Micro-Credit against Poverty - Term Paper Example

Micro-Credit against Poverty Introduction Muhammad Yunus who was born in the year 1940 was a Bangladeshi entrepreneur was awarded or felicitated with the noble peace prize for the establishment of the Grameen Bank and he is considered as the father of the micro credit and micro finance as he has emerged and developed the concept of micro finance. This is a major and very significant step that has been adopted by him for extending his support and help for the poorer section of the people in the society who are not able to access loan from the various financial institutions and the traditional banks. He is the founder of the concept of micro credit through which the small amount loans can be utilized at an affordable interest rate for transforming and improving the lives of the poorer people especially the women section. The banking system has existed in the economy since a long period of time which was appreciated by many people as well as blamed by many but still the banking system played an important role in the economy. Muhammad Yunus have struggled and made arrangements for providing loans and credit to the poorer or the weaker sections of people. The pioneer of the concept of micro credit and micro finance has extended its help and support to millions of people that are in need of loans and assistance. There are many facilities provided to the people for availing loans from the Grameen bank and easily repaying the loan. Micro credit Micro credit is the concept that has been developed for providing loan and assistance to the weaker section of the people in the economy through the improvement in the lives of the people by motivating and encouraging them to become self employed. Micro credit is commonly known as the micro finance or micro banking and this concept explains the process of extending of loans to the people without any collaterals and this type of loan is provided to the nontraditional borrowers which mainly includes the poor and the weaker sections of the people in the undeveloped and in the rural areas(Chemin, 2008).The concept of micro loans or the micro credit first emerged in Bangladesh and the development and the success of the concept has lead to the widening and the adoption of the concept in other less developed, developing and underdeveloped countries of the world which includes Indonesia, Bolivia (Roodman and Morduch, 2014). Through the utilization of the micro loans the borrowers are able to purchase the livestock for starting their own businesses. The Grameen approach for extending of the micro credit is considered as a different and unique feature for providing small loans to the people and this type of loans are guaranteed by the members belonging to the community of the borrowers as a result it creates a pressure on the borrower to pay back the money on a timely basis. The clients or the customers availing the micro credit are generally categorized among those who have never accessed money and have relied on the system and the concept of the barter system for fulfilling their needs and requirements (Khandker, 2005). The micro credit institutions generally charges a lower interest rate as compared to the historical financial institutions and it requires collateral very rarely which signifies that the micro credit is considered as a important and prime component of the micro finance therefore the poor or the weaker section of the people for accessing the capital for increasing of the credit and also increasing the productivity. The poor and the weaker section of the people are excluded previously from the formal or the classical banking structure or the financial institutions due to the increase the cost, risk, propensity towards the low savings through the way of collateral. Therefore many micro finance institutions are mainly subsidized the non government organizations for ensuring the requirement of profit that will not overtake the benefit or the advantages (Angelucci, Karlan and Zinman, 2014). Need of micro credit The concept of micro credit is considered as the concept that deals with the imperfect or the problem that existed in the credit market of the economy. Presently the credit market is divided into two parts which includes the formal market and the informal market. The rural credit market are generally imperfect in nature and do not allow the poor borrower and the weaker section to access the credit that is required by them (Banerjee and Duflo, 2006). Therefore the concept of micro credit have been developed or emerged to reduce or decrease the imperfection that exist in the credit system in the economy and allowing the poor section of the people to become entrepreneur . The use of the loan is required to be considered. Micro credit is required by the weaker section of the people in order to increase their source of earning, increasing the consumption level, fulfillment of the requirement of the children, making arrangement for education of the children and increasing the opportunity for leisure activities (Cull, Demirgu, Kunt and Morduch 2009). This indicates and signifies that the micro credit program is required to be developed in such a way that it provides various micro credit programs for advocating the health, education, family planning and nutrition together with the loan or the credit that is provided (Hulme and Arun, 2009). The importance or the need of microfinance by the poor or the weaker section of the society can be analyzed from the fact that the poor people are in need of credit and they cannot access funds or loans from the banks or the other financial institutions and they are not able to access loans from the banks since the transaction cost in case of banks are very high and the banks are not willing to provide the loan since it is very difficult to monitor and supervise the poor or the weaker sections of the people. Since the weaker section of the people have to find various creative solutions for surviving in the economy. Therefore the poorer people require micro credit facilities for improving the entrepreneurship and creativity of the poor or the weaker section of the society (Banerjee, Duflo, Glennerster and Kinnan, 2014). Micro finance institutions have adopted a lot of steps towards providing micro credit to the people. But the problem or the constraint that is associated with it is that the default in the repayment of the credit (Kiva, 2015). The main benefit or the advantages of the micro credit is that it is considered as one size that is fit for all people and the micro credit is required to be evaluated and verified carefully against all the alternatives that are available for choosing or selecting the most appropriate or preferred intervention tool related to a specific situation. Micro finance is capable of reaching the lower income level people in the economy (Burgess and Pande, 2005). Figure 1: microfinance Strategy The rationing of the credit explains the adverse selection as well as the moral hazards. It mainly deals when the borrower would prefer to borrow money at the present interest rate. The credit rationing that is related to the adverse selection generally arises when the lender desire of the borrowers in maintaining of the interest rate and if the lender decides to charge a low rate of interest and gamble on the process of lending and increasing the expected return . In both this case the lender is rationing its credit by keeping the market busy (Hermes and Lensink, 2007). Availability of credit for moving out of poverty The availability of the credit that is provided to the weaker section of the people provides various opportunities for raising the income of the poor or the weaker section of the people in the economy or the nation. The Grameen bank has been introduced by Muhammad Yunus for the process of progressive lending for reducing or decreasing the risk and the cost of lending to the poor and the weaker section of the people in the economy. The micro credit loans are efficiently used by the borrowers in reducing or decreasing the extent of poverty through the increase in the income (Morduch, 1999). The factors leading to the poverty can be developed through the various programs related to microfinance. The micro credit system or the process is developed and designed for increasing the profitability of the business venture. The first generation is removed from the aspect of poverty but the second is not benefited if it is related with the poverty such as health care, low education and nutrition are not overcome. Now a day’s many Non government organizations and the mutual fund institutions are looking forward for providing various social benefits than providing of profit (Morduch, 1999). This implies that the micro credit programs are advocated for the development of health, education, nutrition, family planning and health together with the loans. Therefore there are various factors that are required to be considered in order to determine the success of the micro credit that is moving the poor out of the poverty (Ledgerwood, 2000). The clients prefer the services that are provided by the micro credit since it is considered as the valuable to such an extent that they are ready to pay high rate of interest on the loans and accept minimum or no return out of it. Utilizing the loans for purchasing the goods is considered as the main aim and objective of the micro credit institutions that directly facilitate the people in increasing their profitability and productivity (Khandker, 2005). The concept of micro credit provides various opportunities by facilitating those who are in poverty to transform themselves into rich or wealthier section of the people in the economy. The concept of Micro finance provides or offers an idea that the low income group of the individuals are able to escape themselves out from the situation of poverty in the economy or the nation at the time of assessment of various financial services while the microfinance plays a major and a significant role in the battle against the poverty and it has been recognized that micro finance only cannot be considered as the appropriate or favorable and the concept of micro credit shall not be considered for ending or eliminating the situation of poverty prevailing in the economy or the nation (Goldberg, 2005). Poorer people may not have access to credit markets The poor or the weaker section of the people may not have easy access to the credit markets since most of the weaker section of the people do not have easy access in providing the formal credit that is by excluding the micro credit that reaches or connects more than 200 million people across the world. The credit is mainly provided from the informal commercial as well as non commercial money lenders at a very high cost to its borrowers. The poor people are not able to access easily the credit market due to the increase in the interest rate, the variables in the interest rate and the poor or the weaker section of the people are unable to borrow from the formal lenders. There are two types of market in the formal and the informal markets. These loans are provided and funded by the money lenders for exploiting the vulnerability of the poor, who have very little or limited options for charging a very high rate of interest. The money lenders generally play an important role in the local economy as the people are using their services by facilitating them to continue charging at extortionate rates. Therefore the high rate can be justified when it includes all risk and the cost that the formal credit market is engaged in extending higher rate of credit to the poor or the weaker section of the people in the economy. The increase in the interest rate has removed the incentive that is provided on the long term projects or investments and the return that is received from it is not able to fulfill the interest on loan and the loans from the money lenders are unproductive in nature. Therefore the intervention in the credit market explains the reason or the cause for formal credit market that perceives and excludes the exploitation in the informal market (Masanjala, 2002). The main reason behind the micro credit in providing of formal credit that mainly excludes the poor or the weak borrowers and lends to the rich borrowers and the prime reason behind this exclusion is the limited liability, agency problems, moral hazard and the existence of asymmetric information. Application of theoretical models and empirical evidence  The theoretical models and the empirical evidence towards the group lending in case of micro financing can be explained with the help of the theoretical approach that is related to Game theoretical approach. The traditional financial institutions require the existence of the various collaterals as security before granting loans to the clients. However the lack of assets and the decrease in the income levels excludes the people of the developing countries from obtaining of credit from the standard banks. Whereas in case of the micro finance institutions it applies the concept of group lending. The micro finance institutions instead of using the collateral from each of the individual they mainly utilizes the peer pressure and also the social selectivity towards increasing of the repayment rates and it also facilitates to hedge or safeguard against such risk mainly the risk that is associated with default. Therefore in order to provide the credit facilities to the poor and the weaker section and reducing the risk of the micro finance institutions several individuals have together formed a group in which each member of the group will receive a specific or particular loan but the whole group is held responsible for the repayment of the loan . Since the responsibility lies equally with each of the group members therefore they are not willing to accept any member in their group who has the tendency of committing default in the payment of the credit. The micro finance institution mainly substitutes the collateral with the mechanism resulting in maintenance of the social reputation within the group. Therefore it reduces or decreases the risk of default in making payment of credit. The group lending also possess certain advantages or benefits that is related to the decrease or minimization of the transaction cost. Therefore the micro credit or the micro finance institutions have facilitated the poor and the weaker section of the people in availing of credit for accessing the local financial markets and also investing in the small businesses. By fulfilling all the requirements associated with the members of the large group reduces or decreases the transaction cost by five times relative to the individual borrowers. Therefore group lending is capable of shifting the cost and the risk to the potential borrowers (Honohan, 2004). Conclusion Micro credit is considered as the one of the most important and innovative tool in the field of banking. Muhammad Yunus was the pioneer in introducing the concept of micro credit in order to benefit the developing and the underdeveloped countries of the world. He is known as the father of the micro finance and he has also introduced or established the Grameen bank in order to facilitate the poor and weaker section of the people who are in need of finance and requires fund on credit and for developing the entrepreneurial skill and encouraging them to become self employed. He has extended help to the weaker section of the people in the economy. The major problem that the people used to face before the introduction of the micro finance institution is the large transaction cost that is used to be charged by the other traditional banks and therefore the Grameen bank have been established in order to serve this section of the people in the economy. This concept has helped the poor borrowers and has assisted them in reducing or eliminating poverty from the economy as a whole. Micro finance institutions have adopted several steps which includes transformation of the subsidized non government organizations to the sustainable banking. Therefore this indicates that the banking sector contributes strongly in the local and the domestic economy. The default risk that was associated with the extending of credit to the poorer section is minimized since the loans were provided to the individual members and the repayment of the credit is to be provided in group. The micro finance institutions are planning various measures for development by implementing sustainable microfinance models. References Angelucci, M., Karlan, D. and Zinman, J., 2014. Microcredit impacts: Evidence from a randomized micro- credit program placement experiment by Compartamos Banco. Working Paper. Banerjee, A. V. and Duflo, E., 2006. The Economic Lives of the Poor. Available at < http://economics.mit.edu/files/530 > [Accessed 14 April 2015]. Banerjee, A., Duflo, E., Glennerster, R. and Kinnan, C. 2014. The Miracle of Microfinance? Evidence from a Randomized Evaluation. Available at < http://www.nber.org/papers/w18950 > [Accessed 14 April 2015]. 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Roodman, D. and Morduch, J., 2014.The Impact of Microcredit on the Poor in Bangladesh: Revisiting the Evidence. Journal of Development Studies. 50(4). pp. 583-604. Read More