Giving the Poor Some Credit

Microcredit for the poor is one of those ideas that attracts both liberals and conservatives. In principle, even the world's poorest people can acquire habits of savings and investment -- if they have access to capital. The strategy is both redistributive (liberal) and entrepreneurial (conservative). Why is it necessary? Conventional banking institutions usually write off the poor as potential creditors. On average, they are too risky as borrowers, and even credit-worthy individuals seem hardly worth the trouble because the loans are so small.

Though it was not the first microlending institution, the famed Grameen Bank of Bangladesh has become the most celebrated. It has been widely imitated, both in the Third World and as an entrepreneurial brand of anti-poverty policy in the United States. Started in 1976 as an experiment by a practical visionary named Muhammad Yunus, the Grameen ("village") system had some unusual traits for a lending institution: It required borrowers to fall below a certain income level, did not require collateral and forced clients to join five-member groups that met once a week and cross-guaranteed one another's loans; if one member defaulted, it damaged the entire group's access to credit.

Grameen, which became a full-fledged bank in 1983, also began with ambitious goals in the realm of social empowerment for its borrowers, 94 percent of whom are women. Group members were expected to abide by the bank's principles of discipline, unity, courage and hard work, as well as its "Sixteen Decisions," which included keeping families small, providing education for all children, practicing home improvement and helping out fellow group members in the event of difficulty. In a Muslim country with a patriarchal tradition, empowering women, as Grameen did, had social-change implications far beyond immediate entrepreneurship. Repayment rates until 1996 remained consistently above 95 percent. Replication programs in Malaysia, China and elsewhere followed essentially the same model with similar success rates, according to Mike Getubig of Grameen Foundation USA.

The global-development community has treated Grameen as something of a shrine. Today there are more than 7,000 microlending organizations providing loans to more than 25 million poor people throughout the world, the vast majority of them women. The number of these organizations grew astronomically during the 1990s, supercharged by the rhetoric of self-help and its faith in the creditworthiness and entrepreneurial potential of the world's poorest people. The movement took off with strong support both from the free-enterprise zealots of the right and the anti-poverty warriors of the left.

Donor agencies frustrated with negligible results in other sectors were drawn by the comparatively low costs of microcredit programs, which did not simply give away money but actually made a profit while carrying out their professed mission of poverty alleviation and women's empowerment. Grameen replications proliferated, as did other microcredit organizations in Latin America, Southeast Asia and, eventually, in the United States.

But three decades into the vast social experiment of lending to the poor, many questions remain. Does microcredit really help the world's poorest citizens? Does it genuinely empower women? How well has the Grameen model worked in other countries? Is microcredit a promising anti-poverty strategy in the United States? And should we expect it to be sustainable without subsidy?

Coming to America

Interestingly enough, microcredit came to the United States via Latin America as well as from Bangladesh. The private organization Acción began lending in Brazilian slums, or favelas, in 1973 and expanded across the continent. Acción began by lending to individuals, but eventually found three- to five-person "solidarity groups" more effective. Acción group members, unlike their Grameen counterparts (at least in the early days), all received their loans at the same time rather than waiting for others to repay first. Yet today 60 percent of Acción's loans are to individuals. In 1992, Acción helped found BancoSol in Bolivia, making loans available to the country's poorest citizens. Another group, the Foundation for International Community Assistance (FINCA), operates throughout the world and closely resembles Grameen, though its loans are for shorter periods and each group is self-managed and makes its own bylaws (rather than following a centralized model).

Bill Burrus, the CEO of Acción USA, formerly headed Acción's Latin American operations. Burrus says that in the land of Wal-Mart and ubiquitous credit-card offers, microloans are a harder sell. "We've had to do a lot more marketing and outreach [in the United States] than we had to do in Latin America," he says. Through a combination of walking blocks, engaging community groups, visiting child-care centers and getting referrals from banks that have turned down loan applications, Acción has built a modest network of some 4,000 active microloan clients. Still, it will never be on the same scale as in the developing world, where in many areas wage labor is nearly nonexistent and self-employment is the norm. "Here you're talking about a minority of the population," Burrus says. Group lending seems to work best when group members run similar businesses and face similar challenges. Unlike third-world marketplaces, where merchants and customers often see each other daily and haggle over prices, Americans are generally far less willing to tie their future credit options to the performance of a group.

One of the most successful community-lending institutions in the United States has been ShoreBank of Chicago. Started in 1973 in a depressed South Side neighborhood, the bank has long been doing what the 1977 Community Reinvestment Act (CRA) forced other banks to do: invest in poor inner-city communities. ShoreBank found its niche in the housing-rehabilitation market and now has subsidiaries throughout Chicago, as well as in Detroit and Cleveland. It primarily lends to blue-collar minorities who buy dilapidated properties, fix them up and rent them out. ShoreBank predated Grameen by several years. In fact, ShoreBank Chairman Ron Grzywinski was invited by Muhammad Yunus to help lay the groundwork for Grameen Bank in Bangladesh. Today, housing rehabilitation remains the primary focus, though Grzywinski notes that ShoreBank has also become the largest financier of Pakistani-owned Dunkin' Donuts shops in Chicago, as well as several churches and child-care centers. "If you can imagine it, we've financed it," he says.

Many banks currently fulfill their CRA obligations by lending to smaller microfinance institutions but do not themselves operate in poor communities. As ShoreBank's Mary Houghton explains, "The micro people have the dream -- or maybe it's a reality -- that the commercial banking system will be so attracted by the profitability and the business-development opportunities of microfinance that they will voluntarily do what CRA forced those banks to do." But many question whether a critical mass of mainstream banks will ever do so. FINCA founder John Hatch contends, "Commercial banks know how to lend to the rich and the middle class. They simply do not know how to lend to the poorest." As commercial banks become more adept at lending to the poor, microfinance institutions will reach into even poorer communities. Hatch adds, "I know for certain [banks] will never reach the poorest except if they work in partnership with microfinance institutions."

What the Critics Say

Some critics argue that microcredit in many cases ends up covering daily household expenses rather than funding the development of small businesses and, in some cases, wives' loans disappear into the hands of their husbands. Others contend that microcredit is merely a drop in the bucket, yet it has become a fad at the expense of other development projects. As a result, critics argue, funding is flowing primarily to lending institutions rather than in the form of direct aid to poor communities. In Bangladesh, group members have occasionally resorted to aggression in pressuring fellow villagers to make weekly payments, seizing their properties or removing roofs from their homes. Alex Counts, president of the Grameen Foundation USA, acknowledges that the group model was "a very good idea, but it had a dark side ... . It brought a lot of solidarity but also brought an enormous amount of tension. If someone fell behind, people got very tense and even got hostile with each other." Counts claims, however, that revisions to the original Grameen model have ironed out these glitches.

Mahasweta Banerjee, a University of Kansas social-welfare professor who began her career working with microcredit in a Calcutta slum, sees similar reticence among the former welfare recipients she worked with in Kansas City. "Group pressure works very well in rural settings where people know each other. This notion of a peer loan doesn't work in urban centers in the United States," she says. Banerjee managed a large grant from the state of Kansas from 1999 to 2001 that was designed to help former welfare recipients reach financial independence through self-employment. In the end, one-third of the program's women started businesses, but few took out loans. Rather, they used grant money, state-funded business training, and subsidized child care and transportation to jumpstart their businesses. (In the absence of this affordable child care, high day-care costs would likely put even the most successful single mother microentrepreneur out of business.) It is not surprising that one of the most successful microenterprises in the Kansas City program was a home day-care center where women could care for their own children while operating the business. Nevertheless, critics on the left have lambasted the importation of microcredit to the United States as tokenism. Gina Neff of the Left Business Observer wrote, "The notion that microlending could seriously reduce poverty in the United States is ludicrous ... home-based self-employment sounds frighteningly like a return to 19th-century-style piecework."

It's important to keep in mind that the Grameen Bank was committed to fairly drastic social change, not just lending. Studies have shown that microcredit provided to women in Bangladesh by Grameen and other institutions does have a positive impact on children's health and education. SUSAn Davis of the Grameen Foundation also attributes a rise in female voter participation to involvement in microcredit programs. In Bangladesh's 1996 election, 75 percent of eligible women voters voted, and thoUSAnds were elected to local offices. Acción's Robin Ratcliffe attests to similar signs of women's empowerment in Latin America based on their financial stability and independence, even though social empowerment is not an explicit part of the program.

Another concern is the risk of loading debt onto the very poor, unless it is combined with technical help and grant aid. Microcredit proponent Elizabeth Littlefield, director of the Consultative Group to Assist the Poorest (CGAP), which is housed at the World Bank, says, "Microcredit, which is, after all, debt, is not the most appropriate thing for all poor people. Some people are so poor they're not going to be able to generate income from the loan they take." Littlefield describes a situation in Afghanistan where aid agencies offered loans to poor poppy farmers whom they hoped would try to cultivate alternative products. "In those circumstances it may make much more sense to provide grants along with training that allows [recipients] to develop business skills," she adds. "Grants are an appropriate tool for those populations that are not able to use credit constructively." Littlefield hopes that microcredit gives way to a broader field of "microfinance," which would encompass a variety of other financial services that have long been inaccessible to the poor.

Today, CGAP is encouraging institutions to offer other essential financial services, namely savings, insurance and transfers from urban markets to rural villages. Lara Goldmark, a former Inter-American Development Bank official, agrees. "If you look at the poorest people, they want insulation from shock. They would die for insurance," she says. Another key focus is the issue of creating sustainable poverty-alleviation programs. For years a debate raged between the "poverty camp" and the "sustainability camp" over whether microfinance programs could provide services to the "poorest of the poor" and still become viable institutions themselves. Often this meant charging higher interest rates on tiny loans to the very poor, or abandoning them to make larger loans to less impoverished clients. CGAP officials were even dubbed "financial fascists" by Yunus and others put off by the excessive focus on sustainability.

Littlefield claims that today the tenor of this debate has softened somewhat, and she's adamant that "poverty alleviation and sustainability do not run counter to one another." She does insist, however, that microfinance institutions have for too long been "dependent on fickle and unpredictable donor funds," and that aid grants are "never going to be sufficient to reach the billions we're trying to reach with microfinance."

Toward a Sustainable Movement

At the same time, a relatively small amount of subsidy, for counseling and technical assistance, may be money well spent if the microcredit movement is to make a durable difference. "This additional cost of training, which serves as a human capital-development strategy, makes it unlikely that many programs will be able to cover all of their costs," the Association for Enterprise Opportunity's Zach Gast wrote in an e-mail. Acción USA's Burrus notes that his organization gets about half of its operating budget from interest income while the rest comes from foundations, banks and government. Given that the poor are more expensive borrowers (the loans are smaller, the counseling needs greater), it may be unrealistic to think that the movement can work over time without some subsidy.

Microfinance experts across the board are increasingly calling for a range of financial institutions that provide a variety of services to different populations. Littlefield maintains, "One institutional model is definitely not enough to do what we want to do: reach a billion people." Instead, some will target those just above the poverty line while others will focus on impoverished and remote rural villages. "We're talking about creating an entire financial system for the poor," Littlefield adds. Naturally the institutions serving the poorest clients and charging the lowest interest rates may take a much longer time to cover their costs, if ever.

It remains to be seen whether the microcredit movement can -- or should -- expect to operate at a profit. Yet some leaders believe that social entrepreneurship must become self-sustaining in order to survive. Bill Drayton, CEO, chairman and founder of Ashoka, which sponsors worldwide fellows to organize for economic and social change, laments that "financial institutions are beyond primitive." He adds, "The world of philanthropy doesn't even see this market." But Drayton believes that a more entrepreneurial generation of nongovernmental organizations could free institutions such as his from dependency on the funding whims of government agencies and foundations. The key, according to Drayton, is getting new players to enter what he sees as a "moribund market" and provide capital to bridge the gap between the "garage point" of social entrepreneurship and the break-even point. "Once that happens you've solved the financing problem for the whole array of citizen groups," he says. "The moment you solve the wealth problem to any significant degree, the power equation has changed."