Micro credit is a term you may or may not be familiar with. Micro credit is a development strategy formulated by a man named Muhammed Yunus; it is a concept perceived to be so impactful and empowering that Yunus and the Grameen Bank won the Nobel peace prize in 2006 for their efforts at implementing the approach in 2006. To explain this fully, I invite you to consider a developing country context, specifically a small rural community where each individual has minimal disposable incomes, let alone assets to their name. If one such individual wants to take out a loan, whether for starting a business or for consumption purposes, they have two options (so far).
- Approach a formal lender. (These will be institutions such as banks)
- Approach an informal lender. (This could be someone in the village, an individual with money etc)
Formal institutions will always be preferable for the borrower- whilst interest rates are high they are a lot lower than informal alternatives.
So what is the problem?
Some of you may have gone through the process of getting a bank loan such as a mortgage. Often some form of collateral is needed so that if you fail to make the loan repayments, the bank can collect this collateral in lieu of the payment. In the above context of a developing country and a poor rural community, it is very unlikely that the borrower will have any acceptable collateral to promise to the bank in case they miss the repayments. Because they don’t have this, the borrower has nothing to lose - if they can’t make the repayment nothing can be taken from them. There is an incentive to choose riskier projects or try and cheat. The lender will be aware of this and, without any collateral, will refuse the loan.
So option 1 is not an option for the poor borrower. That leaves option 2. This is an undesirable option as interest rates are so high on any loan given. This is to account for all the risk (because the borrower has no collateral) that the informal lender is accepting.
So both options are unattractive or unavailable to the poor borrower. This is where microcredit comes in. The premise of microcredit is to provide some middle ground option using social collateral and peer monitoring.
Microcredit grants small loans to groups of people rather than individuals. The loans are staggered at first, to demonstrate the reliability of the group. Once this is established more loans will become available. So how can the lender afford to give lower interest rates when these are still risky borrowers? Two concepts are important to understand here.
Social Collateral-when monetary punishments are not an option, as is the case with a poor borrower, it can be more effective to take advantage of close knit communities and social sanctions that they can impose on people who do not pay back their loans. Social sanctions would include the awareness that an individual and their family are not to be trusted, making it unlikely that other members of the community will lend to this person again or work with them. This reintroduces the incentive to pay back the loan- you don’t want to be seen as untrustworthy and blocked out of business in your community. This is used in the Grameen Banks use of microcredit by making borrowers repay their loans publicly in the centre of the community so that their payment or lack thereof is witnessed and appropriate action may be taken.
Peer monitoring- this can be seen in the allocation of microcredit loans to groups rather than individual. If one group member fails to make a payment, the whole group is no longer eligible for loans. This means that other group members success and reputation is based upon each members reliability. There will be pressure placed upon each other to make the payments and if the group cares about each other, they will not want to let the group down. Furthermore, this helps microcredit institutions cut down on screening costs. You don’t have to check each person is reliable because each member of the group wants to make sure the group they are with when asking for the loan is reliable and hard working- they will only select good people for the borrowing group.
This means that microcredit can afford to offer lower interest rates and provide loans to poor people otherwise blocked from getting credit because the risks are severely reduced. Indeed in 2000 only 2% of loans were defaulted at the Grameen Bank, the first big implementor of microcredit, compared to default rates of 60-70% in informal rural credit markets. (Default= not able to pay back the loan)
From an economics perspective, this is a tremendous success, allowing people in developing countries increased opportunity to start businesses and improve their economic status (especially for women who are the principal recipients of microcredit loans) and actually providing the incentives needed for these borrowers to make the repayments without high costs of enforcement (chasing borrowers for their payment etc)
So what is the political perspective on this strategy?
First let’s consider the structural critique
“Encouraging the poor to participate in their own survival strategies by accumulating personal debt and creating small businesses displaces any sense that poverty may be structural or that the state has any responsibility for collective welfare”
This understanding considers the broader problem of the inequalities and poverty that has put these rural workers in this position of poverty in the first place. If you accept that this is the result of political structures, with poor social safety nets and a system that rewards the pursuit of profit at the expense of other people it may seem laughable to put the responsibility back onto the very people who are the victims of such a system and celebrating the fact that they need to work hard just to survive also may seem uncomfortable. This is especially pertinent because whilst yes, the interest rates are lower than other options, they are still high (30%!) and people are still putting themselves into debt.
Next let’s consider the disconnect between theory and reality
Despite theoretically appearing sound and assertions abound of the opportunities for business start ups and entrepreneurship, this may grossly underestimate the poverty that exists in targeted communities, and ignore the results. 94% of microcredit loans in South Africa are used for consumption- that is just to get by; to get food, water and basic necessities. This means that actually, these people are not making a return on their loans, placing themselves into debt for pure survival and not on a business idea to make a return. Even more misleading, when groups do use the loans for business start ups, there is a real deficit in consumer demand. Remember, these communities are poor, many can barely afford food let alone extra bits their neighbour is now trying to sell.
Jason Hickel describes this as a "socially acceptable mechanism for extracting wealth and resources from poor people".
A final point I would add here is related to the values microcredit depends upon; needing social collateral that potentially will lead to a generation of exclusion seems like a punishment for being poor rather than a punishment for not making a payment. This is particularly emphasised when microloans are being taken out for consumption.
Maybe theory doesn't always work the way it should