Microfinance as a concept can be traced back to the 1800s, when the benefits of granting small loans to entrepreneurs were debated by legal theorist Lysander Spooner. Amidst the 1974 famine in Bangladesh, microfinance was popularised by Bangladeshi economist Professor Muhammad Yunus. It is a banking service which provides for low-income individuals who have been experiencing financial exclusion.
The straw that broke the camel’s back
As the rest of the world was discovering the allure of afros and madras shirts, a very young country was experiencing one of the deadliest famines in recent decades.
Bangladesh depends on the Brahmaputra River Delta for prosperity. A regular amount of flooding every year ensures that the land is fertile for the cultivation of staple crops such as rice, which accounts for 80% of Bangladesh’s agricultural output. However, when it doesn’t flood, the land becomes infertile and rice crops cannot grow; and if there are severe floods, the rice crops drown. The prosperity of the country therefore lays on this knife-edge. The heavy rainfall from April destroyed crops, leaving farmers and labourers without a source of income for that harvest. The rural population during this time accounted for 90% of Bangladesh’s population- the turmoil affected the overwhelming majority of the country. The spiralling inflation rendered the market too expensive for the poor and left them with no choice except for starvation. Bangladesh’s recent emancipation and its independence war meant that it could not ease the consequences because of its dire political and economical state.
The evidence of the famine was impossible to escape with thousands impacted the most harshly travelled from the rural south to the capital Dhaka.
You couldn’t be sure who was alive and who was dead. They all looked alike: men, women, children. You couldn’t guess their age. Old people looked like children, and children looked like old people.Professor Muhammad Yunus, Banker to the Poor
Muhammad Yunus was outraged by this injustice and by the fact that while he taught economic theory, nothing was being done for improving the problem of poverty in Bangladesh.
$27 – the price of freedom?
Yunus discovered the root of the problem in the village of Jobra, Chittagong. Labourers and non-landowners were stuck in a poverty trap, and were forced to take the exploitative interest rates and payback times of middlemen. Buying raw materials themselves was out of the question as banks, both public and private, demanded collateral on top of skyrocketing interest rates, which instead of providing salvation, crippled people (if they could afford it). The rates that middlemen offered also barely provided any relief as the meagre profit the customers received just covered survival, throwing them further into a debt trap. There was no financial structure to promote economic innovation and growth. A structural failing was the cause of the seemingly entrenched abject poverty in Bangladesh.
Microcredit now joins the scene. It is the most prevalent form of microfinance where borrowers- predominantly low-income individuals- receive small, repeated loans to allow them to become prosperous or to grow a small business. The reasoning behind this scheme is that these small loans will allow poorer individuals to gain entry into the market and result in business innovation. The aim is to allow individuals to make profit, excess that will allow them to reach greater heights in life. Many microfinance schemes follow the group borrowing model begun by Muhammad Yunus through Grameen (meaning ‘from the village) Bank.
The Grameen Bank model includes:
- Collateral-free loans
- Groups of 5-7 borrowers
- Relatively high interest rates (the amount charged for use of the loan as a proportion of the loan)
- Borrowers begin repayment after receiving loans
- Each repayment is only a small amount of the capital
The scheme began in Bangladesh in the village of Jobra, Chittagong on a very small scale. It birthed from a rejection of charity as a method of poverty alleviation and focuses on making financial institutions owned by the poor, for the poor, proactively working towards financial inclusion. Yunus lent $27 to a group of forty-two families, allowing families to repay Yunus whenever they were able to.
Grameen Bank sought to provide financial inclusion for the disenfranchised in society, those who were barred from entering the market. Women in Bangladesh have been continually excluded from the financial market, societal expectations holding them back from taking control. Therefore, Yunus targeted female borrowers and placed financial control in women’s hands. Combatting the entrenched gender inequality has resulted in the overall prosperity of the country: the literacy rate for young adults has risen to 73.9% in 2018 from a low of 32.4% in 1974 (Unesco) and the GDP growth rate also reached 5% in the last decade due to the microfinance sector and the garments industry.
Yunus writes in his book, Banker to the Poor, “All I had to do was lend her 5 takas.” The solution seemed so simple. It is the same dilemma experienced by passersby facing beggars and the viability of foreign aid. The microfinance scheme birthed from a ‘Helicopter money’, directly injecting cash to households, as coined by the American economist Milton Friedman. It has been suggested as an unconventional weapon against financial crises but it is not a sustainable method. Unregulated money injections into developing economies where corruption is rife, like Bangladesh, is a risk too great to take a chance on. Bias is present in financial institutions in Bangladesh, meaning that the money is unlikely to reach those who need it. Furthermore, this method of alleviating poverty results in a dependency on the debt rather than nurturing innovation.
My God, my God, all this misery in all these forty-two families all because of the lack of $27!Muhammad Yunus, Banker to the Poor
Accounting for these issues, Yunus popularised the microcredit scheme in the form of Grameen Bank which is a collateral and middleman-free bank that provides small-scale but increasing repeater loans. The model had its modest roots in a $27 loan from Yunus’ pocket given to forty-two families but has now evolved. It now consists of small loans given to a group of 15-20 people (women are prioritised) and the uses of the loan written in a group diary (passbook) which means that each member knows how much has been borrowed. This is a feature that increases transparency as information flows freely between the Grameen staff and borrowers. Borrowers also attend financial literacy lessons to enfranchise the poor. Grameen Bank states that 8-10 years on microcredit for the poor is needed from them to be pulled out of abject poverty.
The microfinance scheme aimed to:
- Target female empowerment and engagement in economic activity
- Provide financial literacy to the poor
- Alleviate poverty
- Promote the concept of savings and investments
- Promote human capital investment
Grameen Bank, within ten years of its establishment in 1983, has pulled a third of its clients from abject poverty, out of which 94% are women. In a country where the entrenched gender roles excluded women from financial activities and left them unable to find wage employment, this has made a significant impact in the path towards equality . For them, self-employment is their opportunity to take control of their finances.
One success story is that of Manjira. Although now a Grameen Bank board member, she was previously living in abject poverty. In a world of smart suits and briefcases, Grameen Bank displays a refreshing brand of leadership. Manjira, prior to being introduced to Grameen, was recovering from the death of her son for whom she could not afford a 1 taka ice cream. With the help of Grameen Bank, she is now a successful seamstress. The policy-making body is led in a democratic process in which the 8 million members can vote for candidates. On the board, Manjira is joined by three government representatives and eight other village women. The women know poverty intimately – this is the driving force of the bank, creating a bank that is owned by the people, for the people. This allows for policy implementation that truly helps the target population.
While business innovation is a goal for Grameen Bank, there is no solid quantitative data to support the fact that business innovation is fostered through this scheme but the few success stories in the media.
The microfinance scheme has meant that the poverty reduction rate among borrowers is 1.6 percentage points per year. Microcredit also has a positive effect on non-borrowers, whose poverty level went down by 0.3 percentage point a year. This is due to access to financial institutions, which has increased to 40% of the adult population and 75% of households in Bangladesh in 2016. This allows poorer individuals to take control of their financial future with greater ease, giving way for increased prosperity.
Can a leopard change its spots?
Regulation- or lack thereof, is a frontier at which the microfinance scheme faces problems. The work of Microfinance Institutions (MFIs) are overseen by the Microcredit Regulatory Authority (MRA), established in 2006. However, the extent of the MRA’s power is limited. Not only does it only have jurisdiction over NGO-MFIs (discounting the many private MFIs), but it is also run by a very ‘small human resource pool’ where only nine members of staff are in charge of onsite supervision while four members of staff are responsible for audit and offsite supervision, according to a study from the East Asian Journal of Business Management. Considering that the microfinance sector has 33 million clients in Bangladesh, there is a strong argument to be made that the regulation of the sector is grossly lacking and practically non-existent.
Corruption is intertwined in Bangladesh’s governance. In the 2017 Corruption Perception Index, Bangladesh finds itself 143rd out of 180 countries, where 0 is least corrupt and 180 is the most. The most recent report of corruption was in Faridpur, Bangladesh where the leaders of the local branch of Awami League, the ruling political party, await trial on charges of money-laundering as $340 million had passed through their accounts. Complaints about the leaders to the police had been ignored, revealing a culture of corruption in the leading governing bodies which has filtered into the general population.
A lack of regulation in the microfinance sector therefore leaves the sector open to corruption, as the government cannot be depended upon to weed out fraud which is rampant within the society. It is common for a portion of people’s incomes to be devoted to bribing public officials for school or job applications. A stronger independent authority must be put in place as, without it, the goal of poverty alleviation turns into a money-making scheme for the upper classes.
The geographical distribution of the MFIs is also a point of concern. MFIs in Bangladesh are largely concentrated in cities such as Dhaka and Chittagong where economic diversity is already high and places where natural disasters do not have an immediate and urgent impact.
MFIs in the south of Bangladesh, where natural disasters have the most impact, are very sparsely located. In these areas, with economic diversity low and abject poverty is high, the residents there are most in need of MFIs. Due to the difficulties the poorest members of society in Bangladesh face in accessing MFIs, competition is very low, meaning that these organisations can charge very high-interest rates without a loss of clients. A cap on interest rates is a viable option in this instance as competition is so low.
To be truly effective, MFIs must expand into areas where economic diversity is low – to their target population.
Debt Trap 2.0
The debt trap is a recurring character in this fight for poverty alleviation. It is a phenomenon where a debt becomes impossible to pay off, usually due to high interest rates. Borrowers in this situation fall into a state of constantly re-paying or rolling over debts.
A lack of regulation has led to clients in debt attempting to pay off loans from borrowing from other MFIs. While the microfinance scheme had solved the problem of collateral and middlemen, interest rates remained high. Private MFIs (who seek a profit) have been seen to charge interest rates between 20% and 50% – well and truly forcing people into the debt trap. In 2010, this level was capped at 27% by the MRA. However, the limited powers of the MRA raised the question of whether this cap is being enforced. Establishing the cap in more than 65,000 villages with a near-crippling human resource pool and a lack of contact with the target populace is a laughable aim.
A cap in the microfinance interest rate is certainly applicable in this situation, however, an urgent rehaul of regulation is required to make the cap effective.
Yunus and Grameen Bank have also faced a backlash from Sheikh Hasina, the Prime Minister of Bangladesh, who accused Yunus of treating Grameen as his personal property and claimed the group was ‘sucking blood from the poor’. The threat of government control certainly puts the scheme in a dilemma, as independence from the state has played a large role in its success. While microfinance certainly has its flaws, such as the fact that high interest rates have meant more people are prone to fall into a vicious cycle of debt, the pressure of the debt trap has been eased to a large extent relative to the level of abject poverty that was present before the establishment of the scheme.
A hopeful future
The microfinance scheme is one not without its flaws. In the words of Ama Muhith, the Bangladeshi finance minister, microcredit is no panacea for poverty. It has not, in its current form, proven to be a tool for business innovation but the poverty alleviation that the scheme has brought is a promising sign for its potential success. There are significant limitations on its impact: combatting culture, regulation, the debt trap/dependency but it can be considered as one of the tools to fight poverty. There is no singular ‘magic bullet’ to end poverty, but an amalgamation of schemes and programs is necessary to ‘put poverty in a museum.’
So you want to know more about microfinance?
(Book) Banker to the Poor: Micro-Lending and the Battle Against World Poverty – Prof. Muhammad Yunus
(Book) Poor Economics – Abhijit V. Banerjee and Esther Duflo
(Documentary) Natural Disaster | Bangladesh Famine | Bangladesh Floods | This Week | 1974 (Youtube)