Microcredit
Microcredit is the extension of very small loans to impoverished borrowers who typically do not have access to traditional banking services due to a lack of collateral, steady employment, and a verifiable credit history. The primary aim of microcredit is to support entrepreneurship, facilitate self-employment, and alleviate poverty, particularly in low-income communities.
The United Nations declared 2005 as the International Year of Microcredit to raise awareness of microfinance as a strategy for poverty reduction and financial inclusion. By the early 2010s, microcredit had expanded significantly across developing countries, with estimates suggesting that more than 200 million people were beneficiaries of microcredit services worldwide.
While widely adopted, the effectiveness of microcredit remains debated, with mixed evidence on its long-term impact on poverty alleviation. Some studies have indicated that while microcredit can increase business activity, it has limited effects on household income, education, and health outcomes. Critics argue that microcredit may contribute to over-indebtedness and perpetuate financial instability for some borrowers.
History
While the term "microcredit" gained prominence in the late 20th century, the practice of offering small loans to the poor has earlier roots. In the 18th century, Jonathan Swift, the Anglo-Irish satirist and Dean of St. Patrick's Cathedral in Dublin, established a charitable loan fund in 1727 with £500 of his own money. This fund provided small, interest-free loans to impoverished tradespeople, requiring borrowers to have two neighbors act as guarantors, thereby ensuring community accountability. Swift's initiative inspired the creation of similar loan funds across Ireland, which, at their peak in the 19th century, provided credit to approximately 20% of Irish households. These early efforts laid the groundwork for later institutional models of microfinance.Additional early examples of small-scale lending emerged throughout the 18th and 19th centuries. In 1746, John Wesley, the founder of Methodism, created a lending stock for the poor in England. His journal on 17/1/1748 records:
I made a public collection toward a lending stock for the poor. Our rule is, to lend only twenty shillings at once, which is repaid weekly within three months. I began this about a year and a half ago: thirty pounds sixteen shillings were then collected; and out of this, no less than two hundred and fifty-five persons have been relieved in eighteen months.In the mid-19th century, Lysander Spooner, an American legal theorist, argued that access to small loans could enable the poor to become self-reliant entrepreneurs. Around the same time in Germany, Friedrich Wilhelm Raiffeisen founded the first cooperative rural credit unions to provide affordable credit to farmers, laying the foundation for the global credit union movement.
Modern microcredit
The institutionalization of microcredit in its contemporary form began in the 1970s, with Bangladesh serving as a central hub for early development. In 1983, Muhammad Yunus established the Grameen Bank, which is widely regarded as the first modern microcredit institution. Yunus began the project in Jobra, using his own funds to deliver small loans at low-interest rates to the rural poor. The Grameen model introduced a group-based lending system aimed at reducing risk through peer accountability and promoting financial inclusion for low-income borrowers, particularly women.The Grameen Bank model inspired the creation of similar institutions globally, including BRAC in 1972 and ASA in 1978 in Bangladesh, and PRODEM in Bolivia, which later became the for-profit BancoSol in 1986. Simultaneously, savings and credit cooperatives, organized in regional associations under the aegis of the World Council of Credit Unions, were establishing and promoting access at the grassroots level to small amounts of credit throughout West Africa and Latin America. In Chile, BancoEstado Microempresas became a major provider of microcredit services. Though the Grameen Bank was formed initially as a non-profit organization dependent upon government subsidies, it later became a corporate entity and was renamed Grameen II in 2002. Yunus and Grameen Bank were awarded the Nobel Peace Prize in 2006 combinedly for their "efforts to create economic and social development from below".Principles
Economic principles
Microcredit organizations were initially created as alternatives to the "loan sharks" known to take advantage of clients. Indeed, many microlenders began as non-profit organizations and operated with government funds or private subsidies. By the 1980s, however, the "financial systems approach", influenced by neoliberalism and propagated by the Harvard Institute for International Development, became the dominant ideology among microcredit organizations. The neoliberal model of microcredit can also be referred to as the institutionist model, which promotes applying market solutions as a viable way to address social problems. The commercialization of microcredit officially began in 1984 with the formation of Unit Desa within the Bank Rakyat Indonesia. Unit Desa offered 'kupedes' microloans based on market interest rates.Yunus has sharply criticized the shift in microcredit organizations from the Grameen Bank model as a non-profit bank to for-profit institutions:
I never dreamed that one day microcredit would give rise to its own breed of loan sharks... There are always people eager to take advantage of the vulnerable. But credit programs that seek to profit from the suffering of the poor should not be described as "microcredit," and investors who own such programs should not be allowed to benefit from the trust and respect that microcredit banks have rightly earned.Many microcredit organizations now function as independent banks. This has led to their charging higher interest rates on loans and placing more emphasis on savings programs. Notably, Unit Desa has charged in excess of 20 percent on small business loans. The application of neoliberal economics to microcredit has generated much debate among scholars and development practitioners, with some claiming that microcredit bank directors, such as Muhammad Yunus, apply the practices of loan sharks for their personal enrichment. Indeed, the academic debate foreshadowed a Wall-street style scandal involving the Mexican microcredit organization Compartamos.
Even so, the numbers indicate that ethical microlending and investor profit can go hand-in-hand. In the 1990s a rural finance minister in Indonesia showed how Unit Desa could lower its rates by about 8% while still bringing attractive returns to investors.