Definition: Microcredit can be defined as a lending system which allows a meagre sum as a loan to the low-income section of the society for supporting self-employment and other income-generating activities. This underprivileged segment was often ignored by the traditional credit system due to its low creditworthiness.
This concept can be seen as a special form of microfinance. It was introduced as ‘Grameen Bank’ by Muhammad Yunus, in Bangladesh in the year 1976. He won the Nobel prize for his extraordinary concept of ‘bank for the poor’.
Microcredit was assumed to be a transformation approach in the lives of the underprivileged section of the society. The change this concept brings in the life of a poor can be seen in the following image:
The above theory demonstrates the use of microcredit for progressive activities like pottery. The borrower can earn more revenue, save money and ensure a better lifestyle when his/her business flourishes.
In the case of microcredit, a borrower can be anyone i.e., an individual, a group of individuals or a village bank.
While an individual loan involves more risk of non-repayment, a group loan is considered to be slightly more reliable due to the positive social pressure it creates over the group members.
Features of Microcredit
Microcredit is a completely different concept that blends the social objective with economic development.
Its various characteristics which distinguish it from the traditional finance are discussed below:
- Small Loan Amount: The microfinance company usually sanctions a small sum as a loan to the borrowers.
- Finances Low Income Households: The borrowers under this category belong to underprivileged families.
- Weekly or Monthly Repayment: The total of principal and interest payable by the borrower, is apportioned into either weekly or monthly instalments.
- No Collateral Requirement: There is no requirement of keeping anything mortgaged or as collateral by the loan seeker, for availing this credit facility.
- Constructive Social Pressure: In the case of group loans, the borrower is under social pressure from the group members to pay off the instalments on time.
- Trust-Based System: The whole lending process is dependant upon trustworthiness between the lending organization and the borrowers.
- Socio-Economic Development: This is considered as a step towards safeguarding the social rights of the poor along with ensuring overall economic welfare.
- 1-3 Years Loan Period: The credit period for such loans is usually short, i.e., at least one year or at most three years.
- Additional Borrowing Facility: Under this finance system, one can obtain additional credit or another loan after the repayment of the prior.
Types of Microcredit
The form of microcredit varies from country to country, some of the most common lending methods are as follows:
- Traditional Microcredit: These include individual lenders such as peers or relatives; and consumer credit.
- Grameen Credit: Originally known by the name of Grameen Bank it initiated credit facility to the poor people.
- Rural Credit: Under rural credit, the specialized banks facilitated grants to the underprivileged village households especially women.
- Consumer Microcredit: The poor consumers can buy goods or services under a credit scheme which lets them pay the sum in instalments.
- Cooperative Microcredit: Such lendings are initiated by credit unions or cooperative banks.
- Informal Group Microcredit: Popular by the name of group loans, the institutions lend a sum to the people who form a group where the group leader takes the responsibility of instalment collection.
- Activity-Based Microcredit: This form of loan is allowed for the activities that make the living, i.e., for agriculture, fishery, craft, pottery, livestock, handloom, etc.
- Bank-NGO Microcredit: The bank and the NGO join hands to uplift the underprivileged community and ensure sustainable development of the society.
- Others: There are multiple other forms of microcredit including NGO microcredit, non-NGO non-collateralized microcredit, etc.
Advantages of Microcredit
Microcredit was proposed to resolve a macro-level issue, i.e., lack of credit access for the underprivileged community.
It has below-mentioned benefits to the poor households of the society:
Eliminate Credit Discrimination: When the traditional lending system only provided loans to the people with the sound financial condition, microcredit brings equality by allowing grant to the poor.
Supports Self-Employment of Poor: The underprivileged people often fails to carry out income-generating activities due to lack of funds, thus microcredit aids them to set up such means.
Repetitive Borrowing Facility: The borrowers can avail additional funds or even take consecutive loans on repayment of the previous ones.
Aids Underpriveledged to Fight Poverty: When the poor households are supported by loans, they tend to generate earning sources for themselves, which ultimately upraises their financial condition.
Easy Payback in Installments: The microcredit borrowers can pay off the instalments monthly or even weekly without even visiting the financial institution or bank branch.
Collateral Free Lending: Ofcourse, microcredit is known for this major benefit, i.e., it lends the sum without keeping any collateral from the borrower, as it functions on the grounds of trust.
Drawbacks of Microcredit
While the idea behind microcredit was to help the poor community, its multiple adverse outcomes were identified over the years. Some of these disadvantages include:
- Insufficient Funding: A meagre amount is allowed as a loan under microcredit which is not apt to meet the requirements of the poor.
- Debt Load on Poor: The borrowers are overburdened by the debt liabilities leading to their worsened financial condition.
- High-Interest Rates: The interest charged on such lendings is more than usual, due to its high-risk exposure.
- Only Meets Basic Expenses: The underprivileged borrow the sum to meet their ends or daily expenses rather than for income generation activities.
- High Risk of Bad Debts: Being penniless, the poor borrowers may not be able to repay the credit, resulting in bad debts for the lending institution.
Microcredit was developed for the welfare of the poor but later on seen as the means of their exploitation in the hands of lending institutions. It is more often seen as a debt trap which is difficult to come out from.