The Potency of Microfinance in Accelerating Poverty Reduction: The Case of the Grameen Bank

Introduction

The term “microcredit or microfinance” is no longer unknown to the world. In the last three decades, the topic of microfinance has captured the imagination of institutions and people working in the area of poverty alleviation. Microcredit embodies the distribution of small-scale loans principally by the poor themselves and those suffering deficiency in access to the formal sources of finance. The loans provided by microfinance institutions are mostly collateral-free, which is innovative and sensible to the client base. Microfinance institutions expect that, by receiving the loans, the poor will derive economic sustenance by investing the money for self-employment. Undeniably, there is a critical mass of examples illustrating the effectiveness of microcredit as a means for poverty reduction.

Largely, the formal and informal financial sectors within developing countries have failed to serve the underprivileged. The poor are increasingly becoming even more marginalized; close to 25% of the world population (approximately 1.4 billion people) lives in poverty (Tony, 2014). The World Bank estimates that close to 17% of people in developing countries live at or below $1.25 a day. Although, the present poverty levels are unacceptable, the world has witnessed a dramatic poverty level decline from the 43% registered in 1990 and 52% in 1981 (World Bank, 2015). Several factors prevent the poor from participating in the formal sector institutions, including credit rationing, collateral requirements, a penchant for large loans and high-income customers and protracted bureaucratic procedures of sanctioning loans (Tony, 2014). Unfortunately, the informal financial sector has not done much in helping the poor owing to the monopolistic power, exploitation via the undervaluation of collateral and disproportionate interest rates. The outlined factors have undermined the capacity of informal financial sectors in availing credit to poor people for poverty alleviation and income making purposes. The failure of the informal and formal financial sectors in availing affordable credit to the poor ranked as one of the core factors that caused poverty. The Grameen Bank seeks to provide the rural poor, especially women, with the means to diversify their economic activities, so that to increase family incomes.

Background

Poverty alleviation, as a shared goal, was institutionalized six and half decades ago after the establishing of the Bretton Woods system with the incorporation of global bodies, such as the World Bank. The role of the global financial institutions centered on the stabilization of global economy and fostering free trade in the aftermath of the Second World War. The industrialized nations considered themselves to bear some responsibility for the world’s poor given that the majority of the poor developing countries were former colonies of the European empires. Institutions, such as World Bank, worked through formal institutions and state governments to advance credit to developing countries provided that they observed the policies prescribed.

From 1950s to 1980s, the focus of the poverty alleviation efforts centered on the integration of the poor populations into the economy via improved macroeconomic performance. At that time, economists categorized the poor as a significant “informal” sector that largely remained “invisible, in budgets and government plans, in national policies, economists’ models, and bankers’ portfolios (Khandker & Samad, 2014). The structural adjustment programs were hugely unsuccessful given that the costs of subsidies grew exponentially. States’ loan repayment decreased below 50%, and corruption became more entrenched as the majority of the funds were dishonestly utilized by the powerful politicians. The high rates of fraud rendered decades of international aid without visible results, which reinforced the notion that subsidies and international aid stoked dependency and that global support was of little significance to the poor. The poverty reduction efforts, such as debt forgiveness, healthcare and food aid merely responded to the short-term side effects of poverty; microcredit constituted a much more effective initiative to reduce poverty levels.

Microfinance materialized in light of a shift in development thinking dominated by the opening for microfinance. Microfinance can be conceived as one of the ideas that seemed small in the beginning, but have turned out to have immense implications. When Muhammad Yunus invested his money into a lending project to Bangladesh rural poor, it was uncertain what result it would bring. Indeed, there were numerous examples of state-managed banks that had spectacularly failed in their attempt to avail loans to poor households owing to a dubious legacy of corruption and inefficiency (Khandker & Samad, 2014). At the time, some of the governments, such as Indian Government, were subsidizing credit programs to the poor, but the programs were largely politicized and functioned almost like free transfers. Today, Yunus’ efforts attract widespread praise for their role in broadening access to credit for millions of poor who have no access to formal banking institutions, which corroborates his 2006 Nobel Peace Prize win. Indeed, Grameen Bank embodies the institutionalized adaptation of the microfinance model.

The Grameen Bank Model

In the post-war period, Bangladesh experienced a horrible famine in 1974 that made the already bad situation worse by pushing rural people further into suffering and extreme poverty. The post-independence war economy was ailing from widespread poverty and acute infrastructure shortage. The Bangladesh Government implemented a number of initiatives in an effort to improve the plight of the rural poor. Some of the initiatives included the nationalization of commercial banks and the requirement that all the banks decentralize to rural areas so that to broaden financial access. The decentralization and nationalization had a negative influence on some banks, since a significant number of branches collapsed. Consequently, the credit initiatives executed in order to improve the plight of the rural poor turned out to be ineffective. The commercial bank’s programs for the poor failed to succeed, owing to the overriding perception that the poor are high-risk borrowers (Chowdhury, Ghosh, & Wright, 2005).

Muhammad Yunus started a project (action research) in which he lent $27 to 42 poor women (working as bamboo furniture makers) residing in a village called Jobra situated near the Chittagong University campus where he taught. In order to endure the tough times, the rural poor borrowed money from the local informal lenders. However, the loans were advanced with exorbitant and restrictive loan terms. Yunus saw the importance of improving rural poor people’s access to credit, not through charity, but affordable microcredit (Chowdhury, Ghosh, & Wright, 2005). The objective was to transform poor people from “aid recipients” into active market participants. Most importantly, social enterprises deliver a win-win situation by creating social value and profitability simultaneously.

Yunus composed a list of the poverty stricken people in the village and established that 42 people were in that position and required $27 to live. Yunus used private resources, since most banks were reluctant to extend loans to poor people owing to the perception that poor people did not qualify as creditworthy. Later, in 1983, the money lending project was transformed into a bank named Grameen Bank, which was exclusively committed to the poor. The Grameen Ban became a fully fledge independent bank after the passage of a special legislation that awarded 95% share ownership to the borrowers and 5% to the Government of Bangladesh (Nurul & Getubig, 2010).

The Grameen Bank exploits social collateral instead of utilizing financial collaterals. Largely, the loans are not advanced to individuals, but rather to groups comprising roughly of five to ten members. The process of loan provision and recovery hinges on relationship, trust and network. Indeed, the Grameen Bank operates via the creation of relationships grounded in social capital, which guarantees the sustainability of the bank, since it recovers its full costs. The loan recovery and deposits rate for the Grameen Bank are reasonable, which plays a great role in ensuring the sustainability of the bank.

Theoretical Framework

The definition of poverty can take many forms and debate rages on how to accurately define poverty. Poverty is a multifaceted phenomenon with meaning that hinges on the context and perspective that one is examining. According to Yunus, poverty embodies that point of being within a state of powerlessness, homeless, unemployed, illiterate, landless, absence of sufficient capital, amenities and food necessary to earn a decent living (Yunus & Karl, 2013). As such, poverty alleviation represents the act of minimizing the scourges tied to poverty for an individual or community (Shil, 2009). Discussions on poverty revolve around the difference between materialistic poverty (gauged in terms of income and consumption) and the broader concept of needs for improvement of well-being. Current study exclusively focuses on materialistic aspects of poverty principally based on income and consumption. Poverty can be divided into three categories: absolute or extreme poverty, moderate and relative poverty. Absolute poverty refers to households that are unable to satisfy their needs necessarily for survival, such as food, healthcare and sanitation. Moderate poverty relates to situations in which an individual can barely address the fundamental needs for survival, while relative poverty suggests a level of deficiency based on certain parameters, such average national income.

Debate rages on whether microfinance institutions should merely target the “poor” or the “poorest” sections of the society. The first school of thought contends that microfinance should target the poor given that they are highly probable to have income-generating activities, thus increasing financial efficiency. As such, poor people’s loans are theoretically more likely to yield to the creation of employment opportunities within the local community and the gains will trickle down to the poorest (Hamada, 2010). The second thought critiques such strategy, since the redistribution based on consumption or the generation of jobs will not essentially trickle down to the poorest. The second school of thought roots for direct targeting of the most vulnerable people, irrespective of how costly. Improving productivity is likely to enhance income, allowing the borrowers to save, repay the interest and the loan (Hamada, 2010).

Analytical Discussion

The field of microcredit has grown rapidly over the last three decades as an economic model for reducing the poverty level among people. Microfinance bridges the deficiency intrinsic in most formal financial services, which are inaccessible to poor people owing to the high interest rates, excessive collateral requirements, burdensome application procedures and extended admissions processing (Shil, 2009). Microcredit resourcefully recycles lending resources and registers low rates of late payment and high recovery rates. Indeed, the loan repayment rates oppose the ones recorded by a majority of the mainstream financial institutions. According to Yunus and Karl (2013), the core objective of microcredit programs centers on increasing incomes and widening the financial markets by availing financial services (mostly credit) to small-scale entrepreneurs who do not have access to regulated markets. In some instances, the microcredit programs are principally motivated by social missions concentrating on outreach to the rural and urban poor, especially women, and gauging effectiveness in terms of poverty alleviation. As such, microcredit is justified and deployed based on the ideas of equity or fairness intended to create new income inflows and employment opportunities (Shil, 2009). Moreover, in reaching out to the rural poor, microcredit programs have made major steps towards financial and operational self-sufficiency.

Microcredit has become a useful tool for alleviating poverty and generating wealth, while causing positive externalities, including enhanced health and improved education. The microfinance offers a platform on which impoverished people can surmount abject poverty and attain self-sufficiency. The number of borrowers at Grameen Bank averages at approximately 8.35 million, 96% of whom are women. Grameen Bank operates close to 2,565 branches covering over 80,000 Bangladesh villages and enjoys a loan recovery rate of 96.53%. Grameen Bank avails reduced interest rates on loans ranging from 20% on income-generating loans, to 8% (housing loans) and 5% for student loans (Shams, 2009). Grameen Bank’s interest rate is low in comparison to the market rate, given that the regulatory authority recommends a rate of 25-33%, while the Bangladeshi government’s loan interest rate stands at 22%. Since its inception, Grameen Bank has disbursed over $11.21 billion in loans to poor women. It is estimated that the lending programs have aided 50% of the poor families to rise above the poverty line (Shams, 2009). Presently, Bangladesh’s microfinance institutions have a client base of over 30 million members and disburse over $2 billion per year (Khandker & Samad, 2014).

The Effectiveness of the Grameen Bank in Poverty Alleviation

Grameen Bank is renowned for following a distinct and innovative lending policy. Grameen Bank views social business as a missing part to integrate the market with the fight against poverty and related social problems. A social business represents a non-loss making, non-dividend paying entity structured to respond to social problems. The profits drawn from the social business are employed to broaden the company’s reach and improve the entity’s products and services. The Grameen Bank considers credit a core development component and access to credit a fundamental human right. As such, the Grameen Bank seeks to empower the poor by availing collateral-free loans to ensure that they have the tools to create productive self-employment through the creation of economic enterprises.

Grameen Bank operates under certain principles, namely: the belief that the poor do not necessarily create poverty, but rather poverty is a product of policies and institutions surrounding the people. In addition, Grameen Bank believes that poverty cannot be resolved though charity, since charity causes dependency; instead, people should harness the creativity and inner energy to alleviate poverty (Nurul & Getubig, 2010). Grameen Bank also believes that poor people manifest an equal capacity, in the same way as other people in the society, and their participation is crucial to growing the economy. Grameen Bank abandons the conventional banking style in which the wealthy receive more credits, and awards the poor the opportunity to borrow and pay back. Lastly, Grameen Bank preference for lending to women draws from the belief that women present the most benefits to families and the society at large.

Grameen Bank’s model core features include: a self-empowerment system that gives women assertive power in the community and their families. Furthermore, the Bank’s structure guarantees that the great number of the clients fall in the bottom half of socioeconomic hierarchy. In order to qualify for a loan, Grameen Bank demands the formation of small groups comprising of women that avail mutual and morally binding guarantees to function as the collateral. The overriding assumption, in this case, details that if individual borrowers are provided with access to credit, they will be able to discover and engage in viable income-generating activities (Hossain, 2013). The groups also provide a platform through which relevant information on the means to enhance education, health, sanitation and legal rights can be disseminated.

The Grameen Model encourages close interactions of the employees with the borrowers and relies on group solidarity and peer pressure to drastically minimize the risk of default. The loan recovery efforts are fostered by the institutional innovation, in which the repayments are done in small regular installments (Khandker & Samad, 2014). One of the strengths of Grameen Bank’s microcredit programs is in its capacity to empower women within social contexts infamous for devaluing women’s work, entrenching women’s exclusion and facilitating gender-based discrimination. Lending to poor women who acted as head of households proved to be a success, since women were more reliable as they invested the borrowed funds directly into microenterprises instead of repaying previous loans.

Overall, Grameen Bank’s microfinance programs have contributed towards raising the net worth and asset base of the poor, more than it has led to the emergence of undesirable effects, such as indebtedness. The available evidence unequivocally demonstrates that Grameen Bank’s microcredit programs possess substantial positive impacts in improving household welfare in terms of per capital income and consumption, personal net worth and asset ownership (Hossain, 2013; Yunus, Moingeon, & Lehmann-Ortega, 2010). Microfinance programs correlate with an increase in expenditure and income, as well as externalities, such as improved literacy levels.

The case of Grameen Bank illustrates that social enterprises within the field of microfinance (social and economic) can be effective in accelerating poverty reduction (Yunus, Moingeon, & Lehmann-Ortega, 2010). The Grameen Bank demonstrates that business ventures can act as potent social enterprises. Since the alleviation of poverty forms the bottom line of microfinance, it is essential to ensure that the individuals who access microfinance exploit the opportunity to enhance their socio-economic situation (Nurul & Getubig, 2010). Part of the success of the poverty reduction efforts results from the robust growth of microfinance.

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