Module 4: Microlending

A Case Study: The Grameen Bank

The Grameen Bank, started in 1983 by Muhammed Yunus, is a bank specializing in microlending. Microlending is defined as the provision of small monetary loans to the poor who generally do not have access to these sorts of services. In South Africa alone, 15.3 million adults do not have bank accounts in regulated financial institutions.(1) This lack leads many to turn to loan sharks for money. Grameen Bank was founded to provide an alternative.

Grameen Bank works by giving out small loans to small groups of five individuals of the rural poor. Each of these groups of five functions as a unit that is responsible for repaying the initial loan. For repayment, neither collateral nor contracts are required; instead, Grameen bank relies on social capital—such as peer pressure, mutual support, and a culture of repayment—to pressure recipients to repay. Furthermore, no further credit is extended to groups in which a member has defaulted on a loan. The combination of these various pressures has yielded repayment rates of an astonishingly high 98 %, although a fifth of loans are overdue past the two-year window Grameen sets.(2)

A unique aspect of the Grameen Bank system is that approximately 95 % of its cilents are women.(3) Women comprise over 70 % of the world’s poor and are more likely to devote earnings to their families.(4) They are also more efficient managers of scarce resources.(5) Furthermore, the social pressure used as incentive for loan repayment is stronger among women than men.

Another aspect of Grameen is its encouragement of a set of values called the Sixteen Decisions, which are a set of values designed to improve social habits. Some of these habits include encouraging education for their children and improving sanitation practices, as well as some simple business tips. 

Grameen Bank has proven to be a widespread success, and now serves over seven million borrowers. In Bangladesh, over 93 % of villages have access to Grameen Bank services.(6) Grameen also claims that greater than 50 % of borrowers in Bangladesh have used Grameen loans to rise out of acute poverty, which is a total of 50 million people.(7)

Criticisms of Grameen Bank and Microlending

Despite the widespread success of microlending at the individual level, a number of concerns have been raised about the system. A problem with microlending is that its focus on funding enterprise is narrow when compared to the wide spectrum of needs for the poor. Not unlike the North American experience, credit is often needed for general consumer finance, not simply for starting businesses.(8) These needs include health shocks, school fees, food, as well as communal or religious activities. A recent South African study found that many would use their “business” loans for personal needs, although the lines dividing productive and consumption debt is often blurry. For instance, purchasing a school uniform for a child might be labeled as a purely consumer purchase, but could also increase school participation, leading to greater level of education and a higher-paying job.(9)

Microlending also only incompletely addresses needs for the entrepreneur, as the borrower is also burdened by regulation and a lack of management and marketing skills in addition to a lack of credit. (10) Furthermore, Grameen Bank, like all microlending institutes, uses a much higher interest rate than traditional banks—approximately 20 % annually.(11) The high interest has been suggested to keep borrowers in a debt trap and sap household savings. 

As a result of the solidarity lending practice, good burrowers can get stuck in groups of poor borrowers, and their ability to draw credit can suffer as a result. Another problem is that within a group, ambitions can diverge and become problematic.(12) These groups are also only composed of the poor, but incorporating more socio-economic diversity within the group would mean that their incomes are less likely to vary with each other, and so they can insure each other. One drawback of this approach is that this type of group would be even more likely see their financial ambitions diverge.(13)

There are also concerns about the sustainability of the microlending system itself. Microlending works well on a small scale, but is usually not as influential at a system-wide scale. One of the reasons for this is that small businesses created through microlending often are not sustained over time.(14) Despite this defect, reliable financial access can have positive social and economic impacts.(15) Other alternatives, such as franchising, have been proposed to work better under the same conditions. For a detailed discussion on franchising in the developing world, follow this link.  

Despite the concerns about microlending and its inability to scale businesses, there are some prominent exceptions. One of these examples is the planned town of Kaputei in Kenya.

Larger-Scale Success of Microfinancing: Jamii Bora Trust

In Kenya, the Jamii Bora Trust and the nonprofit Unitus have worked together to design a town called Kaputei, located a few kilometers outside the capital Nairobi. Kaputei is completely built with microlending, and is designed to attract people from slum areas of Nairobi.(15)

In the Nairobi slums, individuals earn less than US1$ a day and lack electricity, water, and sanitation. Kaputei is designed to have electrical power, running water, and flush toilets. Furthermore, the houses are relatively spacious and allow for many to have their own room for the first time, improving their quality of life.(16)

These houses are designed to be low-cost and are sold to families at approximately one-tenth of the normal price of a house, approximately US$1,875.(17) Moreover, Jamii Bora provides small loans with a reasonable 8.5 to 10 % annual interest, paid over a 10 to 15 year term. The cost of the mortgage added to the cost of interest amounts to US$32 monthly, which is comparable to the price of living in a Nairobi slum house.(18),(19)

An on-site construction facility builds the homes and also employs families to produce bricks and tiles used in construction. The money the villagers earn during construction helps to pay off their loans. Lumber will also form part of the local industry.(20) Having begun to house families in 2009, Kaputei will eventually be home to over 2,000 family units. Bringing thousands of these individuals out of the slums also has a social benefit by reducing the likelihood of them entering crime or early motherhood.(21)

Kaputei is also intriguing because it has a strong emphasis on energy independence, which is a significant reason why the fruits of microlending have translated to a large scale. Kaputei is Africa’s first completely ecologically-friendly town. Solar energy helps to power the town, while the ultraviolet light in sunlight is applied to produce clean water.(22) These approaches are cost effective and protect the villagers from price fluctuations of nonrenewable energy sources. 

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Footnotes

(1) Collins, D.L. and Morduch, J. “Banking Low-Income Populations: Perspectives from South Africa.” Access, Assets and Poverty Conference. Barr, M. and Blank, R. (Eds.) 2007. Georgetown University, Washington, DC. p. 1-31. Accessed June 28, 2010.

(2) Parl, D. and Philips, M.M. “Grameen Bank , Which Pioneered Loans For the Poor, Has Hit a Repayment Snag.” 27 Nov 2001. The Wall Street Journal Online. Accessed July 1, 2010.

(3) Yunus, M. and Negus, G. (Interviewer). “World in Focus: Interview with Prof. Muhammad Yunus.” Australian Broadcasting Corporation. 1997. Accessed June 25, 2010.

(4) Gray, A. “Small Premiums, Long Term Benefits: Why Poor Women Need Microinsurance.” NextBillion. 2010. Accessed July 7, 2010.

(5) Yunus, M. and Negus, G., 1997.

(6) Ibid.

(7) Fraser, I. “Microfinance Comes of Age.” 4 Sep 2007. Scottish Banker Magazine. Accessed July 1, 2010.

(8) Ibid.

(9) Collins, D.L. and Morduch, J. “Banking Low-Income Populations: Perspectives from South Africa.” Access, Assets and Poverty Conference. Barr, M. and Blank, R. (Eds.) 2007. Georgetown University, Washington, DC. p. 1-31. Accessed June 28, 2010.

(10) Fraser, I., 2007. 

(11) Fernando, N.A. “Understanding and Dealing with High Interest Rates on Microcredit.” Asian Development Bank. 2006. Accessed July 1, 2010.

(12) De Aghinon, B.A. and Morduch, J. The Economics of Microfinance. p.114. 2005. Cambridge, MA: MIT Press.

(13) Ibid., p. 108.

(14) Collins, D.L. and Morduch, J. “Banking Low-Income Populations: Perspectives from South Africa.” Access, Assets and Poverty Conference. Barr, M. and Blank, R. (Eds.) 2007. Georgetown University, Washington, DC. p. 1-31. Accessed June 28, 2010.

(15) Ibid.

(16) Majtenyi, C. “Microloands Building Eco-Friendly Town in Kenya.” Voice of America News. [video clip]. 2009. Accessed June 25, 2010.

(17) Wahome, P. “Unitus and Jamii Bora on CNBC Africa.” CNBC Africa. [video clip]. 2009. Accessed June 25, 2010.

(18) Jamii Bora. “Housing.” Jamii Bora. 2006. Accessed July 6, 2010.

(19) Ibid.

(20) Wahome, P., 2009.

(21) Jamii Bora, 2006.

(22) Wahome, P., 2009.

(23) Ibid.