Definition of Micro Credit:
Micro Credit (MC) is a socioeconomic tool to alleviate poverty by providing loan to the underprivileged peoples without any collateral to recognize their productive potentiality.
Factors that contributed to the emergence of Micro Credit as a tool to Poverty Alleviation:
Micro credit has created an immense contribution in socioeconomic development and indeed in the sector of poverty alleviation. There are numerous factors that facilitated to form a micro credit friendly environment leading to poverty alleviation in Bangladesh.
The key factors are given bellow:
· Failure of the growth oriented development strategies GODS: GODS is a top down and centralized planning policy of the state steers to industrialization and urbanization in Bangladesh. But it failed to generate adequate national income and to equally distribute the income among the mass people.
· Failure of the State and the Market to provide poor friendly loans: Both the market and state have failed to provide necessary financial support and also to reach the poor so that they may change their fortune. The financial institutions are still unsuccessful to provide user-friendly and poor friendly loan to the grassroots.
· Dependence on foreign aid ends to a conditional economic development and demobilizing own economic activities.
Basically the above grounds have created a firm base to emerge MC as a poverty alleviation tool.
c. Why Micro Credit in Bangladesh?
Sprit of the 1971 liberation war has given birth of MC in Bangladesh (Dr Hakim PKSF). The adverse situation of the combat, forced the elites & intellectuals towards the Villages and that helped them to apprehend the poverty condition of poor. The situation gradually generated the idea of MC as an apparatus to fight the poverty.
d. Major features that distinguishes the MC from other forms of credit?
1.Credit of trust and Mutual Understanding
Credit of collateral security.
2. Only for poor.
General banking, not poor friendly.
3. Small & Medium size interest free loan. (3000tk to 100000tk)
High amount loan and includes compound interest.
4. Informal proposal and Home banking.
Formal proposal with a lot of administrative hassles.
5. Successful repayment leads to further loan options.
Cares only repayment.
6. Investment consultancy is free with the product.
Only approves the project proposal and loan.
7. Direct and regular interaction with the beneficiaries for loan disbursement and repayment.
Only disburses the credit, the beneficiary is responsible to bring the repayment.
8. Loans are regularly monitored and supervised.
Records only the installments and maturity period.
9. Free social welfare service.
ATM, online banking and other promotional packages are provided to the consumers.
10. Creates small business entrepreneurs.
It mainly sponsors the big investments.
Role of Micro Credit in poverty alleviation:
· Micro credit is an economic weapon that has created a social revolution to attack the poverty. It is a unique mechanism to alleviate poverty from the third world countries. MC is also a proven tool for socioeconomic development in Bangladesh. Micro credit plays a great role by providing welcoming financial service to the poor to develop entrepreneurship among them. It is a friendship credit and also a handshake credit that made a financial service so easy to use by the less literate poor. Micro credit is a consumer oriented and consumer faced loan system that easily attracts, motivates and give confidence to the poor to shoulder the risk of a loan with a stress free mind. It has mobilized the grassroots women’s in individual and social development process by empowering them through friendly financial support. The bottom up approach of micro credit facilitates the loan scheme in such a manner so that it could gain the information’s about the beneficiaries quickly and adequately and provides assistance in effective planning. The aforesaid activities actually alleviating different dimensions of poverty like
Eliminating Agony and hopelessness from the life of the poor.
Reducing the lack of dignity.
Minimizing physical deprivation by providing health services.
Diminishing isolation by providing education to the poor.
a) Four broad categories of services that are provided to the poor.
Four categories of services that are provided to the poor are given below:
Financial Intermediation: – The provision of financial products and services, such as savings, credit, insurance, credit cards and payment systems. But in practice Bangladeshi MFIs provides small loans, savings services in general.
Social Intermediation: The societal process of forming the humans as social capital and also leading to economic capital for financial sustainability.
Enterprise development Services: Non-financial services package depending on the type of business of the micro entrepreneurs, includes professional training, market analysis, technology services, competence development and business analysis.
Social Services: Covering the human development stage through providing free education, sanitation, health, non-financial services to improve the standard of living and building consciousness about reproductive health.
b) Understanding of social intermediation and how it helps financial intermediation.
Process of building human and social capital for sustainable financial intermediation for the poor.
Successful financial intermediation is often accompanied by social intermediation. Social intermediation prepares marginalized groups or individuals to enter into solid business relationships with MFIs.
Evidence has shown that it is easier to establish sustainable financial intermediation systems with the poor in societies that encourage cooperative efforts through local clubs, temple associations, or work groups-in other words, societies with high levels of social capital.
Perhaps more than any other economic transaction, financial intermediation depends on social capital, because it depends on trust between the borrower and the lender. Where neither traditional systems nor modern institutions provide a basis for trust, financial intermediation systems are difficult to establish.
Social intermediation can thus be understood as the process of building the human and social capital required for sustainable financial intermediation with the poor.
Ultimately, it is the groups cohesiveness and self-management capacity that enables them to lower the costs of financial intermediation by reducing default through peer pressure- and consequently to lo9wer the transaction costs the MFIs incur in dealing with many small borrowers and savers (Bennett, Hunte, and Goldberg 1995).
c) Types of savings and Reasons to support the compulsory savings:
Two types of savings:-
- Compulsory savings.
- Voluntary savings.
Logical support to compulsory savings and various reasons behind:
- It creates a favorable practice of MC beneficiaries to generate their own resource. It builds an asset base of the poor.
- It also safeguards the interest of the MC service providers for assuring their repayments from the beneficiaries. It serves as an additional guarantee mechanism to ensure the repayment of loans. The savings minimizes the defaulter case through balancing the installments from the savings accounts. Compulsory savings is basically works as compensating balances.
- Compulsory savings are useful because it exhibits the importance of savings practices to the beneficiary.
- It develops financial management capability among the clients in managing regular cash flow and to make periodic contributions.
Principles of financially viable lending to poor:
MC is poor friendly and popular because of its financial capability in lending. Financial viability of lending demands some philosophy and principles to follow.
The principles of financially viable lending to the poor are given below:-
Offer services that fit the preferences of poor entrepreneurs.
These services might include:
Short loan terms: compatible with enterprise outlay and income patterns. ACCION International programs typically lend for three-month terms, and Grameen Bank for one year.
Repeat loans: Full repayment of one loan brings access to another. Repeat lending allows credit to support financial management as a process rather than as an isolated event.
Relatively unrestricted uses While most programs select customers with active enterprises, they recognize that clients may need to use funds for a mixture of household or enterprise purposes.
Very small loans, appropriate for meeting the day-to-day financial requirements of business. Average loan sizes at Badan kredit Kecamatan in Indonesia and Grameen are well under $100, while most ACCION and Bank Rakyat Indonesia activities feature average loans in the $200 to $800 range.
Consumer-friendly approach: Locate outlets close to entrepreneurs, use extremely simple applications, and limit the time between application and disbursement to a few days. Develop a public image of being approachable by poor people.
Streamline operations to reduce unit costs.
Develop highly streamlined operations, minimizing staff time per loan.
Standardize the lending process. Make applications very simple and approve on the basis of easily verifiable criteria, such as the existence of a going enterprise. Decentralize loan approval. Maintain inexpensive offices-Badan Kredit Kecamatan operates its village posts once a week from rooms in local government buildings, paying little or no overhead while reaching deep into rural areas. Select staff from local communities, including people with lower levels or education than staff in formal banking institutions.
Motivate clients to repay loans.
Substitute for pre-loan project analysis and formal collateral by assuming that clients will be able to repay. Concentrate on providing motivation to repay. These motivations might include:
Joint- liability of the groups. An arrangement whereby a handful of borrowers guarantee each other’s loans is by far the most frequently used repayment motivation. This technique is employed by Grameen and in a slightly different form by ACCION affiliates. It has proved effective in many different countries and settings worldwide. Individual character lending can be effective when the social structure is cohesive, as has been demonstrated throughout Indonesia’s array of credit programs.
Incentives: Incentives such as guaranteeing access to loans motivate repayment, as do increases in loan sizes and preferential pricing in exchange for prompt repayment. Institutions that successfully motivate repayments develop staff competence and a public image that signals that they are serious about loan collection.
Charge full-cost interest rates and fees based on objectivity condition.
The small loan sizes necessary to serve the poor may result in costs per loan requiring interest rates that are significantly higher that commercial bank rates. Poor entrepreneurs have shown willingness and an ability to pay such rates for services with attributes that fit their needs.
a) Preferring group lending instead of individual lending:
Reasons to support group lending:
1. Economies of Scale: Group lending assures minimal increment in operating costs.
2. Economies of scope: increases capacity by delivering multi dimensional services through the similar group method.
3. Alleviation of information irregularity related to potential borrowers and savers through the group’s knowledge of individual members.
4. Reduction of moral hazard risks due to group monitoring and peer pressure.
5. Joint liability as individual collateral.
6. Improved easy loan collection through screening and selecting peer pressure, and joint liability, especially if group penalties and incentives are incorporated in the loan terms.
7. Superior quality investment mobilization, especially if incentives are incorporated in a group scheme.
8. Lower administrative costs to orient the group with the MC mechanism.
9. Develops sprit de corps among the group members that motivates in their individual development.
10. Unity gives moral strength to every member of the group.
b) If you prefer group lending, how will you make it effective?
Guidelines for effective use of groups:
· Building small and homogeneous. Grouping from the same community.
· Imposing group penalties and incentives (such as no access to further loans while an individual is in default) to improve loan performance and to avoid default case.
· Fixing limited loan sizes.
· Staggered disbursements to group members can be based on the repayment performance of other members.