Introduction to Microfinance

Dr. Muhammad Yunus I think since I am mentioning microfinance so much in my posts that I should expand on it a little for those who have not encountered it before.  Microfinance was pioneered by Dr. Muhammad Yunus, an economics professor from Bangladesh.  What Dr. Yunus did was to take traditional banking and transform some of the assumptions so that it helped the poor rather than excluded them.

There are a few problems with traditional banking that Dr. Yunus overcame in his quest to become “Banker to the Poor” and win the Nobel Prize doing it.  For instance, the typical loan process at a bank involves the giving of collateral. Banks do not wish their borrowers to fail repaying loans, so banks demand that borrowers present proof of repayment ability.  Usually, we see borrowers put up houses as collateral in America.  However, this process has the side effect of excluding the poor, since they have very little collateral to put up.  Also, banks are traditionally interested only in giving loans either with large principle amounts or large interest rates.  It is not profitable to earn small interest on a loan that is only $100 in size, given the operating costs that go with granting a loan.

But Dr. Yunus found ways to avoid these problems and make credit accessible to the poor.  Instead of collateral, he demanded something different: community backing.  If someone wants to get a loan, they must first create a credit group — a group of people that all agree to back up the loan.  These people are there for support during the loan process, and they are unable to receive a loan until the first has been repaid.  Thus, the incentives to repay come not from the giving of collateral, but from community ties.  Dr. Yunus also found ways to give small loans at small interest rates.  By standardizing the loan process and minimizing the screening costs, he was actually able to give extremely small loans at rates barely above the inflation rate, and still even turn a profit!

Granted, Dr. Yunus’ will be the first to tell you that his bank, the Grameen Bank, is not a profit-maximizing entity.  It is what he calls a “social business.”  If it makes a profit, that is all well and good; however, its measure of success comes not from the bottom line, but from the number of people that it helps escape poverty.  And by that measure, it has performed quite well.  Today, there are over seven million poor people in Bangladesh who have loans from Grameen Bank.  To date, it has loaned the equivalent of $6 billion (U.S.), and the repayment rate is an astonishing 98.6 percent.  Bangladesh is currently the only country in the world on track to meet the Millennium Development Goals, and that is in no small part due to the Grameen Bank and Dr. Yunus’ many other social businesses.

That brief explanation should be enough to understand anything that I address in future posts.  If you are interested in learning more about Dr. Yunus and his development of the microfinance model, read his autobiography Banker to the Poor. If you are interested in microfinance and social business as it stands today, I recommend his second book, Creating a World without Poverty, which looks more towards the future.

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