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Microcredit Primer

INTRODUCTION

We met Sonia Gutierrez Vlandon during the summer of 1998 while volunteering with FINCA International (one of the largest microcredit organizations in Latin America) in steamy Nicaragua. She had been living in a small dilapidated home with her husband and six children ever since the Sandanista government had provided the land to her family. Across the dirt access road into her neighborhood was a large pineapple field. Since moving to the area she had been purchasing pineapples on credit (and paying an obscene interest rate) and reselling them in the local area. She told me how she was never able to get ahead.

In 1997 Sonia joined a group of FINCA Village Bank borrowers called La Arroyito (Spanish for little stream) that met at the home of a neighbor—usually under a large shady tree. After a few initial training sessions Sonia received a microloan for the equivalent of 100 U.S. dollars guaranteed by her word and backed by the social collateral of the members of her Village Bank group. In turn, she joined with the other members and guaranteed their loans. If any of the twenty women in La Arroyito defaulted on their loan it would be the responsibility of the other nineteen women to repay that debt-otherwise they would receive no further loans as a Village Bank group.

A year later Sonia had earned enough money to send her children to the local primary school, provide better food for her family, purchase medicines, and start building a new, larger and more comfortable home. How was she able to accomplish all of this? Instead of purchasing the pineapples from a middleman at an outrageous interest rate, she used her FINCA microloan to purchase pineapples directly from the farmer for cash. These pineapples, purchased in larger quantities, yielded a much lower cost per pineapple giving her far greater profits.

In Sonia's first year with FINCA she received three microcredit loans and paid each back within the allotted sixteen-week period. Throughout that first year she saved enough money to build half of her new home. Now with 120 U.S. dollars in savings, she estimated it would take two more loan cycles (eight more months) to save up enough to finish her new home. Sonia's experience is a good illustration of the benefits of microcredit that excite many economic developers. First, the bulk of her added profits went directly to benefit her family. Second, because each loan is paid back with interest it becomes a perpetual loan fund. Thus, Sonia's repayments recycled as loans to other village women and men, again and again.

MICROCREDIT TODAY

The UN declared 2005 the International Year of Microcredit. Currently, an estimated 100+ million women and men are accessing the services of over 3,000 microfinance institutions (MFIs). These organizations are trying to reach an estimated 1.2 billion people living in absolute poverty, or on less than US$1 a day (an estimated 240 million families).

The 3,000+ institutions reaching these families via microcredit come in various forms. Most are non-governmental organizations (NGOs) directly participating as microcredit practitioners. That is, they acquire funds and provide microcredit services. These are organizations like the FINCA example in this primer. We typically recognize them as nonprofit organizations.

Many microcredit practitioners are commercial banks like Mibanco in Peru, an independent partner of ACCION International, an NGO helping over 4.7 million borrowers. These are specialized banks set up to provide financial services to the poor. Many credit unions are also participating in the microcredit movement.

In the last few years, as microcredit has been recognized for its contribution to poverty alleviation efforts, many government and multilateral organizations (such as USAID, the World Bank, and the United Nations, etc.) have become involved.

Lastly, there are also important microcredit industry research and policy organizations helping to further the impact of microcredit for the poor. These include such organizations as the Microcredit Summit Campaign, the Consultative Group to Help the Poorest (CGAP), and the Small Enterprise Education and Promotion Network (SEEP).



MICROCREDIT DEFINITIONS

Sonia Gutierrez Vlandon's real case is just one example of the many types of microcredit being practiced today. The Microcredit Summit Campaign-a development industry initiative to bolster microcredit's impact among the poorest in the world defines microcredit in this way:

Another common definition of microcredit is that it provides credit and other financial and business services to the poor who are marginalized, or otherwise ignored by the usual financial institutions. While microcredit loans are often small in dollar amount, there is no industry rule that limits the size of such loans. In addition to standard loans, other services may be offered including short-term credit, long-term credit (i.e., mortgages), savings, life insurance, property insurance, technical assistance, health care training, etc.

Perhaps the easiest way to describe microcredit is to look at the people it serves. They are often called microentrepreneurs-again, entrepreneurs ignored by traditional financial institutions due to: (a) their small business size, (b) their poverty situation, (c) their usual lack of collateral, and (d) their non-existent credit history. Microcredit, then, is the set of financial services required by existing and new microentrepreneurs to help lift themselves up the next rung of self-reliance on the economic ladder. It is most commonly used to describe efforts to help the poorest people living in developing economies-though microcredit programs exist in developed economies, including the United States.

USUAL COMPONENTS

One way to understand microcredit is to examine its usual components. Though programs differ from each other, and even from country to country within the same program, there is a usual set of defining components for microcredit programs.

Services The usual banking services include savings mechanisms and small, "micro" loans.

Borrowers In any given country, microcredit organizations target microentrepreneurs living below the poverty line who have been ignored by the traditional financial institutions.

More often than not, these microentrepreneurs are women running microbusinesses (some call these cottage businesses) in order to keep their family alive. Worldwide, approximately eighty percent of microcredit loans are given to women. Many of these developing world microbusinesses operate in the informal or gray market-that is, outside of the formal, government-regulated marketplace.

Families Microcredit is widely recognized as a method for providing financial aid directly to families. As opposed to top-down economic development strategies, microcredit immediately impacts a family's bottom-line. Repeated research shows an almost immediate impact providing better access to food, medical help, and education for families.

Social Collateral Many microcredit organizations provide their services without requiring traditional collateral. These groups use what is called social collateral to maintain high repayment rates of loans. In Sonia's case, for instance, the social consequences of defaulting on a loan are very high. And when it does happen, the local village bank collectively covers the loan repayment to ensure that they will each be able to receive their subsequent loans.

ADDITIONAL COMPONENTS

There may also be other aspects of microcredit that exist in a microfinance institution's product and services offering. In some cases they include the items below:

Services The market demand from the world's poor is bringing more and more financial services to them, including an offering of insurance and risk services: life, health, property, etc. Likewise, additional loan types have been developed for specific markets which include home loans, leasing options, emergency loans, etc.

Training Some microcredit organizations provide training, technical assistance, and business consulting along with the usual financial services. In addition, many "microcredit with education" MFIs provide health training, AIDS prevention, or similar training services to the borrowers, in addition to their loans.

Financial Sustainability Many microcredit institutions also focus on financial self-sufficiency as a goal. Organizations that are more financially sustainable do not require the same level of outside subsidies from government or other donors. This allows them to use any available government and donor funds to grow their microcredit sphere of influence rather than focusing on keeping current activities viable.

Most microcredit organizations charge an interest rate that seems high by U. S. standards, but very low in comparison to the usurious rates charged by local money lenders, loan sharks, and the like. Due to the cost of delivering microcredit (much higher transaction rates that traditional banks usually sustain) and inflationary and currency pressures in developing countries, these rates are often in the 20-40 percent range.

Gender Empowerment Some microcredit organizations target women borrowers in order to improve their social status. They recognize microcredit as a method to not only change the financial status of women and their families, but also as a method to bring about social change for women. In many situations, it has been found that women, in contrast to men, are a more dependable credit risk, start businesses that flourish under the microcredit model, and utilize the profits to the benefit of their families.

A short historical tour helps us to ground the present microcredit situation.

MICROCREDIT HISTORY

1970s & 1980s: THE PIONEERS Informal financial mechanisms have traditionally serviced the billions of poor households in developing nations. These include informal arrangements like moneylenders, loan sharks, pawnshops, and saving and loan clubs. Another source for funds often comes from relatives.

After World War II some economic development initiatives focused on providing agricultural credit to marginalized farmers. However, these loans were highly dependant upon weather and crop success. Therefore the repayment rates were not always high. Then, in the 1970-1980s, simultaneous efforts launched the microcredit movement and it started having an economic development impact in the lives of thousands of families.

Three of the organizations in Small Fortunes were pioneers in the movement. A summary of their stories helps to see the varying ways that microcredit got its start.

Grameen Bank In the mid-1970s Dr. Muhammad Yunus returned to Bangladesh to teach at Chittagong University after receiving a PhD in economics in the United States. He returned to a newly independent country devastated by war that was trying to deal with a multitude of economic problems. It was not long before Professor Yunus realized that the economic theories and practices he learned were useless in dealing with the abject poverty he saw every day as he commuted to and from his college office. He and some students interviewed 42 impoverished women and found that they were all hardworking people who were paying outrageous fees to suppliers because they could not pay in cash. The suppliers made money, but each of the women had very little money left after paying their suppliers back, or selling their products through them. Adding up the various capital requirements for all 42 of the women, Yunus found out that US$27 was all that was required for these women to be able to purchase their usual supplies directly and bypass the creditors. He gave each of the woman the small amount of money needed, and within weeks was paid back-and each of the women had enough profit to continue to directly purchase their supplies-instantly making more profit than they ever had before.

This was the start of the first Grameen Bank (Bangla for Village Bank). Yunus repeatedly went to the formal Bangladeshi bankers to show them his progress in providing credit to the poor. Each time he was rebuffed with the comment, "The poor aren't credit worthy!" By the end of 2005 we estimate that the Grameen Bank will reach over 5 million borrowers. Ninety-six percent of Grameen Borrowers are women, with a loan recovery rate of 98.93 percent. The Grameen system has subsequently started providing other financial services (such as housing loans and educational loans) and has found unique ways to help Bangladeshi microentrepreneurs start new businesses (such as Grameen Phone). Not being secretive about their success, the Grameen system goes out of its way to share information about itself-helping to start hundreds of Grameen replication programs in many countries around the world.

ACCION International In a similar case during the 1970s, a student-formed organization started providing microloans in Recife, Brazil. This later became ACCION International. Over time ACCION broadened its microcredit efforts and in 1992 helped form BancoSol in Bolivia, the first commercial bank dedicated solely to microenterprise. ACCION has been an innovator in creating similar organizations as a method for reaching large numbers of microentrepreneurs in their respective countries. ACCION is a key innovator at the forefront of efforts to bring microloans to microentrepreneurs through regulated financial institutions. In 2005, fifteen ACCION-affiliated, regulated financial institutions exist to provide microcredit services to impoverished families. Like the other pioneers mentioned in this overview, ACCION provides technical assistance to many other microfinance institutions worldwide.

In the 1990s, ACCION USA, a subsidiary, was formed to bring microcredit services to large urban populations in the United States who likewise find it difficult to access credit through normal banking institutions.

By the end of 2005, we estimate that the ACCION-affiliated programs will have reached over 5 million borrowers. ACCION borrowers have a historical repayment rate of 97 percent.

FINCA International Meanwhile, in the 1980s, John Hatch was inspired with the same lending principles in Bolivia. While finding it increasingly difficult to provide agricultural loans, he got the idea of providing loans to women to finance their microbusinesses. He found success similar to Grameen and ACCION and formed the Foundation for International Community Assistance (FINCA). FINCA is the organization from which Sonia (mentioned at the beginning of this introduction) received her loan. In 2005 we estimate that FINCA will reach over 2 million borrowers. FINCA works in 23 countries, mostly with women, and has a loan repayment rate of 97 percent.

Just as in Grameen and ACCION's cases, FINCA readily shares its Village Banking model with others. FINCA's Village Banking replication programs have been started in over 32 countries throughout the world.

1990s: A MOVEMENT In the 1990s the microcredit movement took hold and microcredit was established as a viable development tool. Networks and associations were started to facilitate the sharing of best practices, establish goals for the movement, and focus on innovations to improve microcredit practice.

A pivotal moment occurred in 1997 when the first Microcredit Summit was held in Washington, DC and the Microcredit Summit Campaign was launched. Over 2,900 people from 137 countries attended, and a goal was set to reach 100 million of the world's poorest families by 2005. Sam Daley-Harris, the founder of the Microcredit Summit Campaign, is interviewed in Small Fortunes. The Microcredit Summit Campaign has held a subsequent Microcredit Summit +5 conference in 2002 and multiple regional conference in intervening years.

Specific reference to reaching the poorest means those borrowers living on less than US$1 a day or the bottom 50 percent of those living below a country's poverty line. At the end of 1999 the Microcredit Summit Campaign reported that 23.5 million borrowers had access to microcredit—13.75 million of these were classified as the poorest.

By the end of the 1990s microfinance institutions had taken on many forms such as nonprofit organizations, regulated financial institutions, and nongovernmental organizations (NGOs).

2000s: GROWTH & INNOVATIONS As mentioned earlier, 2005 has been declared by the United Nations as the International Year of Microcredit. Microcredit is not the panacea for solving poverty. It is, however, widely recognized as a great tool for providing tangible and intangible resources to help the poor lift themselves out of poverty through self-employment.

We believe that the microcredit movement will continue to grow in numbers as well as in impact as existing microfinance institutions become stronger and new organizations become involved. In addition, we see continued innovation through research, customer-driven products, and the continued sharing of best practices among microfinance institutions.