Definition of the microcredit
Microcredit is the main tool of the microfinance concept, which is considered to be invented by the Professor Mohammad Yunus, the founder of Grameen Bank in Bangladesh. As it is stated on the Crammen Bank web page, a microcredit is a program of small loans, offered to the poorest people so that they could generate income through self-employment projects (Grameen Bank, 2012). Microcredit can be also defined as a small loan to poorer households or small entrepreneurs, that lack steady employment and a verifiable credit history. In most cases microcredit does not require any collateral, as its target audience rarely can provide one (Banerjee, Karlan, & Zinman, 2015, p.1). These peculiarities make the microcredit not only the most available form of money borrowing, but also one of the most risky financial operations, offered by the banks and non-banking credit organizations. However, during the past decades, it was proved that microfinance programs have demonstrated that it is can be successfully lent to low-income households and still maintain high repayment rates.
Therefore, it can be stated that microcredit programs look promising in terms of revolutionary approaches to alleviating poverty. Besides reducing the poverty level, microcredits are also tend to spread financial services among the millions of poorer households, which did not have an access to any similar opportunities before. However, recently evolved microlending requires more certain and precious research. Hereby, modern economic theory keeps a keen eye on the development of the microcredit in different markets. It is also suggested that new contractual forms can be a key to the microfinance success, especially when talking about the use of group-lending contracts with joint liability. Meanwhile, in most cases, high repayment rates have still did not bring any profits to creditors, and researches of impacts on the poverty rate yield a mixed picture (Morduch, 1999, Abstract).
Why do poorer people need microcredits?
Modern economy is vibrant and fast developing. Which is why small households and micro-enterprises require a flexible, well-functioning domestic market that can sustain the majority if not all people with enough money and resources. Poorer people in most cases work as employees, however, more and more individuals become self employed, or basically run their micro business. These new small businesses create new labour demand, thus all benefit greatly from an expanding supply of decent wage-paying jobs in their local economies. Hence, microcredit may serve here as a great supporting power for the economic growth of developing countries (Chowdhury, 2009, p.3).
Another reason that forces people to borrow is when they have not yet experienced, but rather expect to experience negative economic effects, like increased inflation for example. Increasing microcrediting will produce both downward bias and upward bias. In particular, estimated impact will be lower than its real effects; while people will start borrowing when they expect to see an improvement some time later. Through either group or individual lending of the microcredit, financials may decrease the poverty level. Numerous researches held prove that microcredit has a positive influence on income, assets’ endowment and living standards. Due to its multiple effects on the economy, some economists define microcredit as a set of financial services, offered to low-income, poor and very poor self-employed people. Among the financial services meant in this definition there are savings and credit, insurance and payment services, etc. (Mazumder, & Wencong, 2013, pp.403-404) Consequently, a variety of the services offered, create an increasing demand on them from the side of the low-income households. Ability to have an access to different banking and non-banking financial services allows poorer people to interact with larger suppliers and partners, hence both parties may benefit.
The first large and widely known microcredit program started from Grameen Bank in Bangladesh. Besides the before mentioned reasons of its popularity among the pooper people, microcredit was perceived as a tool that helps to improve women’s socio-economic status in Bangladesh. And, as it was reported later, questionnaries proved that there was a strong relationship between the microcredit and decreased poverty, especially in females’ group (Mazumder, & Wencong, 2013, p.415). Microcredit also gives to its borrowers a feeling of safety, as some of the basic needs may be satisfied. Later on, availability of extra funds motivates an individual to desire better living conditions, or to develop their business, if talking bout entrepreneurs. Tight relations with financials allow poorer consumers to run business with large partners, as they may enjoy equal opportunities. This is only possible as microcredit may be lent without any collateral required or other strict measures.
What may prevent poorer people from getting a microcredit?
Small entrepreneurs and especially poorer individuals often concern about supply-side selection biases of the possible lenders. Most financial institutions are more interested in providing a credit to large and medium sized businesses or individuals with a good credit history, as such operations are more profitable. Small borrowers rarely make financial decisions based on facts, that are easy to observe and analyze, they are more concerned about how to meet their current needs. Hence, lenders choose which neighborhoods and markets to enter, and whether to seek for higher profits in the vibrant and growing markets, or run their business in a stagnant and particularly poor market so that to meet social concerns (Banerjee, Karlan, & Zinman, 2015, p.8).
In many developing economies micro credits and lending to small business are regulated by a number of different laws and restrictions. All these measures together with high interest rates prevent financial growth of low income households and small enterprises. Financial institutions are expected to make relatively small provisions for the microcredits lended. However, other requirements may remain very strict. Low provisions and weak securitization on the micro lending lead to the greater risks, thus make the aforementioned operations less interesting for the financial organizations (Hardy, Holden, & Prokopenko, 2002, p.19). Since most poor households cannot be considered as micro entrepreneurs, it becomes challenging to measure and evaluate their solvency. Most of them are interested in diverse income sources rather than in a big one. First of all, it is due to inability to pay out large amounts at once. Hence, extending of payback deadline is one of the largest advantages of the multiple credits. Secondly, microcredits may provide a so called escalator of sustained growth of income. (Islam, 2012, p.146) Microcredit is mainly called to alleviate poverty, therefore one of its essential characteristics is the availability for the poor people. Which is why it appears to be difficult to monitor properly the clientele of the various financial institutions only through their mainstream of credit and saving activities (Islam, 2012, p.147). Therefore, many financial institutions avoid lending microcredits so that to avoid any risks related to that type of operations.
It is worse mentioning that microcredit is mostly important for developing countries, where financial literacy is common for a large amount of population. Therefore, poorer individuals do not seek for any credit, as they are simply not aware about the lending process and its peculiarities. Religion and cultural prohibitions may also appear to be challenges, on the one’s way to receive a credit from the financial institutions.
The results of the research, run across the seven countries did not prove that lending a microcredit further led to substantial increases in borrowers’ incomes. Hence, it questions whether a microcredit has any solid influence on improvement of living standards in a structural way.
Financial institutions in the countries chosen target clients with certain characteristics, as any other lenders do. Besides the usual collateral and reliable credit-savings record history, financials that offer microcredit to the low income customers seek some other aims. As it was reported, financial institutions of the three countries tended to lend only to women; majority of the organizations set minimum and/or maximum ages. All countries, except of India were interested in supporting microentrepreneurs, though some requested to provide business plans before lending. As a preventing measure, some countries limited the number of credited microbusinesses to one per each customer. Meanwhile, there were no lenders that restricted or limited the use of money borrowed. (Banerjee, Karlan & Zinman, 2015, p.4)
Positive and negative impact of the microcredit on economy.
The main purpose of the Microcredit implementation is to sustain the development of the entrepreneurship and alleviate poverty. However, strong evidence is needed so that to prove that a microcredit program has a direct and significant impact on the poverty decrease. Therefore, a number of researches were held recently in seven different countries, namely Bosnia and Herzegovina, Ethiopia, India, Mexico, Mongolia, Morocco and the Philippines. Studies were set up in developing countries with a high number of poor people. The results showed that giving an access to microcredit for people with low income does not necessarily lead to the overall increase in the economy. Which is why an intense debate arose between those economists, who supporter the microcredit campaign and their opponents, who question whether the tool mentioned can lift people out of poverty (EBRD, 2015, p.3). Even tough it was evident from the research that an access to microcredit did not improve the borrowers’ wellbeing greatly, neither made the economic situation in their households better, it was not proved that microcredit caused any systematic negative effects. However, it was clear that each individual enjoyed greater financial freedom, achieved through the microcredit borrowing. This freedom was in the ability to decide how to spend the money (EBRD, 2015, p.2). Besides that, an increasing competition between the lenders resulted in a significant improvement of the financial services offered in the market. Meanwhile, increasing rivalry between the lenders revealed possible threats, of multiple credits taken by one client, and hence over-borrowing and repayment problems.Therefore, it was suggested to implement a unified system that allows lenders to share borrower information via a credit registry, which can help to prevent such problems is to let lenders share borrower information via a credit registry (EBRD, 2015, p.3).
The research results report that a group-lending microcredit program in Hyderabad, India, where lenders operated in 52 different areas, total leading increased to 8.4%. Moreover, investments and profits of small entrepreneurs increased, even though the consumption did not change greatly.It was also declared that the program’s core aim was an improvement of the social level and living standards, although no significant changes in health, education, or women's empowerment were found (Banerjee, Duflo, Glennerster & Kinnan, 2015, Abstract). Hereby, it would be fair to conclude, that microcredit had greater impact on the small business sector, rather than on the wellbeing of the poor people.
Benefits of the microcredit can be viewed on the sample. If a person earns about $40 per week, while his rent expenses reach $80 per week or more. Taking into account the taxes, obliged to be paid, the person is forced to save on his other purchases, even on food. Higher education for his children thus will be unaffordable for him. Large amount cannot be borrowed from the bank, as his credit and savings records are not positive, neither he has a good collateral. However, he can get a microcredit, which will allow him to purchase the necessary things and even let him to start some small business. As a result, a microcredit will cover the income-expenses gap and provide a person with more opportunities. In case his business appears to be profitable, he finally will get a chance to send his children to the university. Hereby, the social level of the whole family will be increased.
Drastic cost-cutting strategies make it difficult for the small and medium enterprises to survive in the market. Microcredit may be used as a tool that supports micro-business and boosts its growth in the long run. However, overuse of this lending tool may lead to a rapidly increasing number of entrants and cause a so called ‘market saturation’ (Chowdhury, 2009, p.3).
The research held also showed that attractiveness of the microcredit can be adjusted and thus, controlled through the various methods. As an example, changes in product design, flexibility of the repayment schedule, grace period options, etc. influence borrowers’ welfare growth and his further business’ development. Therefore, these amendments can serve as an effective strategy to limit or stimulate microlending. Such measures may be used in case there is a need to boost short term economy, or asure financial growth in a long term. Some financial organizations offer microcredits with repayment schedules that coincide with expected seasonal cash flows. Both developed and developing countries face the poverty phenomenon. Herewith, flexible loan products are used to regulate the economic situation in both long and short terms. Small entrepreneurs are as well dependent on the credit policy changes as large companies (Attanasio, 2015).
Flexibility of the microcredit product allows its lenders to arrange payout periods in accordance with the main peculiarities of other industries. Since most of the developing countries rely on the agricultural sector, it is very important to synchronize repayment schedules with the most profitable periods in the sector mentioned. However, this feature of the microlending requires financial organizations to diversify their operations, so that to unnecessary dependence on one of the sectors only. The flexibility described also allows to set different rules for different types of borrowers, and hence mitigate possible risks.
In addition, lenders of the microcredit may concentrate on the most promising entrepreneurs and support their further development. Microcredit program is not a single direction process, but a complex system with strong interrelations. Even though a sole small company does not influence greatly the general financial situation in the country, it is still of a great importance for further development. Lack of small companies may result in a monopoly in the market. Furthermore, small entrepreneurs are the key element in decreasing a poverty rate. Therefore, a microcredit program started in Bangladesh should not only give a helping hand to the poorer people, but rather create an environment which will allow low income households to organize and start their small and/or medium sized business. Many developed countries are famous for their unique and successful family businesses, which started exactly as a small entrepreneurship.
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