In the world of lending, microcredit is a relatively new concept. However, it’s becoming much more popular in the world as a means of helping out those who are in low-income situations or less-developed countries. This term refers to giving extremely small loans or lines of credit to someone so that they can start or grow a small business.
The modern practice of microlending originated in Bangladesh, a developing nation where these small loans are making a huge impact on the local economy. Most of the schemes using this type of lending rely on a group model that originally came from the Grameen Bank and noted Nobel Prize winner Muhammad Yunus.
This concept was built on the idea that people who live outside of the traditional world of banking and money could now gain entry into the economy with the assistance of these small loans. The individuals being given this credit are often living in barter systems or other communities where currency is never actually exchanged, making it more difficult for new businesses to get started or to continue to grow.
How Microcredit Works
Microcredit is built on the principle that while one person may not be able to get a loan on their own, they can pool their efforts together and borrow as a group to get the money they need to grow their business. This original model started with the $27 loan given to a group of women who wanted to start a small business. Today, these micro credit lines and loans range from $10 to $100, with them rarely being more than $1,000-$2,000.
Unlike a traditional loan that requires collateral, there are very few terms on microcredit loans and financing. In some cases, it’s just a verbal agreement and a handshake. In other situations, there might be a piece of paper signed that has the terms of the loan, including interest rates. It all depends on the people involved but there are no hard-and-fast rules for lending within this unique industry so it may differ from one situation to another.
With microcredit, like other lending products, people can use their repayment of each successive loan to prove that they are capable of handling larger and larger loan amounts. For those unable to establish formal credit or get funding another way, this is a great way to build rapport and finance a growing business in a developing community or nation.
Someone might use microcredit for things like:
- Starting or expanding a business
- Savings to help families pay fees and improve their living situation
- Insurance that can offset the cost of medical expenses
- Money transfers and funds to help families send money across borders
There are plenty of ways that people are using microfinance, with millions of borrowers who have used these funds to date and about 140 million borrowers that use these loans every single year.
Terms Vary and Are Flexible
Unlike a lot of loans and lending products, the terms of microcredit are quite flexible and have an impressive amount of room for negotiation. Every lender or company that offers this financing will have their own terms and conditions, as well as their own interest rates and fees. Some will be more flexible than others, while there are those that will have more rigid terms or higher repayment costs for those who choose them.
The important thing is to investigate the options and then weigh the pros and cons of the loan so that you can figure out whether it’s going to be right for you. Some lenders will require that you set some money aside in a savings account, for example, which helps offer insurance if you default on a loan. There are other ways that these lenders might seek out collateral, as well.
The way that many lenders reduce their risk is to pool borrowers for the sake of these small loans. Because everyone’s effort is involved in the success, it helps create a positive form of peer pressure that ensures that people pay their loans in a timely fashion. Interestingly enough, even though these loans are catered to those in poor areas, they often have much higher interest rates and repayment rates than standard loans.
Because these funds come from the pockets of investors, and not a traditional bank in many cases, the terms and rules of the lending are always going to be a little different. The industry is working to create standardized rules and regulations, but that will take some time and there will likely always be those investors who are just waiting to get a little more from someone because they are seeking out a lending alternative like this. That’s not always the case, but it’s important to watch for.
Can Anyone Start a Microcredit Program?
Microcredit is something unique and it can be used by just about everyone. Anyone can decide to lend small amounts of money to people in low-income or less developed situations, but there’s more to it than that. In order to actually be a microcredit lender, there are business licenses to apply for and paperwork that needs filled out so that you are properly recognized as a lender.
Some programs exist that offer crowdfunding for microcredit loans and other microcredit networks where lenders and borrowers can connect. This is a great way to get involved without having to start a whole business out of it or to try to figure it all out on your own. Microcredit loans typically are used to fund developing operations and businesses, so they’re helpful to the economy of any nation or state that they are used in. Thanks to modern business theory, these small loans are making a big impact on the world around us and there’s plenty of ways that you can get involved.
Can Anyone Get Microcredit Funding?
Technically, this type of funding is like any other lending product—anyone can apply for credit and attempt to get the assistance that they need. Bear in mind, though, that these loans are generally reserved for low-income communities or less-developed nations and regions where the regular financing options aren’t available. If you’re in a situation where a $50 loan could make or break your business, this financing could be for you.
Remember, microcredit is a small loan—much more like someone spotting you some cash than an actual loan. In fact, most loans will never be more than $500, with very rare instances of loans going as high as $1,000-$2,000. Thus, in a developed nation or modernized area, that money isn’t going to go very far.
So, even though microcredit is available to just about anyone, it might not be the right type of lending for your situation. That’s why it pays to be prepared and know what you are getting into.
This type of funding is available to just about anyone who needs it, but again they are focused typically on developing places or areas where people don’t have the income and means to start a business on their own or fuel the business that they’ve already started. Theoretically, anyone who needs it could apply for a microcredit loan—they’re not just being used in third-world countries—but of course, then you have to weigh the pros and cons and make sure that it’s the right type of financing for you.
The Pros and Cons of Microcredit
While there is a lot of information to consume about these minute loans, it really stacks up fairly well. These loans, while small, are changing the economy in several places and they have plenty of perks to consider. Here’s what you need to keep in mind.
The benefits of microcredit are really the focus here. While you might not think that someone could do much with $50 or $100, that kind of money has been known to change people’s lives in some areas. This kind of funding is totally unconventional, but that’s part of what makes it so effective. In fact, there are several different types of banks, private investors, and lenders that are now getting involved in the world of microcredit. It offers perks like:
- The ability to grow a business without access to capital or other funds
- The chance to get out of a debt cycle caused by limited options
- The opportunity to fuel the local economy and help their nation develop
- The chance to get funds when other loans might not be approved
- An alternative to traditional lending for places where currency and finance are not as relevant or developed
- A chance to create financial inclusion for all
- Empowerment to create self-reliance and economic sustainability
- Creation of jobs and economic stimulation in areas where it is hard to find
Of course, the list of pros can go on for days because this relatively simple lending model is changing the world for several people. What previously was not even thought of as a meaningful effort is now one of the biggest lending operations in the world.
The diversification and expansion of these programs is another big benefit—as time goes on, this industry is evolving to create more solutions for people who need them. It’s a great option for those who may be excluded from traditional banking and lending, and it could change the way that the rural poor, and especially communities with a lot of women, are able to promote self-sufficiency and help their own countries develop.
By far, the biggest disadvantage to microcredit is that the program doesn’t always work like it should. If it isn’t introduced correctly, for example, some of the funds may just be spent on consumption rather than actually being used to start or fund a business or assist with employment. This is something that can’t really be regulated, so lenders often find themselves just hoping that the funds get allocated correctly.
The other issue is the debt that is created. Even with microloans of just a few dollars here and there, they can quickly add up over time when people don’t have a steady source of income to help them repay their debts. This has resulted in some people selling off their own assets or trying to find other loans to cover their existing microcredit debt. Like any loan, you shouldn’t commit to this type of funding if you can’t afford to repay the debt.
From the Beginning
Microfinance has existed for thousands of years, even though it hasn’t been aptly named as such. It has been used in Asia for centuries, and often has been a way that struggling cultures help themselves and their people get on their feet. However, the modern form of this lending was not made popular until the 1970s, as mentioned in the beginning, when Dr. Muhammad Yunus entered the picture.
A professor of economics, Yunus couldn’t understand how the abstract theories of economics were unable to explain why there were so many starving, poor people in Bangladesh (and other countries like it). Through his research, he noticed that the people in the villages didn’t have the tools or the means to buy the materials that they needed. He found a group of women who constructed bamboo stools and sold them.
Because these women couldn’t afford their own materials, they ended up caught in a debt cycle with local traders. These traders would give them the money for materials or the materials themselves, and then allow the women to sell the stools for a slightly higher price to recoup their loans. This was creating a lot of stress and financial uncertainty for the group of women, and creating a debt trap that the traders were banking on.
Yunus realized that these 42 women didn’t need a huge business loan—the money of the entire group of women amounted to $27. He pulled that money out of his own pocket and lent it to the women with no interest, helping them break the debt cycle once and for all.
Thus, the modern world of microfinance and microcredit was born, and now people in developing nations and regions have a way to fund their existing operations or start a new business to help support their own local culture. Known as the Grameen Bank project, or “Village Bank”, the lending project now can be found in more than 80,000 villages around the world. There are over 6 million borrowers and the Nobel Prize was awarded for this effort in 2006.
Innovations to Now
As the microfinance world started to expand, there were a number of new lenders around the world that started with grants and public funds that would allow them to help these people who needed money. Companies were able to demonstrate that those who were excessively poor could still be relied upon to repay their loans when they are given affordable options, and created a viable business out of the microcredit world.
Over time, these efforts began to grow and change, with companies realizing they would need to find a new way to fund their business operations. Grants were fine for awhile, but they weren’t able to fuel the system the way that it needed. Through the 90s, business practices continued to be improved, and by the early 2000s, this industry had been fed nearly $15 billion to help fuel the development of villages and nations where just a few dollars could make a big difference.
Experiments and innovations are the topic of today, with things like mobile technology changing the way that people do business and handle their lending needs. Mobile phones are being used to send and receive money these days, which opens up a whole new world of opportunity for microcredit lenders. The available loan products today have diversified significantly and the original model has become much more complex and adapted to various local realities. There are even products like micro savings and micro-insurance that people are no seeking out in addition to these small loans to help them rebuild their financial situation.
The Bottom Line
Microfinance and microcredit are not something that work for every single borrower. In fact, they’re a unique lending product market that is designed specifically for developing areas and those who are outside of the world of traditional banking and lending. In that way, it’s helping the global economy and changing the world for many developing villages and nations around the world. This kind of financing is not new, but the way that it is being used to revolutionize poorer areas is definitely an evolution.
There are millions of people who have benefited from these loans over the years and the industry is changing the way that the world develops. For those who are outside of the traditional financial system, even something like a predatory loan or loan shark might not be a viable option—and it shouldn’t have to be. With things like microcredit, every nation has a chance to do something with its economy. The world of lending is changing every single day. From the modern-day loan shark to microcredit lenders, there’s a lot to look out for. It starts by educating yourself so that you can make informed decisions when it comes to your finances.