Borrowing money for many in the Global North is relatively easy. They enter the bank, ask for a loan and fill out stacks of documents before their loan is processed. For many people in the Global South it’s much more complicated. With a small amount of assets, the poor are unable to borrow from formal financial institutions such as banks so they turn to private lenders who sometimes set arbitrary interest rates. Some borrowers in India, for example, have had to pay interest of 4.69% a day which in a year accumulates to $100 million in interest. To help the poor borrow without fear of losing all of their assets microfinance was popularized.
Microfinance success can be most visibly seen in Bangladesh which was dismissed as a development disaster for years but now has strong human development indicators. The reason for this success is that such microfinance institutions as the Grameen Bank have worked with local communities in Bangladesh to develop financial discipline. The microloans given to local communities have attached obligatory savings, which require the borrowers to save a fraction of the money they receive. This helps the borrowers because it ensures that they have some money in case of deprivation and hunger but also ensures that they have some revenue to give back to the bank. There are also a variety of methods to ensure repayment. Credit unions, for example, are organizations of individuals who save together and make loans to each other. This group of individuals democratically elects directors who rotate periodically. This method allows the community to independently set up a financial system based on trust and local leadership. Another model is the Grameen model which chooses a group of individuals from a community. From that group two people are chosen to receive loans. Based on those individuals’ repayment it is decided if the rest of the members of the group will receive loans. The two individuals who receive loans initially are pressured by the rest of the community to pay back so that everyone else can also receive capital. Community based models such as these ones enforce a sense of responsibility and independence, which encourages returns to the microfinance institution.
Some who become involved in microfinance do so because they believe in bottom billion entrepreneurship, which asserts that with a little bit of revenue the poorest individuals will begin businesses which will flourish. While some borrowers want revenue for business purposes many want it for housing and food. Those focused on entrepreneurial microfinance are reluctant to give money to the most vulnerable people, those who borrow for basic necessities. Pro-poor microfinance institutions like those in Bangladesh focus more on social empowerment. They lend money for water, food and housing, which don’t offer enormous returns. Pro-poor institutions also provide infrastructure in communities in order to increase human development. They create schools and health clinics. Such involvement with the local community improves people’s lives immensely.
Microfinance began as a poverty alleviation tool but lately as returns from microfinance increase it has veered away from its initial objectives. Focusing on entrepreneurship is important but before one can become an entrepreneur he must first have his basic necessities met. Encouraging pro-poor microfinance in the Global South which focuses on communities and human development can bring higher yields than conventionally imagined. In Bangladesh a 10% increase in men’s borrowing raised male labor by 0.18% while women’s borrowing increased the female labor supply by three times as much as men’s. Borrowing has also increased school enrollments by 8%. Lending for non income generating activities such as food and water acquisition may not give back immediate financial returns but this kind of microfinance can eventually give us a world full of healthy individuals eager to contribute to the global workforce. In my opinion, the microfinance practices of Bangladesh shouldn’t be considered exceptional; they should become the norm.
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