1. Microcredit
Claudio Di Benedetto
Project Engineer of EWB-MI
PhD Students at DIG
01/04/2014

2. History of Microcredit
Programs:
• Saving and Credit Group
• Formal Saving and Credit Institutions (poor)
• Model Adaptation to rural context
(Rural Support Program)
• Modern Microcredit (Muhammad Yunus)
Period
1700s
1800s
1900s
1970s

3. Microfinance Definition
A small financial loan made to poverty-stricken
individuals seeking to start their own business
Microcredit, or microfinance, is banking the un-
bankables, bringing credit, savings and other essential
financial services within the reach of millions of people
who are too poor to be served by regular banks

4. Microfinance
 Micro-credit
 Micro-saving
 Micro Insurance
 Remittance Management

5. Microfinance Outreach

6. Regions Outreach

7. Grameen Bank

8. Microcredit and Poverty Cycle

9. Microcredit Target

10. (Micro)credit Market
(Information Asymmetry theory)
Borrower has more or better information than lender
In developed countries use of material collaterals
(guarantees on loans)
Microcredit is a “contract mode” that reduces
Adverse Selection and Moral Hazard
based on
Social Collaterals

11. Economics of Microcredit
Microcredit officers by using
Innovative Lending (Group) Methodologies
are able to distiguish
Low Risk Debtors vs High Risk Debtors
(Adverse Selection)
and
Provide the right incentives for the action
(Moral Hazard)

12. Mechanisms to reduce Information Asymmetry
 Group lending (joint liability)
 Threat of non-renewal
 Rotating access to credit
 Weekly repayment
 Forced savings
 Meeting participation
 Village meeting
 Women borrowers
 Dynamic incentives
Adverse Selection
Moral Hazard
Moral Hazard
Self-signaling
Self-signaling
Self-signaling
Social Pressure
Adverse Selection
Moral Hazard

14. The lending methodology adopted in every specific
context from Bangladesh to South America blends
some of the previous mechanisms, but the way in
which do that depends on local context, and so
does not exist a best lending methodology in
absolute, especially if is not well linked to the specific
social, cultural, economic and legal environment
of the place in which operates.
Best Lending Methodology

15.  Individual lending: is the oldest form of micro-lending –
generally approximates traditional commercial bank lending. Modify
bank methods to meet the needs of low income borrowers.
 Latin American Solidarity Groups: consist of four to seven
members. Groups self-select members and guarantee each
other’s loans (joint liability). Initially, most of the clients were
female.
 The Grameen Bank: lending programs form small, five-member
self-selected solidarity groups that are then incorporated into
village “centers”. Clients are women, members assume
responsibility and manage themselves, making decisions.
Conventional Microcredit Models

16. Village banking: community managed loan fund methodology,
30 to 50 members, mostly women. By this methodology village
bank will be independent financially and in the administration and
management. Approach successful in reaching the rural poor
(income-generating activities).
 Credit unions: rely totally on the savings and fees paid by their
members. They are financially independent from their creation.
Community-based often consist of 30 to 100 members. CUs set
their own terms and conditions for loans.
Conventional Microcredit Models

17. Loans Type
Enterprise Loan
are for establishing a new business or expanding
an existing one with the aim of enabling the
borrower to secure a sustainable livelihood
Liberation
Loans
are for repayment of loans taken from money
lenders on exorbitant high interest rates
The Education
Loan
caters to the needs of the poor who are unable to
finance their own or their dependent’s education
The Health
Loan
is for those who are unable to support the costs
for necessary health care

18. Loans Type
The Emergency
Loan
is intended to diffuse the impacts of major
contingencies or crisis situations that undermine
the sustainability of the livelihoods of the poor
The Housing
Loan
is for necessary renovation of houses including
construction of rooms, roofs and walls
The Marriage
Loan
is to facilitate the marriages of daughters
The Silver Loan to support the expansion of existing businesses

19. Sustainability vs Povery Alleviation
Interest Rate
=
Cost of Funds
+
Loan loss expense
+
Transaction cost
Average MF rate
20% - 37%
Money Lenders
200%
Transaction cost:
(application, evaluation, loan
process, disbursing, monitoring
and repayment)

20. The Case of Pakistan

21. Riba
Despite some discussion among scholars, Riba
refers to all forms of interest (Khan 2008).
Prohibition of
speculation
Any form of business activity where monetary
gains are derived from mere chance, speculation
and conjecture are prohibited
Prohibited
Activity
Activities which are prohibited under the Shari'a
(casinos, breweries, etc).
Sharing
business risk:
Funder are not considered creditors but rather
investors.
Uncertainty is
forbidden
In commercial transactions must not be any
uncertainty about the key terms of the contract.
Islamic (Micro)finance Principles

22. Murabaha
An asset-based sale transaction used to finance
goods. Involves the resale of a commodity, after
adding a specific profit margin (mark-up).
Mudaraba
Financing agreement whereby an investor entrusts
capital to an agent for a project. This agreement is
akin to the Western style limited partnership.
Musharaka
Is an equity participation in a business venture.
Profits are shared in pre-agreed ratios but losses are
borne in proportion to equity participation.
Ijarah
Is a leasing contract typically used for financing
equipment and asset.
Qard hasan
Borrower should only repay the principal (interest–
free), weak or needy sections of society.
Islamic (Micro)finance Models

23. Social Innovative Business Model
Akhuwat
Social Vision: interest-free loans to economically poor
(Qard Hasan)
Innovative Lending Methodology: Family Loans
Sustainability: Transforming Borrowers into Donors
Very Open Expansion strategy
High Operational Efficiency, Service Quality and Transparency
Islamic model (do not limit access due to religious norms)

25. (Individual Lending Methodology)
 Family loan is the most common type of loan that Akhuwat offers
to its clients for setting up or expanding a business.
 Family members have to support the business idea
 Loans are co-signed by male and female head of the family
 Income from the business is jointly shared by the whole family
 Mechanism used: Membership fee, Guarantors, Insurance,
Evaluation business idea, family support, public disbursement and
repayment, of religious place, interest free loans  responsibility
Family Loans

28. Group lending vs Individual Lending
• Rural Poor
• Strong social ties
• Minimize Cost
• Empowerment
• Urban Context
• No strong social ties
(Group Leader Role)
• Higher Cost
• Less Inefficiencies
(Timing- Innovative PRJ.- No
sharing PRJ. - Higher Amounts)

29. Criticisms
 Alleviation of Poverty vs Profit Maximization
 Microcredit has driven poor households into a debt-
trap
 Microcredit has not had a positive impact on gender
relationships
 Interest rates are too high
 The ‘privatizing of welfare’
Strong link to the local context – Integrated Approach