group methods? This puzzle is sharpened by knowing that two of the pioneers of microcredit finance Grameen Bank of Bangladesh and BancoSol of Bolivia switched from group based model to individual based models nowadays. One element that justifies the above change is that individual loans create more profit because of their larger size and the higher interest rates that apply. If though we use loan size as a proxy of poverty then we will find out that the larger loans are not applicable for the group borrowers and it has to be a less poor borrower that is interested in investing in larger businesses. From the institute side prospective the above change is vital for them to be self-sustain, but this comes to a contradiction with the reason why those institutes created and their mission in the first place. They were made to support the poor and give them access to funds and now they turning to more profitable loans that most of the time do not apply to the very poor borrowers and this leads to a mission drift.

Mission drift is the procedure that takes place in the composition of new clients and the re-alignment from poorer to wealthier clients throughout the existing ones. In search of cost-effectiveness institutes want to increase their loan size and that means that they have to focus on clients that seek larger size loans. Also the existing clients get slowly less poor than the originally where so the institutes now seem to lend wealthier clients that the ones they started with and they were devoted to. This means that institutes might shift focus to wealthier clients and that will affect the outreach to the poorest that are those ones that originally microcredit institutes made for.

Some more disadvantages are that many institutes do not arrange meetings with the groups so they can guide them in what way they can get the better use of their loan, in some cases those meetings helped very much to have the group focused and achieve grater wealth improvement than if they did not have the guidelines, as well as if there are constrains on the contract about how the money have to be distribute among business investment and self-purchases. So every institute has to do so if they wish truly to fight poverty than just have a return on their money invested.

Another drawback as it was found (Nguyen and Hollister, 2012) is the increased bureaucracy in the load administration that increases the cost as well as the time that a loan needs so it gets approved. Also they found that the credit limit especially among the group members is very low so it helps a little but it is no sufficient for someone to invest in a business and have the appropriate returns. This means that more time is needed to be able to improve their living standards and become less poor than thy originally where.


Even if the drawbacks sound very serious and they are grate issues that they have to be solved no one can deny that micro-credit continues to reduce poverty between the poor borrowers and enhance the local economy, even though this happens in a lower paste nowadays. Since the late 1970s micro-credit is the best and most sufficient way to fight poverty and provide better living standards for billion of people in the developing countries. One grate aspect that has to be noted is that even if someone is not participating in a micro-credit program at the end he/she will be benefited from others that took part in these programmes. So the overall living standards and consumption will be improved for both participants and nonparticipants and this is due to the general increase of the local community income. Studies sawn that each year the average village poverty level is reduced by 1 per cent, it is not a great number but in some cases the percentage is higher. Also we must not forget that even such small number make huge changes if we consider the billion of people that involves.

So it is very important that micro-credit institutes keep on doing their best to provide as many loans as possible to the extreme poor and poor people around the globe because it was been proved that their way works very well in fighting poverty. And as the saying goes it is better to teach someone how to catch fish than give him the fish, because this will keep on providing him food for years after years.

Still studies have to be made to determine the level of impact of micro-credit institutes regarding poverty reduction, but it is not easy to compare all this cases and come out with a clear result, and access al the socio political aspect of micro-credit. As long as micro-credit movement helps people escape from poverty and have more chances to live a better life then it has to keep on going.

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