Microfinance, or microcredit, basically means giving loans to poor people without any collateral. It began in the 1970s, in Bangladesh, when the Grameen Bank, recipient of the 2006 Nobel Peace Prize, together with its founder Mohammad Yunus, started giving small loans to people who were too poor to be eligible for credit from institutional banks.

The idea was a success. Grameen lent mainly to women to start up some income-generating activity. In most cases, the loan was repaid. The idea caught on and, over time, several microfinance institutions have come into existence worldwide to service the rural sector; they could be foundations, individuals, government or private investors.

Microcredit has now come to be regarded as a powerful tool for development because:

• It empowers borrowers to escape from poverty by giving them the means to generate income.
• It proves that the poor are creditworthy.
• Most microcredit programmes target women. This increases their self-worth and independence.

There are 3,133 microcredit organisations reaching 113 million people worldwide, according to the State of the Microfinance Summit Campaign Report 2006.

The campaign was started by a group of international organisations in 1997. It pledged to reach 100 million of the world’s poorest families with microfinance by 2005. It held its second summit in Halifax, Canada, on November 12-15, 2006.

In India, the most popular form of microcredit is the Self-Help Group (SHG) Bank Linkage Programme.

SHGs are usually promoted by non-government organisations. Their members save and lend among themselves and also manage the affairs of the group. Mature SHGs are linked to the formal banking system.

The National Bank for Agriculture and Rural Development (NABARD) has connected thousands of SHGs with formal banks. In 2005-06, more than 960,000 SHGs received bank loans, taking the total number of SHGs to over 2 million.

However, while microcredit has the potential to reduce poverty, and has done so in many instances (a World Bank study says microfinance accounts for 40% of the “entire reduction” of moderate poverty in Bangladesh), it is increasingly being eyed by commercial banks and microfinance institutions (MFIs) as a way of making money.

Problems

Commercial lending institutions are attracted by the fact that the rate of interest is much higher when lending to the poor. Where interest on a home loan in urban areas would be around 9.75%, interest on loans to SHGs could be as high as 20% or more.

The risk of default is also not very high; though there is no collateral, pressure from other people in the SHG forces a borrower to repay on time.

The concept of credit driving consumerism in urban areas has been fairly successful. Once urban areas get saturated, commercial lending institutions will need to look elsewhere for profits. Untapped rural areas are the obvious answer.

What worries many development experts is whether the sound conceptual rationale of microcredit can be straitjacketed into the institutional framework of MFIs. The importance of microcredit should be the empowerment of the poor people who borrow, not the financial viability of the institution that lends.

“When the stress is on the financial viability of the organisation rather than the social and economical viability of the process, we are left with a top-down, target-oriented, lender-centric approach that is preoccupied with disciplinary repayment mechanisms and profit-generation rather than community empowerment,” writes John Samuel of ActionAid (see ‘Who sets the agenda for microcredit’).

A better model would be the one evolved by the Self-Employed Women’s Association (SEWA). The SEWA Bank was set up by SEWA members themselves; they decide what is best for them and how it should be done. It is SEWA that prioritises the needs of those who work, save and borrow, not some blueprint of capital growth. The SEWA Bank is therefore sympathetic to the needs of its clients. It accepts that sometimes women borrow money not to generate income but to meet their daily consumption needs.

As a result, it is unlikely to see the sort of situation that has arisen in Andhra Pradesh where microcredit was extensively used. In the Krishna district, debtors are now refusing to pay back their loans because of the aggressive manner in which MFIs have pursued loan recovery.

There are some who question whether microfinance can impact poverty in any big way. They argue that research is yet to show the causality between poverty alleviation and microcredit. It may smoothen cash flow and empower women, but whether that reduces poverty significantly is unclear.

Some sections of the development community also question whether credit is an appropriate way of dealing with poverty. They point to the rise in women’s indebtedness with back-to-back borrowing, and increased migration of women who cannot repay their loans. There is also the fact that poor households can only uphold limited amounts of credit.

The Microcredit Report 2006 makes it clear that microcredit is not a panacea for all ills. It says that what is required are well designed programmes whose ultimate goal is to transform lives and reduce poverty. It cautions against a situation where “the health of microfinance investors and of microfinance institutions is robust but the lives of many very poor clients remain untouched”.

As the popularity of microcredit as a development tool increases, the challenge will be to ensure that development of the poor is at the centre of the process.