Several systems of lending and borrowing within financial markets have been progressively devised and implemented over centuries. Microloans refer to the diminutive loans awarded to groups of and individuals in society who have no access to rudimentary financial services. In most cases lenders have no access to physical character or credit history of the borrower. Microloans are therefore extended to individuals who do not merit conventional bank loans due to the lack of collateral, a verifiable credit history and formal employment. Microloans are largely formalized hence different from informal credit markets such as credits from pawn brokers, pay day lenders, or money lenders.
According to Cheung & Sundaresan, (2006), all microloan programs are founded on similar principles. The borrowers lack physical collateral, consequently the lending institutions award small loans with little or no security. The loans are short-term in nature, with the repayment period being as short as one week. They are in small amounts, Cheung, & Sundaresan (2006) further notes that the average amount lent out by the micro loaning institutions is $130. Further, microloans are characterized by joint liability in which loans are awarded to groups and not individuals. This enables liability to be shared among many borrowers in addition to group monitoring for accountability purposes.
They are further characterized by virtual or real threats of grave consequences on defaulters by the institutions. This is to scare borrowers, thereby limiting misuse of funds and payment default. Microloans are further characterized by high administrative costs owing to the cumbersome process of monitoring the mostly subprime borrowers, high borrowing rates and the greater probability of default. The interest rates are frequent most of which are calculated on a weakly or monthly basis.
Currently, there exists a broad spectrum of views on the concept of microloans. Most economic and social scholars have been lauded microloans for empowering the poor (both the unemployed and struggling entrepreneurs) thereby creating independence among the poor.
Although there is evidence of the practice after the Second World War, Hermes, & Lensink, (2007) the rise in the popularity of the microloan concept has been credited to Grameen Bank and its founder Professor Yunus who was awarded the 2006 Nobel Peace Prize for successfully implementing the microloan conception to benefit poor women in Bangladesh. Their model of operation have been replicated the world over.
There has been a phenomenal rise in the access to microloans. This is attributable to the exponential increase in the number of micro-credit institution that reached 3,316 by December, 2006. The 2007 report on the global state of microcredit, from the proceedings of the 2007 microcredit campaign, indicate that the clientele base has risen from eight million in 1997 to over 132 million in 2007. The report further indicate that, of the 132 million, a whooping 85.2% are poor women an indication that micro-loans predominantly benefit the women, Daley-Harris, (2007).
Currently, microloans are accessed by individuals in all the continents. A survey presented by Cheung & Sundaresan (2006) showed that the microloan market had a substantial market of $28 trillion of which Africa, East Asia, East Europe, Latin America, Middle East and South Asia had 12%, 23%,17%,31%,2% and 15% respectively. His survey further shows high write off rates ranging between 20.29 and 39.4% with the average in excess of 30%. The above statistics indicate that, Majority of the population that access microloans in South America and South Asia who form 50% of the global population.
Microloans and commercial banking
A notable difference between microloans and contemporary commercial banking is the grouping structure. Most Microcredit institutions award loans to groups and not individuals. This is a deviation from the common lending arrangement of commercial banks that extend its loans to both groups and individuals. This principle is considered ideal, as it promotes accountability and ensures repayment by individual group members through the principle of social responsibility in which group members are accountable for one another.
Critics, however view this concept as a hindrance to its popularity among individuals citing the fear of joint liability among group members and high overhead costs. Microloans are further accessible without collateral besides having very little formal paperwork as opposed to commercial banks in which loanees must demonstrate their ability to repay. A further difference between micro-loans and commercial banks is the joint-liability agreement; Microloans are characterized by heightened monitoring and administrative processes. This is created by the need to deliver loans to the borrowers rather than borrowers coming for the loans and a necessity to ensure that the loanees do not divert the money into unproductive activities.
But are microloans the vessel out of poverty as so popularized? May critics see microloans as having no ability to entirely save the poor, but a further promotion of misery by indebting the very poor it seeks to help. According to Hermes, & Lensink, (2007), most microcredit institutions have exorbitant interest rates which far exceed that of commercial banks. The diminutive amounts of money awarded to recipients coupled with high interest rates and the savage sanctions to defaulters are shortcomings which cannot get the poor out of poverty, but only guarantees their daily livelihood without ensuring prosperity, Daley-Harris, (2007)
Statistics shown above indicate higher interest rates on microloans in comparison to commercial loans. The inflated interest rates have however been defended by most microcredit institutions, citing the cost of monitoring borrowers who are often subprime as the determinants of equilibrium borrowing and the interest rates. Furthermore the high rate of write-offs as a result of wilful default or genuine inabilities of repayment offer vindication to the considerably high interest rates. Analogous to commercial loans, credible and committed individuals who successfully repay their loans should be subsequently awarded loans of larger amounts to serve as an example and motivation to others to enable consequent repayments.
Although micro-loans are a recent development, it is without doubt they have provided a forum in which poor households are able to access credit. Furthermore they have helped and continue to lift massive proportions of the world population out of poverty. The popularity and rise of the micro loaning system is a clear indication of its positive contribution to the poverty reduction campaign. It also evidences the considerable proportion in need of rudimentary financial services but cannot access them.
Daley-Harris, S. (2007) Sate of the Microcredit Summit Campaign Report 2007
Cheung, S. & Sundaresan, S. (2006) Lending Without Access to Collateral; A theory
of Micro-Loan Borrowing Rates. Retrieved
Hermes, N. & Lensink, R. (2007) Impact of Microfinance: A critical Survey.
Economic and Political Weekly Pg. 462-465.