Microcredit Meaning

You are free to use this image on you website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be HyperlinkedFor eg:Source: Microcredit (wallstreetmojo.com)

Key Takeaways

  • Microcredit helps low-income individuals, including skilled laborers without the means to produce goods on their own, escape from poverty with small loans that help them buy the tools and materials. It improves the sustainability of their craft and gives them more independence.The first bank credited with offering microcredits to people was the Grameen Bank in Bangladesh. The experiment was successful and replicated on a large scale in other developing countries.While it offers several advantages, such as economic growth for poor regions, microcredit is often criticized for having excessively high-interest rates.Microcredit is a part of microfinance, a broader category of services that are aimed to help small entrepreneurs and poorer citizens.

How Does Microcredit Programs Work?

Microcredit, as a concept, goes back to Europe during the 18th and 19th Centuries. We can cite two examples of that. First, we have initiatives that provided small loans in Ireland during the 1700s.

Then, there were also credit cooperatives in Germany that helped local peasants to work independently. Providing them with the capital to start a business improved their lives and gave them more autonomy.

Today, these tools have been heavily modified as they evolved a lot over time. Muhammad Yunus a social entrepreneur, created the modern version of microcredit. He started the Grameen Bank in Bangladesh in 1983 to reduce poverty.

The goal was to offer microloans to skilled workers and other low-income individuals, so they could get out of poverty by having the investments which are necessary to start a business. With the money, they will go from unemployment to entrepreneurship and will have the capacity to produce their own wealthWealthWealth refers to the overall value of assets, including tangible, intangible, and financial, accumulated by an individual, business, organization, or nation.read more. This model has achieved popularity around the world since then.

Microcredit today

It is the government that funds these programs, as it needs to promote economic growth.Economic Growth.Economic growth refers to an increase in the aggregated production and market value of economic commodities and services in an economy over a specific period.read more

In this case, the main goal is to help people get out of the dependency that they may have on third parties such as loan sharksLoan SharksA loan shark offers easy credit to borrowers at unreasonably high interest rates. Such lenders usually trap destitute borrowers who are desperate for immediate cash. They make profits out of exorbitant rates and unethical vehicles of debt recovery. read more or exploitative employers. They may also help people stop living based on barter systems and enhance their financial inclusivity.

However, because these loans are very high-risk, they often have higher interest rates than the traditional system. In addition, the interest is high because many of these people will likely not pay the loan back, as they don’t have a good credit ratingCredit RatingCredit rating process is the process in which a credit rating agency (preferably third party) analyzes a security and rates it accordingly so that the stakeholders can make their investing decisions.read more.

Most microloans range from something between $10 and $100, which may not seem like a huge amount for someone in a developed country, but it makes the difference for people living in poverty. The ceiling of the loans can go as high as $2,000 for small companies.

Real-World Examples

  • The most famous real-world example of microcredit is the Grameen Bank of Bangladesh. This community development bank offered microloans to poor residents of villages in Bangladesh during the 80s.It was based on an initial experiment made by Muhammad Yunus in the 70s, in which he lent money from his pocket to aid a group of women in a rural community. So they could start their craft, and all of them paid him later.The result is that their lives, as well as their confidence, greatly improved after a while. People could get rid of shark-loans who took advantage of their work and started their craft by themselves.In India, the National Bank for Agriculture and Rural Development started the Self Help Group Bank Linkage program in 1992. With this program, the government offered several microloans to poor individuals, and over $867 million were given to self-help groups.It also aided in the construction of associations such as the Self-Employed Women’s Association, which offers microfinance aid in the country. This bank offers loans to women, mostly in rural and poor regions.

Advantages & Limitations

  • The main advantage of offering microcredit is how it can improve a country’s economy. Studies show that microloans have an overall positive effect on the financial sectorFinancial SectorThe financial sector refers to businesses, firms, banks, and institutions providing financial services and supporting the economy. It encompasses several industries, including banking and investment, consumer finance, mortgage, money markets, real estate, insurance, retail, etc.read more, making it more inclusive and helping countries to be more developed.Microfinance plans such as microcredit raise the per capita consumption of the people and allow people to live above the poverty line, so it can be a real game-changer, especially to fight hunger.Overall, it can also improve whole communities. For example, this study in Bangladesh tracked the program for over 20 years locally in villages in the country, and it showed how locals increased their income levels and its stability. Microcredit can have a transformative effect on whole communities, essentially changing how they work for the better. Also, it helps to take people from an informal economyEconomyAn economy comprises individuals, commercial entities, and the government involved in the production, distribution, exchange, and consumption of products and services in a society.read more to a formal one (which also helps the government to raise more taxes).One of the main limitations of microcredit is that the amount of money lent to the people can’t be very high. As the standards for lending are very low, most banks won’t offer a huge amount of money. So it may be a problem for people who need a more substantial investment for a start.Another disadvantage is that people feel very pressured to pay off the loans because they have high rates. The interest rates on these loans tend to be very high because of their risk factor, and it falls upon the very people who can least afford them, the poor people. Rates as high as 20% or 30% are not uncommon in these cases, which has drawn criticism about these initiatives.

Microcredit vs Microfinance

Microcredit is part of a broader concept called microfinance. It directly refers to a small loan, while microfinance refers to a diverse number of services provided to small entrepreneurs.

To understand the difference better, let’s dig into what microfinance is. This umbrella term refers to a large diversity of financial services aimed at small entrepreneurs and poor individuals.

For instance, people will mostly use the term microcredit to lend $50 to a low-income individual willing to start a new business. However, if someone already has a business and is looking for additional aid to support it, they will be using microfinance programs.

The microfinance services may include services on a larger and more strategic scale. Some examples are:

  • Larger loans.Tax breaks for companies willing to help in microcredit.Government subsidiesSubsidiesA subsidy in economics refers to direct or indirect financial assistance from the government to an individual, household, business, or institution to promote social and economic policies.read more to small enterprises.Agricultura loans for fertilizer, livestock, etc.Insurance credit.Saving accounts for poor individuals.Pensions.

This has been a guide to Microcredit & its meaning. We discuss its examples, how it works, microcredit vs microfinance, advantages & limitations. You may also have a look at the following articles to learn more –

Micorcredits are small loans that are aimed to give a financial boost to poor and illiterate people who belong to underdeveloped countries. These loans often help them start a small business of their own and gain control of their skill without depending on a barter system or loan sharks who can manipulate them. Micro credits are proven to be a successful means to empower people of low economic backgrounds.

Microcredit loans typically aim to fund skilled laborers who can invest in their craft themselves. In other words, it helps them start their entrepreneurship and gain profits without having to depend on anyone else. In addition, the income helps them pay back the loans and help improve their independence and confidence.

Microcredit is a subcategory of microfinance that refers to the collective services undertaken to help people of weak economic backgrounds. Microfinance can include a range of activities like government subsidies, tax breaks, bigger loans, etc. these are often the initiatives of the government to uplift their poorer citizens.

  • Microfinance LoanHard Money LoanJumbo Loan