Is Micro-credit a Development Tool?
By Fernand Vincent
Translate
by Anne Renaudin
History
In the
past, but also today in certain parts of the world, micro-credit is often
linked to usury. In the South as in the
North, merchants who granted loans to those who can’t make ends meet were the
first to lend small amounts of money to villagers who couldn’t afford medicine
or schooling for their children.
Regardless of very high interest rates, often disguised as in-kind
reimbursements at the time of pay-back, usurers were successful and thrived
amongst the population they lived with and knew well. It was important for the lender to be close to the borrowers and
integrated within their cultural environment as this helped him mitigate his
risks.
Over time,
these lenders were challenged because of the astronomical interest rates they
charged. Churches and priests then took
it upon themselves to organize local micro-credit facilities. They were
followed by the Caisse Raiffeisen credit unions in Germany and then all over
Europe, as well as the Caisses Desjardins in Canada and similar initiatives in
other countries.
The first
objective of these facilities was to bring together the populations’ savings
and the parish priest was often the treasurer and guarantor for the security of
funds. The money saved in these local
banks was often used for consumer goods.
Only later, as the global savings of these institutions became larger,
did they become banks promoting economical activity and local business. Today, the European Caisses Raiffeisen and
the Canadian Caisses Desjardins are important banks competing with the large
commercial banks.
In the
South, missionaries also started credit facilities using the credit union
models described above, sharing risk amongst the people of the same village or
neighborhood.
The term
“micro-credit”, however, became well-known following the launching of Grameen
Banks in Bangladesh. Tired of seeing
banks refuse credit to finance women’s small business projects, Professor Yunus
lent them his own money in small amounts which was quickly reimbursed
100%. The Grameen Bank was born from
this experience and today it lends money to millions of poor men and women who
are able to reimburse their loans without any problem. The Grameen model is based on the same
principles as the Caisses Raffeisen or Desjardins: credit and savings facilities for small groups, mainly women, who
know each other and meet weekly and who accept the responsibility of a peer lending
guarantee to cover the potential risk of one the members not being able to
reimburse the loan. Saving and lending
within the same environment, not letting the money go to the capital,
self-management based on the understanding of each member’s personal situation,
solidarity at times of hardship, these are the recognized values of this
system.
The Grameen
Banks as well as similar credit unions in other countries grew from 1980 to
1995 and became recognized as full-fledged banks by governments and
international organizations.
Recently,
all these micro-credit organizations met in Washington for the first
Micro-credit Summit, at the initiative of Professor Yunus. This “high-mass” enabled thousands of people
from the South, the East and the North, involved in the development of their
country, to become aware of the importance of their action and to decide to use
micro-credit in their efforts to eradicate world poverty.
The summit
heads prepared an exemplary communication campaign. Their lobbying enabled the general directors of large international
organizations, the directors of various commercial banks, the multilateral and
bilateral cooperation agencies to commit to the financing and development of
micro-credit as a “miracle tool” to fight poverty. The term micro-credit then became a fashionable term in the
language of development.
We must now
question the contents and effectiveness of micro-credit. Is it really a solution in the context of
development and if so, what are its terms?
Micro-credit has now been taken over by international organizations and
since it generates income, tomorrow it will attract the large banks. Isn’t this a danger for the poor? We know that micro-credit has a positive
effect on social development but can it be a generator of business and if so,
at what conditions? In short, a
detailed study is required to question the causes of success and failure and to
establish the limits of past experience.
What
does “Micro-credit” mean exactly?
There is no
consensus amongst professionals to define micro-credit.
Some who
are influenced by the Washington Summit heads consider that any credit larger
than US$100 can no longer be called a micro-credit. The initial credit facilities of Grameen Bank and other
organizations lending to women for small business or micro-projects belong to
this category.
More
numerous are the organizations lending amounts in local currency from US$100 to
US$5,000 sometimes up to US$10,000 or more and they consider these loans as
being micro-credit.
The
beneficiaries of micro-credit are usually women who need funds to start their
trade (selling food, cigarettes, drinks, etc.), to buy a cow or to pay their
children’s schooling.
Micro-credit
is therefore closely linked to the activity performed by the informal sector
workers. It is local and close to the
people. Only sometimes is it used for
savings, mostly in Africa.
Various
types of organizations managing micro-credit
For the
past 10 years, the number of micro-credit managers has grown based on
demand. They can be categorized as
follows:
a) Local credit unions and tontines
Tontines
represent the traditional and most efficient version of savings and small loan
mechanisms. As is the case with local
banks and credit unions, they are not linked to large organizations or banks. They work independently for a group of
villages or an urban neighborhood. They
hold their members’ savings and set their own interest rates regardless of
local market rules. They are informal. Members lend each other the money that has
been saved in their environment. They
rarely appeal to the financial market and receive no outside support. Their role and their function are
essential. They are the perfect
response to local needs – the reimbursement rate is excellent as people know
each other and the process is self-managed, thereby generating very little
risk.
b) National and international credit unions
In order to
respond to local needs, many credit unions have organized themselves to obtain
higher credit than the possibilities created by their savings and also to invest
their available savings. They have
constituted some powerful unions and federations like APRACA (Asia-Pacific
Rural and Agricultural Credit Association), AFRACA (African Rural and
Agricultural Credit Association) or even COOCEC and COOPEC credit banks. At a national level in West Africa,
institutions such as Nyesigiso and Kafo Jiginew in Mali, ACEP in Senegal and
FECECAM in Benin bring together tens of thousands of members, savers or
borrowers who are the effective and inevitable partners of credit attribution
to peasants or to craftsmen of the informal urban sector.
These
unions and federations therefore represent millions of members mostly
originating from the peasant, civil-servant small trade environments. They are well set in their environment and
organized as unions in the Raiffeisen way to cover their risks. They invest in training their managers and
their members. They are well managed. The interest rates used on savings or loans
to peasants, sales or business women vary depending on each situation. Very often these rates are lower than market
rates. Because of the training expenses
incurred, these institutions have trouble self-financing themselves and they
must frequently rely on outside support.
c) Foundations and NGOs – micro-credit managers
Since about
20 years, many foundations and NGOs have been created to manage micro-credit in
Latin America, Africa and Asia. These
organizations work as intermediaries between the “financer” (cooperation
agencies, Northern NGOs, banks, etc.) and the credit applicants, be they
individual or organized in small professional groups.
International
aid has decreased its non-return donations to development projects and these
donations are rather converted into loans or fund loans in Southern NGOs. This has in turn facilitated, particularly
in Latin America, the creation of organizations such as “Fundacion del
Desarollo” which manage credit facilities offered to producers or merchants of
the informal sector of large cities. A
few examples are IDESI in Peru, FIE in Bolivia, SOINTRAL in Chile, APEM in
Madagascar, Rural Finance Facility, Get Ahead Foundation and Start UP Fund in
South Africa, Proshika, BRAC-Credit in Bangladesh, etc.
These
foundations and NGOs played and still play today an essential role in the
development of micro-credit. Millions
of small producers or merchants depend on their action. These organizations have become more
professional and now offer high quality market intermediation services.
These
foundations and NGOs are close to their beneficiaries and willing to help them
progress. As such, they are vital in
the successful operation of micro-credit in the South as well as today in
Eastern Europe and in some areas of European and Northern American cities.
Of course,
as we will see further, their cost is high, as is the cost of managing and
supporting micro-credit. Hence, if
these organizations want to become self-financed and no longer receive aid from
the North, they will have to bill their services at cost resulting in
substantial increases in interest rates that often include these support costs.
d) Micro-credit Banks
Based on
the experience of Grameen Bank in Bangladesh, micro-credit foundations and NGOs
set up their own bank a few years ago.
In the past these organizations’ financing was often limited by national
administrative rules. Faced with
growing credit requests from small producers, merchants from the informal
sector as well as small and middle-sized start-up or developing businesses,
these organizations promoted financial tools which progressed with government
approval and the recognition of the central banks to become formal financial
institutions or banks specialized in the area of micro-credit financing.
Several of
them manage micro-credit portfolios in excess of US$ 10 million, such as
Bancosol in Bolivia, ProEmpresa in Peru, Carjeival Foundation in Colombia,
Syndicate Banks in India, Proshika and Grameen Bank in Bangladesh, BRI Bank in
Indonesia, K-REP in Kenya, Rural Credit Facility in South Africa, etc.
Hence, micro-credit
professionals now have the necessary financial tools and banks to attract and
manage the savings of local populations and of clients to whom they lend in
order to take advantage of the credit lines granted by international
development banks or bilateral cooperation agencies. This is an enormous progress.
Micro-credit
– the main questions
A. Is micro-credit a tool for economic development?
Does
micro-credit produce economic growth by enabling the creation of businesses and
therefore partially solving employment problems? The answer is not that simple.
Two studies carried out in Asia have delivered an initial interesting
answer:
-
Loans under US$ 100, usually made to women,
rarely (less than 3%) permit the creation of small trade
or new jobs. These loans
help improve the social situation of the recipients who are able to satisfy
vital
needs such as healthcare, food,
housing, schooling, etc., but few of them are able to cross over the
poverty threshold.
These loans must continue to be developed, however, as they have an
essential role
in social improvement.
-
Loans
between US$ 100 and US$ 1,000 result in the same but they also contribute to
the creation of jobs and small trade (7 to 12% depending on the country and the
case).
-
Loans
above US$ 5,000 are the ones which trigger a growth process by enabling
investments in new production units, increases in productivity and an opening
towards new markets.
Another
interesting example of micro-credit management is represented by the activities
of IDESI/PRO EMPRESA in Peru. Having
recently created its own financial institution, this support organization
manages over 50,000 micro-credit files in urban and rural sectors and has
become a very effective economic development tool for the country.
IDESI/PRO EMPRESA has divided the market into
3 areas:
IDESI/PRO
EMPRESA distinguishes its loans as follows:
a micro-loan granted for the “growth” of its recipients, a small loan
granted for “market” purposes (small business) and the other loans granted for “development” (medium-sized and large
companies). The choice of a target-beneficiary is therefore quite important
when launching a program. To reach the
poorest, one must consider loans of US$ 20-300 for sometimes little or no
return. To create jobs and
significantly increase income, the loan recipients are different and the loans
are greater. If an NGO wants to consider
clients in various categories, it will have to separate the management of each
program and use different methods for each case.
B. What interest rate should be applied?
There are
various schools of thought.
The
question therefore has a very clear answer – we can continue to help the poor
by granting loans without interest but we can’t continue to “play Mother
Teresa” without acknowledging that these programs can’t last without outside
aid.
If we want
these programs to be financially independent they will have to bill their
financing and training support costs to their beneficiaries. It is no longer just a question of
poverty. More importantly it is a
question of training so that the beneficiaries can not only reimburse the
interest but also develop the profitability of their economic activity.
However,
are the local beneficiaries (from the villages or suburbs) the ones to be
burdened with this expense?
Micro-credit management is very expensive. International aid could concentrate its efforts on subsidizing
these intermediary costs (training, risk coverage, negotiation facilitation,
management costs of loan guarantees with local commercial banks, etc.) which
need to be accounted for separately rather than included within credit
management costs.
C. What are the risks?
Most
micro-credit management organizations report reimbursement results varying from
95 to 100%. What does this mean? Is there no or little risk in granting
micro-credit facilities?
The answer
is not simple. Often for strategic
reasons, these organizations do not count certain costs or some
non-reimbursements. Also, exogenous
conditions can also considerably increase risk. In Bangladesh recently, floods destroyed goods that women had
bought with the help of loans from Grameen Bank. These women could not reimburse their loans. Furthermore, according to the Peru-Canada
fund, the non-reimbursement risk has reached 20% for the small borrowers who
suffered from El Nino. This results in
the need for a complete program restructuring.
A reality study has demonstrated that the risk is higher than announced
and that it is closely linked to the quality of the support and loan
tracking. This in turn generates high
tracking costs. Does the success of
micro-credit activities therefore depend on these costs being subsidized so
that they are not included in the profitability calculations of loan management
operations?
On the
other hand, risks are also linked to the competency of micro-credit management
organizations. Non-specialized NGOs
have too often made loans which were not reimbursed. No sound tracking, arguable accounting and good feelings resulted
in wreckage. These organizations did a
lot of harm. They confused donations
and loans. “You don’t lend to someone
who can’t reimburse, otherwise you kill him…” is now a saying in Sahel.
It is true,
however, that risks vary depending on the category of borrowers, whether they
are groups functioning under a peer lending guarantee system or whether they
belong to small trade or agriculture. “Women reimburse better than men”. This is true - if they are organized, their
reimbursement rate is close to 100%. It
is also true, as demonstrated by Christine Guéneau, that certain service or
production areas are less risk-prone because they are more profitable than
others.
D. How do you obtain credit from local commercial banks?
If
micro-credit and small loans are to have a larger impact and better respond to
expressed requirements, the final goal is to gradually build professional
relationships between these new categories of clients and local commercial
banks. This will mobilize local funds,
ensure the financial durability of these systems and will break the dependency
perpetuated by international aid. Of
course, this will require learning and mutual understanding. It will take time. Interesting experiences are already proving that we are on our
way to success.
How do you
obtain credit from local commercial banks?
The first
well-known method we have already mentioned is the peer lending guarantee used
systematically by the Grameen, Raiffeisen or Desjardins models. A group of villagers or producers from an
area where people know each other becomes the guarantor of the reimbursement on
behalf of all the other members. This
system often works but is not infallible.
Quite often, banks do not count on the peer lending guarantee
system: too much work and therefore too
expensive to recover small amounts!
Risk
coverage by mortgaging goods (except for modern buildings) doesn’t work well
either and is also very expensive. The
backyards of micro-credit NGOs are full of wrecked cars, tools, equipment and
all sorts of confiscated goods they are unable to resell.
What about a bank guarantee?
It’s one of
the best ways to obtain a loan from a commercial bank. These guarantees are usually covered by the
salaries of family members or friends.
They can be local or international.
Several
foundations such as RAFAD in Geneva,
ACCION in the United States or FUNDES in Latin America, have set up very
efficient bank guarantees. The
principle is simple: constitute a strong currency fund, invest in an
international bank that will grant a guarantee to a local bank that will, in
turn, grant loans to small local borrowers (as groups or individuals) because
its risk is partially or totally covered.
Local NGOs are often the intermediaries of such operations.
Based on a
comparative study of the impact of such funds, the following lessons have been
learned:
Certainly,
a guarantee is not THE risk coverage solution but it is one of the most
efficient. Over a period of 12 years,
the experience of the RAFAD Foundation has resulted in the following conclusions:
-
the
average annual loss of such a Fund is in the order of 5%
-
the
multiplying factor is 3.5, which means that local banks have granted loans of
US$ 350,000 based on a guarantee of US$ 100,000
-
the
interest charged by banks was at market rate less 1 to 3% depending on the
case, since risks were partially covered by the guarantee
-
the
borrowers reimbursed their loans in local rather than foreign currency
-
after
6 years of positive experiences, local banks consider these partners as clients
and no longer require a guarantee.
Conclusions
Since the
Washington Summit, micro-credit has become the fashion or even the new gadget
of International Aid. Some see it as
the solution to the repeated failure in cooperation between the North and the
South. In a special issue of the Monde
Diplomatique dedicated to micro-credit, Mr. Motchane explained that the private
sector, following the U.N., has reclaimed micro-credit as a new tool to prove
their interest in “eradicating poverty”.
It’s time
to state things clearly. Micro-credit
has existed for a long time -- it was not invented in 1998. Both success and failure line the road of
projects financed by micro-credit.
Let’s look at the past in order to learn the lessons for the
future. Credit is one of the financing
techniques for development. As stated
previously, it can “kill” the enterprise it is trying to help if it is granted
without the proper scrutiny regarding reimbursement, or if it falls into the
vicious circle of indebtedness or bankruptcy.
In
addition, what is the global impact of current efforts versus actual need? In Latin America, for example, over a
million persons have taken advantage of micro-credit for a total of US$ 8
million. This, however, only represents one tenth of actual demand and one 1%
of granted commercial credit (as per Francisco Dumie, Director of COPEME in
Peru, during the recent Latin-American conference on microfinance). These facts force our humility but also
encourage us to continue our efforts in particular to strengthen the links with
local banks and financial institutions.
We believe
that well-utilized credit is an effective development tool when used with the
right target groups.
Professionalism,
knowledge of the environment, adapting resources to local conditions in order
to respond to the true needs – these are the keys to success.
Micro-credit
is a weapon against poverty but it is expensive and must be subsidized. Small and medium-sized credit must be
further developed as it is the only way to fight the causes of poverty by
creating employment and facilitating growth.
NB This paper was written in French in 2001 and transleted in English in 2004. fv