Microfinance and the Grameen Bank

Authored by Caleb Levell

Definition

Microfinance is a term applied to a variety of contexts among banking and nonprofit aid practitioners, researchers from varying academic disciplines, and organizations in both the public and private sectors. As a core concept, microfinance refers to delivering financial services to low-income people, particularly in relation to poor or impoverished individuals or groups in developing regions around the world (CGAP Microfinance Gateway). The identifications of low-income, poor, or impoverished individuals represent those living below the international poverty line of $1.90 a day (The World Bank – Poverty). Practitioners within the industry commonly apply the term to describe a specific type of banking or an individual service within the banking system; however, for this briefing paper, the concept relates more closely to the global movement that offers “high-quality and affordable financial services” for philanthropic purposes (CGAP Microfinance Gateway).

Today, microfinance services encompass a broad spectrum of financial tools that aid low-income individuals and families to improve their quality of life and financial reliability (Collins 2009). The most common of these financial tools include microcredit, microsavings, and microinsurance. Microcredit services award small loans to unsalaried borrowers with little or no collateral (CGAP Microfinance Gateway). Microsavings services consist of small deposit banking accounts offered to low-income families or individuals as an incentive to store funds for future use (Babajide, Taiwo and Isibor 2015). Microinsurance services protect low-income people with affordable insurance products with low-premiums and aim to assist them when recovering from common risks (Microinsurance 2006).

Microfinance services are housed within organizations called microfinance institutions (MFIs). Microfinance institutions that dedicate their services to the poor take on many organizational entity types including non-governmental organizations (NGOs), credit unions, cooperatives, private commercial banks and non-bank financial institutions, and parts of state-owned banks (Mawa 2008).

One of the most accomplished and well-known of these microfinance institutions is the Grameen (meaning “of the Village”) Bank. The first of its kind and founded by Dr. Muhammad Yunus, Grameen Bank provides credit to the “poorest of the poor in rural Bangladesh without any collateral” (Grameen Bank). By providing credit to individuals who were previously unable to receive it, Grameen Bank aims to fight poverty and serves as a catalyst in the development of socio-economic conditions of the poor. From its inception to December 2015, Grameen Bank has served 8.81 million borrowers, 97 percent of whom are women, and now covers more than 97 percent of the total villages in Bangladesh (Grameen Bank).

Historic Roots

The philanthropic desire to help poor people access financial services features a long social and cultural tradition across many regions throughout the world. In fact, it is possible that much of the traditional origins of microfinance and microcredit has been lost as charitable lending establishes itself as a familiar business and philanthropic practice repeated throughout much of human history (Roodman 2012). However, “in books, manuscripts, and even stone tablets that have survived the ages,” there are examples of a “rich mosaic of arrangements that people have fashioned to help each other borrow, save, and insure” (Roodman 2012, 38). For instance, the roots of microfinance services trace back to ancient Greece and Athens in the custom of eranos, where an individual would borrow from a group of creditors and repay the debt in installments. Similar practices with different names, such as burial clubs and friendly societies, occurred prior to the industrial era in places such as Rome, Medieval Europe, China, Scotland, and England (Roodman 2012).

The most direct historical root to the modern day microfinance movement emerged in Ireland during the 1720s to mid-1800s in a program called the Irish loan funds. The program started when Dean Jonathan Swift of St. Patrick’s Cathedral in Dublin (and author of Gulliver’s Travels) developed a fund granting small loans to create opportunity for those around him living in poverty. Swift targeted these loans to small businesses and artisans for no collateral, and instead, required each borrower to enlist two co-signers that guaranteed the individual repay the loan installments on time (Roodman 2012, 36). The success of his philanthropic concept sparked a national movement in Ireland over the next couple of centuries where many other regulated, but independent, funds were designed to transfer capital to the “industrious poor” (Hollis and Sweetman 1996). In this nationalized system, loans were required to be no more than 10 pounds, run no longer than a 20-week repayment schedules, and carry low interest rates (commonly around 8 percent) (Krieger 2015). By the mid 19th century, the Irish loan fund system was lending to 20 percent of Irish households (Hollis and Sweetman 1996).

Modern day microfinance is similar to the Irish loan funds, although the services have relocated to the underdeveloped or newly-developing nations of the 21st century. In closer comparison to the Irish loan funds, modern day microfinance retains the same spirit of bypassing the elite and rich within a society to better provide direct access to the poor. Unlike the Irish loan funds, however, today’s microfinance institutions most commonly provision services to women (Roodman 2012).

Dr. Muhammad Yunus, founder of Grameen Bank (est. 1983), is often considered the leading pioneer for modern microfinance. Dr. Yunus, a former Economics Professor at the University of Chittagong, worked with his students to address poverty in nearby villages. Upon investigating the needs of local villagers, Dr. Yunus developed an intervention called the Grameen lending model during the 1970s. Within this model, a group of five villagers join together and request a loan from the lender. The lender distributes the loan to an individual within the group, and the group holds each of its members accountable for their individual loans. Loans are repaid in weekly installments over the course of a year, and once a loan is repaid, the lenders are able to request larger loan amounts (Krieger 2015; Roodman 2012).

The success of the Grameen lending model led to multiple competitors and imitations around the world, and throughout the next few decades, the microfinance movement spread via published reports and word of mouth. As this philanthropic act evolves, other innovators and organizations have developed variations and additional services to the microfinance movement. Today, many differences of opinions, technology opportunities, and profit schemes present disagreements over the future direction of the microfinance movement. For example, when considering just the diversity in the type of microfinance institutions set up to deliver microcredit to the poor, a 2009 report showed there were 407 designated as nonprofits, 384 non-bank financial institutions, and 81 full commercial banks (Roodman 2012, 106). Certainly, the future will continue to bring change and evolution to the microfinance movement, and the ubiquitous availability of digital and mobile technologies will encourage new financial services to aid those individuals and families living in poverty.

Importance

In September 2000, world leaders gathered at the Millennium Summit and adopted the UN Millennium Declaration setting goals to reduce extreme poverty in the world over the next 15 and 30 years (Millennium Project). As of 2013, estimates showed that 10.7 percent of the world’s population (767 million individuals) lived below the international poverty line of $1.90 a day, down 35 percent from 1990 (1.85 billion individuals) (World Bank Overview 2016). A more specific goal of the UN summit focused on delivering universal financial access by the year 2020 under the assumption that financial access serves as a bridge out of poverty. From 2011 to 2014, 700 million adults gained access to financial services dropping the percentage of the unbanked 20 percent; however, this still leaves 2 billion adults without access to banking (World Bank Unbanked 2015). As the UN statistics illustrate, extreme poverty threatens hundreds of millions of adults and children across the world. The past impact and future potential of the microfinance movement maintains a key role in improving the lives of the poor over the upcoming years and decades.

Regarding finances, one of the greatest challenges facing poor people around the world is an unreliable and undependable income (Collins 2009). While poverty is measured by the international poverty line unit of $1.90 a day, those living in poverty do not live off a steady income as the statistic suggests. Poor individuals and families cope with varying ranges of income throughout the week, month, and year, and often times will find themselves managing periods with no income at all. However, research proves that those living in poverty are adept savers and quite responsible when managing money (Collins 2009). Therefore, the incredible benefit and opportunity of microfinance is offering the poor the same full-range of affordable financial advantages that the rich have access to, ultimately empowering them to “manage the uncertainties of being poor” (Roodman 2012, 6).

In fact, the benefits of microfinance could prove to be much greater. As research continues to be gathered and microfinance practices evolve due to technology and mobile banking, the loftiest hopes of the movement could still be realized. For example, many claim microlending increases the opportunity of microenterprises, empowers rural and poor women, and lifts families from extreme poverty (Karnofsky 2009). However, until that research is conclusive, the microfinance movement will settle for improving the quality of life for the poor by helping them “smooth their consumption level, manage unexpected risks, build assets, and educate their children” (Mawa 2008, 881).

Ties to the Philanthropic Sector

Tackling the issue of extreme poverty requires many institutions both collaborating in uniformity and operating independently to develop optimal philanthropic solutions. Look no further than the diverse systems and institutions established to deliver microfinance services to the poor. From commercial banks to charitable aid nonprofits to foundations to social businesses, there is a race to provide these programs to the poor, and while the motivations vary across institutions, research shows the poor will benefit from affordable and bulk packaged financial services regardless of the operational and delivery structures (Roodman 2012).

Consequently, the innovation and expansion of the microfinance movement is considered one of the earliest appearances of a new paradigm shift to the modern philanthropic sector, which relies heavily on cross-sectoral collaboration, sustainable outcomes, social entrepreneurship, and social-impact investing (Salamon 2014). The successes of the Grameen Bank, for example, demonstrate that a traditional, nonprofit is not the only organizational platform that can improve the lives of those living in poverty. Guided by a cause-oriented mission, the for-profit Grameen Bank aids borrowers in business decisions, empowers them to start small-enterprises, and even finds other ways to help members when they cannot pay back their loans (Yunus 2007). Likewise, many microfinance institutions, regardless of their formal operating structure, have similar ties to the philanthropic sector due to setting social objectives that aspire to eliminate poverty and improve the quality of life for the poorest of the poor.

Key Related Ideas

• Microenterprise – A small business created or supported due to a microloan. Often microcredit is lauded for increasing entrepreneurial opportunities, but the financial diaries of the poor show that credit financing is used in a variety of ways (i.e. consumption costs) (Collins 2009).

• Social Business -  A cause-driven business, instead of profit-driven, with the potential to act as a change agent in the world. Within Dr. Yunus’s argument for social business, he describes that the company may earn a profit, but the investors who support it do not take any profits out of the company. The original Grameen Bank operated similar to a social business model (Yunus 2007).

• Social-Impact Investing – An umbrella term that describes the field of study and business practices mobilizing private investment capital for social purposes. Social-impact investing generates outcomes that “promote the health, well-being, and quality of life of a population, particularly disadvantaged segments of that population; encourage the free expression of ideas; or foster tolerance” (Salamon 2014, 18-20).

Important People Related to the Topic

• Sir Fazle Hasan Abed (1936 - ): Founder of BRAC, an organization dedicated to the alleviation of poverty and empowerment of the poor in Bangladesh. BRAC is one of the largest development organization in the world in terms of the scale and diversity of its interventions (BRAC).

• Chelsa Bocci, Matt Flannery (1977- ), Jessica Jackley (1977-), and Premal Shah (1975-): Social entrepreneurs and cofounders of Kiva, the world's first peer-to-peer microlending website. Kiva lets internet users lend as little as $25 to individual entrepreneurs, providing them affordable capital to start or expand a small business.

• Jonathan Swift (1667-1975): Nationalist and author, Jonathan Swift started the 18th and 19th century movement of the Irish loan fund (Krieger 2015).

• Muhammad Yunus, Ph.D. (1940 - ): Dr. Muhammad Yunus, affectionately known as “Banker to the Poor,” established the Grameen Bank in Bangladesh in 1983 fueled by the belief that credit is a fundamental human right. His objective was to help poor people escape from poverty by providing loans on terms suitable to them and by teaching them a few sound financial principles so they could help themselves. He, along with Grameen Bank, received the Nobel Peace Prize in 2006 (Muhammad Yunus).

Related Nonprofit Organizations

• Accion International is a global nonprofit dedicated to building a financially inclusive world with economic opportunity for all, by giving people the financial tools they need to improve their lives. (https://www.accion.org/)

• Bill & Melinda Gates Foundation (Global Development Division) - The Bill & Melinda Gates Foundation’s Financial Services for the Poor program aims to play a catalytic role in broadening the reach of robust, open, and low-cost digital payment systems, particularly in poor and rural areas—and expanding the range of services available on these platforms. (http://www.gatesfoundation.org/)

• Kiva.org - Kiva is an international nonprofit with a mission to connect people through lending to alleviate poverty. Kiva was the world’s first peer-to-peer microlending website. (https://www.kiva.org/)

• Small Enterprise Foundation - The Small Enterprise Foundation (SEF) is a not-for-profit, pro-poor microfinance institution which began operations in 1992. The aim of SEF is to work towards the elimination of poverty and unemployment. SEF employs a group-based lending methodology patterned after the Grameen Bank of Bangladesh. (http://www.sef.co.za/)

Reflection Question - Dr. Muhammad Yunus believes that access to credit is a basic human right just as necessary as universal access to food, shelter, and health. Should access to credit (and other financial services) be considered a fundamental human right, and what role does the world’s philanthropic community have in delivering these financial services to the poor?

Bibliography

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This paper was developed by students taking a Philanthropic Studies course taught at the Lilly Family School of Philanthropy at Indiana University in 2017. It is offered by Learning To Give and the Center on Philanthropy at Indiana University.