Microcredit

As noted in email I've received and in comments, I have been negligent in not yet acknowledging this year's Nobel prize winner, Bangladeshi economist Muhammad Yunus, for his work on microcredit through the Grameen Bank. Here are some passages from a New Times article followed by a commentary by Hal Varian explaining the economics underlying microcredit arrangements (thanks anne):

Peace Prize to Pioneer of Loans to Poor No Bank Would Touch, by Celia W. Dugger, NY Times: A Bangladeshi economist, Muhammad Yunus, and the bank he founded 30 years ago won the Nobel Peace Prize yesterday for pioneering work in giving tiny loans to millions of poor people no commercial bank would touch — destitute widows and abandoned wives, landless laborers and rickshaw drivers, sweepers and beggars.

The Nobel Committee praised Mr. Yunus, 66, and the Grameen Bank for making microcredit ... a practical solution to combating rural poverty in Bangladesh and inspiring similar schemes across the developing world.

“Microcredit has proved to be an important liberating force in societies where women in particular have to struggle against repressive social and economic conditions,” the committee said in announcing the prize.

Mr. Yunus has long been an influential champion of the idea that even the most impoverished people have the drive and creativity to build small businesses with loans as small as $12, and Grameen Bank has dedicated itself to helping the poorest of the poor.

The borrowers used the money to buy milk-giving cows, or bamboo to craft stools, or yarn to weave into stoles, or incense to sell in stalls, among myriad other money-making schemes.

Reached in Dhaka, Bangladesh, by telephone yesterday, Mr. Yunus recalled the day in 1976 when he reached into his own pocket to give his first loan, $27, to 42 villagers living near Chittagong University where he said he was then teaching “elegant theories of economics.” The borrowers invested the money and repaid him in full, though they had no collateral and signed nothing.

He said he asked himself that day, “If you can make so many people so happy with such a small amount of money, why shouldn’t you do more of it?”

Still, over the years, Mr. Yunus faced skeptics and detractors, as it became clear that microcredit loans, alluring as they were, were not by themselves a panacea for poverty. ...

But in interviews yesterday, Mr. Yunus’s skeptics and fans alike credited him and Grameen with helping to fundamentally change the way the world saw the potential of poor people and to popularize the movement to provide financial services to the poor. ...

Or, as the Nobel committee put it: “Yunus’s long-term vision is to eliminate poverty in the world. That vision cannot be realized by means of microcredit alone. But Muhammad Yunus and Grameen Bank have shown that, in the continuing effort to achieve it, microcredit must play a major part.” ...

Indeed, in the decades since Mr. Yunus’s first loan, microcredit has become one of the most popular antipoverty strategies in the world. Last year, more than 100 million people received small loans from more than 3,100 institutions in 130 countries, according to Microcredit Summit, a Washington-based nonprofit advocacy group that Mr. Yunus helped found. The average loan from Grameen Bank was $130.

Over the years, the movement to provide financial services to the poor has become more capacious, stressing the need for services beyond loans — for safe places to save small amounts of money, for crop and life insurance, for inexpensive ways to transfer money earned in distant cities and foreign countries to families back home. ...

In 1974, Mr. Yunus, trained as an economist at Vanderbilt University, found himself teaching economics at Chittagong University when Bangladesh was struck by famine. “I decided I must do something,” he said. He began working in nearby villages, among them Jobra, where he made his first loan in 1976.

He said he tried to persuade commercial banks to give loans to poor people who had no assets and had always been dependent on local moneylenders. But the bankers only did so when he personally co-signed as a guarantor.

Mr. Yunus’s new model of banking for the poor had several unusual features, Professor Morduch said. Grameen lent to groups of five people, who helped ensure that each member repaid his or her share. It lent not only to farmers, but also to laborers and women who had a knack for crafts and shopkeeping. And it required borrowers to repay their loans in manageable, bite-sized weekly installments.

“He proved the impossible: that the poor were bankable,” Professor Morduch said.

But Mr. Yunus’s approach went beyond giving the poor economic opportunity to seeking deeper social change, said Amartya Sen, who, like Mr. Yunus, is a Bengali, an economist and a Nobel prize winner.

Mr. Sen, a professor at Harvard, noted that Grameen’s loans had gone overwhelmingly to women, giving financial clout to women who had little power in Bangladeshi society and often lived cloistered in their homes.

In the overwhelmingly Muslim nation of Bangladesh, Mr. Yunus’s approach also offered hope and ideas to compete with the allure of fundamentalist Islamic causes.

“It’s a very secular movement,” Professor Sen said, “very egalitarian, market friendly and socially radical.” ...

Here's Hal Varian. This was written in 2001 so it was written before the prize was awarded:

In a model for lending in developing nations, a Bangladesh bank relies on peer pressure for collateral, by Hal R. Varian, Commentary, New York Times: The village moneylender in Bangladesh charges interest rates of over 150 percent a year. Citibank would love to get that kind of return on its investments -- so why isn't Citibank lending money in Bangladesh villages?

This is a serious question, in terms of both policy and profit. The painfully high interest rates charged by moneylenders in developing countries suggest that marginal investment opportunities there are much more profitable than in advanced industrial nations.

So why isn't there a rush of investment from Western banks to exploit these profitable opportunities -- and, as a byproduct, increase the pace of economic development in these countries?

There are several barriers to entry in the lending business in developing countries, many of which have to do with the information advantages that incumbent moneylenders have over potential entrants.

To begin, the local moneylender is intimately familiar with his clientele, and this gives him a huge information advantage over a bank officer in selecting reliable loan recipients. At the same time, the moneylender is in a very good position to monitor borrowers since he can check up on their activities daily.

Local moneylenders are also familiar with village customs and practices and can offer useful business advice; they are also in a good position to provide informal insurance to the loan recipients, too, since they know when a nonperforming loan is caused by outside causes, like bad weather, and when laziness is the cause.

Finally, moneylenders operate at a much smaller scale than Citibank does. Most of these loans are minuscule by Western standards, and Citibank just is not set up to handle tiny investments, even if they are potentially very profitable.

These factors -- selection costs, monitoring costs, local experience, insurance and inappropriate scale -- conspire to create a virtual monopoly for the moneylender. Even moneylenders from neighboring villages might find it hard to compete with someone who has an intimate knowledge of a particular village's inhabitants. The result is tens of thousands of tiny monopolies and many profitable projects that are never undertaken because of the high cost of borrowing.

But there is hope. About 25 years ago Muhammad Yunus, a Bangladeshi economist trained in the United States, developed a lending model that managed to overcome these kinds of barriers. His business model for microcredit has been immensely successful, spawning imitators the world over.

Most of these lenders are nonprofits, but they are self-supporting nonprofits, which do not require subsidies or loan guarantees. There are even a few for-profit enterprises experimenting with the Yunus microcredit model.

Mr. Yunus put his plan into effect through an institution he called the Grameen Bank.

The critical feature of the program is that a candidate for a loan must form a group with four other people who are not family members. Two members of the group originally receive a loan, and if they do well, the others then receive loans.

The borrowers are encouraged to assist each other, and all loan disbursements and repayments are made publicly, in front of other groups. Loans are always for one year, at a fixed interest rate of 20 percent, and they are always for modest amounts: no more than a few hundred dollars.

The borrowers use the loans to buy looms, chickens, cows and make other small capital investments. They start repaying the loan two weeks after getting it, and once they have repaid the initial loan, they are allowed to apply for new ones.

How does this business model solve the information problems described above? First, take the selection problem. The Grameen design provides strong incentive for good borrowers to join together, since they don't want to risk losing a loan because of one failure or troublemaker. The fact that they cannot join with other family members removes one sort of pressure to dilute group quality.

Second, the members of the group have an incentive to monitor one another's activities actively. They can provide advice, assistance, education and, if necessary, insurance. The group members themselves are in the best position to know whether a recipient is slacking off or has just had a run of bad luck, and they have great incentives to monitor their behavior in an honest and helpful way.

Third, all of this selection, monitoring, educating and insuring is done not by high-paid professionals, but by Bangladeshi peasants. The transactions costs of using groups are far, far lower than are the transactions costs for traditional bank loans.

There are other interesting economic angles. Over 90 percent of the borrowers are women. This isn't so much an ideological choice as a pragmatic one -- women turned out to be better credit risks. They were more tightly tied to the home and had fewer outside temptations, so they focused much more intently than did male borrowers on completing their projects.

All this seems to work. The bank says it has a repayment rate of 99 percent, and over 92 percent of the bank's shares are owned by the borrowers. Peer pressure can be an immensely strong force, and the Grameen Bank has figured out how to make it work in the cause of economic development.

Experiments elsewhere haven't been uniformly successful. In some countries, the poverty stricken do not have enough group solidarity to provide the necessary discipline. In more urban settings, it may be difficult to find appropriate small-scale investments. But there are numerous successful operations inspired by the Grameen bank.

One program, Project Enterprise, runs a Grameen-type program for minority entrepreneurs in New York.

To answer the question posed in the first paragraph: Citibank and other Western banks are well aware of the Grameen model. In 1999 the Citigroup Foundation donated $1 million to the program.

Citibank, along with others, is currently experimenting with microlending in India and other developing countries. Multinational banks may yet find ways to break the moneylenders' monopolies and finance microinvestment in poor countries.

Access to capital is critical for economic development. Grameen and its many offspring, both nonprofit and for-profit, offer an exciting model for alleviating poverty.

Comments

[tom s.]

Reading some of the comment the last day or two, I am struck by how the Grameen model is both praised and criticized from left and right. I think this is because it is neither market-based (in that it is not motivated by profit and feels more like a social movement) nor state-based (and it does rely on promoting small businesses to some extent), and so stands to some extent apart from the usual axis of left/right economic thinking.

As a lefty, I'd like to claim the idea for our side, but I'm not entirely sure I can. In this way, the Grameen idea reminds my of Jane Jacobs, who is also claimed and criticized by both sides.

There has been some debate also over whether this is an appropriate choice for a peace prize. I have no opinion on this, but it seems like a great idea, a fine movement, and it's great to see it recognized.

[Winslow R.]

"Citibank, along with others, is currently experimenting with microlending in India and other developing countries. Multinational banks may yet find ways to break the moneylenders' monopolies and finance microinvestment in poor countries."

Thanks Anne!

My posts over the last few weeks have been aimed at this very issue. Phelps has also started in this direction. Why not more debate on the very foundations of the money creation system? I have to wonder if economists have a clue about how skewed our present system is towards entrenched interests. Have they ever tried to get a loan for anything beside buying a house or a credit card? Ever talked to a venture capitalist? Every been to a check cashing store?

The current financial system does not work for entrepreneurs in the U.S. or Bangladesh.

A national currency is a "national treasure" not to be controlled by 20 primary dealers but by the people who fight, die and vote. The very idea the Fed should be 'independent' is incredible bizarre idea in a representative democracy. Independent from what? The will of the people?

Yes, 'those people' can get carried away sometimes but despite what we are taught, it is usually for very good reason.

Why do we need banks involved in student loans, home loans, or any loan for that matter. Everyone should be born with a credit score that is theirs to grow or destroy. Credit production should be based on their ability to keep their word. I'd much rather allow 10,000 honest folks to create $100,000 each rather than allowing Neil Bush to create $1 billion at Silverado Savings.

Why should a bush determine whether I get access to money?

This is my bus.

[RWB]

How well does Grameen work? While I wouldn't expect one bank to make a big difference, Bangladesh is still very poor and its per capita real GDP has not grown very rapidly since 1980. How well do the borrowers do compared to people who do not get loans? Is their standard of living imroved (on average)?

I assume the answers are yes. Certainly microcredit is an attractive idea, and the innovations in replacements for collateral are important. But does it work in a practical sense?

Their credit system reminds me of the way some immigrants pool their funds to pay for new businesses. A group of immigrants create a pool, and when one of them wants to start a business, he can with the approval of all the other guys in the pool. He has to pay it back, but he doesn't have to have collateral. It's the pressure of the social network that keeps the borrower honest and hard-working. And when that borrower pays back the investment, another guy in the pool can start a business.

[evagrius]

Why is CitiBank wandering around in Bangladesh when there are plenty of opportunities in the U.S. for 'micro-lending"? How about those people in the 'hoods? I'm not talkin' bout the dealers but the mommas and poppas who want to open a little biznes makin' clothes or hair cuttin' or lamps or a plumbin' store or carpentry- you know, the regular stuff, the regular everyday businesses that people used to have- until Wal-Mart etc; or "urban re-delopment" drove out those businesses.
Winslow R is absolutely correct-

I would really like to see some economists explore this issue.

As for tom s's remarks- I agree- it's time to get away from the old time-worn dichotomy of left-right division of attitudes and interpretation regarding economics, ( and for that matter-politics).

[gordon]

evagrius might consider the "lunch factor" as an explanation. The "mommas and poppas" aren't going to finalise the deal over lunch (paid for by the borrower or an expense account) at a fashionable restaurant. There is no cachet attached to mixing with them. There are no kickbacks.

[Richard]

An interesting notion . . . but note that the largest effects on evolution are extra-biological.

Radiation is a likely engine of genetic difference. Meteorites with complex carbon molecules might well have formed the core for the beginning of evolution.

More importantly, the periodic, once-every-hundred-million-years-or-so asteroid has a way of wiping the slate clean, eradicating 95% of life and starting anew.

[anne]

I understand and am completely sympathetic, Winslow.

[Alan]

Regarding whether Yunus's work is appropriate for a peace prize, note that he had already won at least one other peace prize. In 1994 he received the Pfeffer Peace Prize, awarded by the Fellowship of Reconciliation.

[turquoise]

Insofar as poverty and unemployment cause violence, it is entirely appropriate to give Nobel Peace Prize to Dr. Yunus and the Grameen Bank Movement. I think it is one of the most appropriate Nobel Peace Prizes ever given. American agricultural scientist Norman Borlaug also received a Nobel Peace Prize for his role in green revolution. That was appropriate too.

The world needs to realize that abject poverty in Asia, Africa, Latin America and other places, not only presents a moral dilemma for the privileged people in the West, it is also a potential threat to world peace. Mexicans will come to the US if conditions worsen in Mexico; poor Turks will go to Europe and stir social tensions.

The world of less than $1 a day is a very violent world. Every hour about 1000 children die from malnutrition or related issues. If you see the children die unnecessarily, you will know it is violence - even if you don’t see B-52s or suicide bombers nearby.

[Ken Liffiton @ Grameen Foundation]

Thanks for the post and discussion. This is a great honor for Muhammad Yunus and Grameen Bank, and excellent news for microfinance and our work at Grameen Foundation to bring Grameen Bank style microfinance programs to the poorest of the poor around the world. To address a couple of questions raised:

Are there microfinance programs in the United States? Yes, but not many. We support microfinance programs in New York and Dallas. "Micro" loans are of course much larger in the US than in developing countries, and the programs include business training and peer group support.

Does microfinance work? While it isn't a panacea, microfinance is an important part of the solution to world poverty. Please have a look at a detailed review of the research so far, bringing together over 100 evaluations of the question.

I hope this helps.

[Winslow R.]

I just want to add the most apparent limitation to microfinance is 'lack of funds'.

Microfinanciers can only create as many loans as they have funds. To get additional funds they must go to Citibank (who has access to the Fed spigot) and borrow additional funds. Good luck getting Citibank to loan on anything but 'hard' assets (because of Fed regulation). There needs to be a mechanism where potential 'labor' has easier access to funds.

Though disparged by many, Fannie Mae and Freddie Mac have done wonders, in my opinion. These GSE's have allowed many entreprenuers to turn their houses into cash generating machines allowing them to bypass the 'loan shark' venture capitalists (see Utube payoff if you don't believe).

These GSE's cannot address all needs as not every potential entreprenuer owns a home.

[anne]

Winslow, agreed and thinking along your lines.

[Devang]

I've been thinking along Winslow's lines too, and there is need for a sort of Fannie Mae and Freddie Mac for farmers. Rural farmers in India (or any developing/rural country) don't have reliable incomes, need to make substantial investments in equipment to effectively compete with large-scale farmers. With subsidies bound to become scarce as time goes on, sustainable farming is in need of a revolution. Microcrediting may work for poultry farming, but not too well for ordinary crops.

I say that because a good part of the world population still small scale farmers and creating jobs in other parts of the economy for those farmers hasn't been fast enough in countries like India. If small scale farming is to continue in countries like India there will have to be a government-backed Freddie Mac willing to provide just the right amount of debt-liquidity, so to speak. Not too much so everybody starts planting high-risk crops and not too little either.

Farmers are turning to GM seeds to take out some of the risks, but there are externalities there too. The astute leftist will say technological farming requires more water and causes over-grazing. There is no holy grail here, and small-scale farming has been written off even by some politicians in India who are helping entrepreneurs get land only to use it for what they inevitably see as more productive causes and large-scale farming. Maybe some sort of micro-credit/subsidized low-interest longer-term loans for co-ops could still save small-scale farming... and to do so, without adding bureaucracy to government is to have a Fannie Mae or Freddie Mac for farmers in developing countries, most of which still have loan-shark monopolies which need to be broken by introducing competition and not outright banning (which is what the Indian government did and made things worse).

[Lafayette]

Winslow R.: "But does it work in a practical sense?"

Put yourself in the shoes of a black African woman who has inherited her mother's job as a fishmonger in a small seaside village where the fishermen sell her thier daily catch. But, there is a lot of competition because this sort of retail has always been done by the village women.

She realizes that by going from her seaside village to another village inland, that she can sell in a market with less competition and at higher prices. But, in order to do so, she needs a bicycle because the trip would be otherwise too long and the fish would lose thier freshness. So, she takes on a microcredit financing.

This idea works well and eventually she pays off her credit. So, she asks for another with the intent of buying yet another bike for her daughter to take the fish to another village.

Then, prospering by having her two daughters selling fish at remote villages, she takes out yet another credit, and buys a dugout canoe for her son to employ as a fisherman. Once the micrcredit is paid, she will have higher profit margins on her sales.

She has assimilated thusly the supply chain from production to distribution to retail.

Get the idea? Do you think "it works in a practical sense"? Yes, it does.

[wm]

Subject: Dr. Akhter Hameed Khan - Pioneer of microcredit/microfinance scheme

Dr. Khan introduced the revolutionary idea of microcredit, thereby opening a new door for billions of destitute and underprivileged. As head of the Pakistan Academy for Rural Development (now Bangladesh Academy for Rural Development, BARD) in Comilla, Bangladesh, Dr. Akhter Hameed Khan pioneered microcredit through a farmers/village cooperatives program. Hence, the first microcredit poverty alleviation project was started at this academy.

Sources:

• "The Works of Akhter Hameed Khan" Vol: I-III. Publisher: Bangladesh Academy for Rural Development.

• "Rural Development in Action : A Comprehensive Experiment at Comilla East
Pakistan “by Arthur F Raper. Publisher: Cornell University Press

• Website on Dr. Khan:
http://www.akhtar-hameed-khan.8m.com

says...

Dr. Akhtar Hameed Khan Khan pioneered microcredit(microfinance)through the Comilla Cooperative Pilot Project in 1960. Various articles are written on Comilla model (Started at Pakitan (now Bangladesh) Academy for Rural Development)

[fsosa@ashoka.org]

Hello to all the people who support Muhamad Yunus. You have an opportunity to learn more about his ideas and help at the same time. Ashoka: Inovators for the Public (www.ashoka.org), recently developed a group of films about Social Entrepreneurship, and Yunus is one of the speakers.

Ashoka - just launched an ambitious subtitling project with dotSUB (www.dotsub.com/nobel), a new site that lets you translate films line by line. The plan: volunteers translate one video on Muhammad Yunus and one on Ashoka founder Bill Drayton into 100 languages in time for the Nobel ceremony on December 10th. Go on, translate a few lines (www.dotsub.com/nobel) and learn more about what these Social Entrepreneurs have done. You will be giving people all around the world the opportunity to enjoy and learn from these videos...

[article]

Article: "Dr. Akhter Hameed Khan - The Pioneer of Microcredit". by Nasim Yousaf

Article is available on the web site dedicated to Dr. Khan:
http://www.akhtar-hameed-khan.8m.com