Microcredit has star power. In 2006, the Nobel Committee called it 'an important liberating force' and awarded the Nobel Peace Prize to Muhammad Yunus, the 'godfather of microcredit.' The actress Natalie Portman is a believer too; she advocates support for the Village Banking Campaign on its MySpace page. The end of poverty is "just a mouse click away," she promises. A button on the site swiftly redirects you to paypal.com, where you can make a contribution to microcredit initiatives.
After decades of failure, the world's aid organisations seem to think they have at last found a winning idea. The United Nations declared 2005 the "International Year of Microcredit." Secretary-General Kofi Annan declared that providing microloans to help poor people launch small businesses recognises that they "are the solution, not the problem. It is a way to build on their ideas, energy, and vision. It is a way to grow productive enterprises, and so allow communities to prosper."
Many investors agree. Hundreds of millions of dollars are flowing into microfinance from international financial institutions, foundations, governments, and, most important, private investors, who increasingly see microfinance as a potentially profitable business venture. Private investment through special "microfinance investment vehicles" alone nearly doubled in 2005, from $513 million to $981 million.
On the charitable side, part of microcredit's appeal lies in the fact that the lending institutions can fund themselves once they are launched. Pierre Omidyar, the founder of eBay, explains that you can begin by investing $60 billion in the world's poorest people, "and then you're done!"
But can microcredit achieve the massive changes its proponents claim? Is it the solution to poverty in the developing world, or something more modest, a way to empower the poor, particularly poor women, with some control over their lives and their assets?
On trips to Africa and India we have talked to lenders, borrowers, and other poor people to try to understand the role microcredit plays in their lives. We met people like Stadile Menthe in Botswana. Menthe is, in many ways, the classic borrower. A single mother with little formal education, she borrowed money to expand the small grocery store she runs on a dusty road on the outskirts of Botswana's capital city, Gaborone. Menthe's store has done well, and she has expanded into the lucrative business of selling phone cards. In fact, she's been successful enough that she has built two rental homes next to her store. She has diversified her income and made a better life for herself and her daughter. But how many borrowers are like Menthe? In our judgment, she is the exception, not the norm. Yes, microcredit is mostly a good thing. Very often it helps keep borrowers from even greater catastrophes, but only rarely does it enable them to climb out of poverty.
The modern story of microcredit began 30 years ago, when Yunus, then an economics professor at Chittagong University in southeastern Bangladesh, set out to apply his theories to improving the lives of the poor in the nearby village of Jobra. He began in 1976 by lending $27 to a group of 42 villagers, who used the money to develop informal businesses, such as making soap or weaving baskets to sell at the local market. After the success of the first experiment, Yunus founded Grameen Bank. Today, the bank claims more than five million "members" and a loan repayment rate of 98 percent. It has lent out some $6.5 billion.
At the outset, Yunus set a goal that half of the borrowers would be women. He explained, "The banking system not only rejects poor people, it rejects women. Not even one percent of their borrowers are women." He soon discovered that women were good credit risks, and good at managing family finances. Today, more than 95 percent of Grameen Bank's borrowers are women. The UN estimates that women make up 76 percent of microcredit customers around the world, varying from nearly 90 percent in Asia to less than a third in the Middle East.
While 70 percent of microcredit borrowers are in Asia, the institution has spread around the world; Latin America and sub-Saharan Africa account for 14 and 10 percent of the number of borrowers, respectively. Some of the biggest microfinance institutions include Grameen Bank, ACCION International, and Pro Mujer of Bolivia.
The average loan size varies, usually in proportion to the income level of the home country. In Rwanda, a typical loan might be $50 to $200; in Romania, it is more likely to be $2,500 to $5,000. Often there is no explicit collateral. Instead, the banks lend to small groups of about five people, relying on peer pressure for repayment. At mandatory weekly meetings, if one borrower cannot make her payment, the rest of the group must come up with the cash.
The achievements of microcredit, however, are not quite what they seem. There is, for example, a puzzling fact at the heart of the enterprise. Most microcredit banks charge interest rates of 50 to 100 percent on an annualised basis (loans, typically, must be paid off within weeks or months). That's not as scandalous as it soundsólocal moneylenders demand much higher rates. The puzzle is a matter of basic economics: How can people in new businesses growing at perhaps 20 percent annually afford to pay interest at rates as high as 100 percent?
The answer is that, for the most part, they can't. By and large, the loans serve more modest endsólaudable, but not world changing.
Microcredit does not always lead to the creation of small businesses. Many microlenders refuse to lend money for start-ups; they insist that a business already be in place. This suggests that the business was sustainable to begin with, without a microloan. Sometimes lenders help businesses to grow, but often what they really finance is spending and consumption.
That is not to say that the poor are out shopping for jewelry and fancy clothes.. In Hyderabad, India, as in many other places, we saw that loans are often used to pay for a child's doctor visit. In the Tanzanian capital of Dar es Salaam, Joel Mwakitalu, who runs the Small Enterprise Foundation, a local microlender, told us that 60 percent of his loans are used to send kids to school; 40 percent are for investments. A study of microcredit in Indonesia found that 30 percent of the borrowed money was spent on some form of consumption.
Sometimes consumption and investment are one and the same, such as when parents send their children to school. Indian borrowers often buy mopeds and motorbikesóthey are fun to ride but also a way of getting to work. Cell phones are used to call friends but also to run businesses.