Microcredit

Microcredit is a small loan given to people excluded from the traditional banking system. It includes individuals who do not have proven sources of income, good credit history, or collateral to offer during the loan. In most cases, these are illiterate people who belong to underdeveloped countries.

These loans help poor people work from around the world to find the ability to sustain themselves by opening a small business and earning a reasonable income. By adhering to proper microcredit initiatives, countries can foster their development and give their poorest citizens more power over their lives.

• Microcredit helps low-income individuals, including skilled laborers without the means to produce goods on their own, escape from poverty with small loans that help them buy the tools and materials. It improves the sustainability of their craft and gives them more independence.
• The first bank credited with offering microcredits to people was the Grameen Bank in Bangladesh. The experiment was successful and replicated on a large scale in other developing countries.
• While it offers several advantages, such as economic growth for poor regions, microcredit is often criticized for having excessively high-interest rates.
• Microcredit is a part of microfinance, a broader category of services that are aimed to help small entrepreneurs and poorer citizens.

Microcredit, as a concept, goes back to Europe during the 18th and 19th Centuries. We can cite two examples of that. First, we have initiatives that provided small loans in Ireland during the 1700s.

Then, there were also credit cooperatives in Germany that helped local peasants to work independently. Providing them with the capital to start a business improved their lives and gave them more autonomy.

Today, these tools have been heavily modified as they evolved a lot over time. Muhammad Yunus a social entrepreneur, created the modern version of microcredit. He started the Grameen Bank in Bangladesh in 1983 to reduce poverty.

The goal of microcredit organization was to offer microloans to skilled workers and other low-income individuals, so they could get out of poverty by having the investments which are necessary to start a business. With the money, they will go from unemployment to entrepreneurship and will have the capacity to produce their own wealth. This model has achieved popularity around the world since then.

Some important features of microcredit are as given below:

• Small amount – The main feature of this kind of microcredit programs is that small amount of loan provided to borrowers. They are designed to meet a particular requirement of the borrower like setting up small business, business expansion, financial need during the emergency, etc.
• Low income group – They are targeted towards low income group people who cannot afford to contribute much money but need financial help to move ahead, be it education, business, agriculture, etc.
• Simple application process – The application process and the method of loan approval is very easy and less time consuming as compared to traditional loans. The underwriting process is also very simple.
• Interest rates – This may be higher due to the risk that the lenders need to take since loans are given to perpole with very low income.
• Short term – These loans are for short term which may be for a few weeks to a few months.  The borrowers may have to make frequent and small repayments from time to time. However, they have the flexibility of usage as per requirements.
• No collateral – These loans usually do not have any collateral or security backing them since the borrowers are not in a position to provide so.
• Risk – The lenders are always at a risk of nonpayment or delay in payment because the borrowers are small income groups who may not always have the financial ability to repay. Also, the repayment ability depends on whether the business takes off and becomes profitable, which is again time consumaing and without any guarantee.

This type of credit facility plays a crucial role in poverty alleviation, economic and social development and upliftment of those people who are actually left behind due to lack of financial strength to move ahead and achieve their goal . This system includes such people into the financial system of the country.

Let us study some of the common types of this kind of microcredit programs available in the market.

• Micro savings- These are a type of savings account that institutions offer to their customers. There is no need to maintaina minimum balance in these accounts, but the borrowers continue to get the interest on the savings account.
• Micro loans – These microcredit loans do not require any backing or collateral for availing them. They are usually offered to small or new businesses set up by people who are not financially strong enough to back the loan with assets.
• Micro Insurance – Such insurance requires very low premium compared to normal insurance and the borrowers get a normal insurance plan as a protection against unforeseen situations.
• Agricultural loans – They rae designed for farmers or business related to agriculture, or for purchasing seeds, fertilizers, equipments.
• Group lending- This is a process where borrowers form groups and become equally responsible for repayment of loan. Each person act as a co-guarantor for each other.
• Revolving loan fund – In this, the organization creates a fund pool that provides loans to members. As and when the borrowers repay the loans, the money returned is reinvested for giving out further loans.

Thus, the above are some important and common types of microcredit provided by non-government organizations, microfinance institutions, credit unions, microcredit bank etc. They help in creating financial security, economic development, poverty reduction and control.

It is the government that funds these programs, as it needs to promote economic growth.

In this case, the main goal is to help people get out of the dependency that they may have on third parties such as loan sharks or exploitative employers. They may also help people stop living based on barter systems and enhance their financial inclusivity.

However, because these loans are very high-risk, they often have higher interest rates than the traditional system. In addition, the interest is high because many of these people will likely not pay the loan back, as they don't have a good credit rating.

Most microloans range from something between $10 and $100, which may not seem like a huge amount for someone in a developed country, but it makes the difference for people living in poverty. The ceiling of the loans can go as high as $2,000 for small companies.

Let us understand the concept of microcredit organization with the help of some suitable examples.

• The most famous real-world example of microcredit is the Grameen Bank of Bangladesh. This community development bank offered microloans to poor residents of villages in Bangladesh during the 80s.
• It was based on an initial experiment made by Muhammad Yunus in the 70s, in which he lent money from his pocket to aid a group of women in a rural community. So they could start their craft, and all of them paid him later.
• The result is that their lives, as well as their confidence, greatly improved after a while. People could get rid of shark-loans who took advantage of their work and started their craft by themselves.
• In India, the National Bank for Agriculture and Rural Development started the Self Help Group Bank Linkage program in 1992. With this program, the government offered several microloans to poor individuals, and over $867 million were given to self-help groups.
• It also aided in the construction of associations such as the Self-Employed Women's Association, which offers microfinance aid in the country. This microcredit bank offers loans to women, mostly in rural and poor regions.

Let us look at some of the benefits of the concept of microcredit programs in detail.

• The main advantage of offering microcredit is how it can improve a country's economy. Studies show that microloans have an overall positive effect on the financial sector, making it more inclusive and helping countries to be more developed.
• Microfinance plans such as microcredit raise the per capita consumption of the people and allow people to live above the poverty line, so it can be a real game-changer, especially to fight hunger.
• Overall, it can also improve whole communities. For example, this study in Bangladesh tracked the program for over 20 years locally in villages in the country, and it showed how locals increased their income levels and its stability.
• Microcredit can have a transformative effect on whole communities, essentially changing how they work for the better. Also, it helps to take people from an informal economy to a formal one (which also helps the government to raise more taxes).

Some limitations of the concept of microcredit loans are given below in details.

• One of the main limitations of microcredit is that the amount of money lent to the people can't be very high. As the standards for lending are very low, most banks won't offer a huge amount of money. So it may be a problem for people who need a more substantial investment for a start.
• Another disadvantage is that people feel very pressured to pay off the loans because they have high rates. The interest rates on these loans tend to be very high because of their risk factor, and it falls upon the very people who can least afford them, the poor people. Rates as high as 20% or 30% are not uncommon in these cases, which has drawn criticism about these initiatives.

It is always important to understand the advantages and limitations of any financial concept like this very well so that the facilities can be availed without any risk and misunderstanding, because e main idea behind this process is upliftment of backward sections of the society which is necessary for the economic development as a whole.

Microcredit is part of a broader concept called microfinance. It directly refers to a small loan, while microfinance refers to a diverse number of services provided to small entrepreneurs.

To understand the difference better, let's dig into what microfinance is. This umbrella term refers to a large diversity of financial services aimed at small entrepreneurs and poor individuals.

For instance, people will primarily use the term microcredit to lend $50 to a low-income individual willing to start a new business. However, if someone already has a business and is looking for additional aid to support it, they will be using microfinance programs.

The microfinance services may include services on a larger and more strategic scale. Some examples are:

• Larger loans.
• Tax breaks for companies willing to help in microcredit.
• Government subsidies to small enterprises.
• Agricultura loans for fertilizer, livestock, etc.
• Insurance credit.
• Saving accounts for poor individuals.
• Pensions.

This has been a guide to Microcredit & its definition. We explain it with example, features, benefits, types, differences with microfinance and limitations. You may also have a look at the following articles to learn more –

• Microfinance Loan
• Hard Money Loan
• Jumbo Loan