Saturday, January 2, 2010

Microcredit – An Opportunity for Financial Institutions

Microcredit is an extension of very small loans (microloans) to those in poverty designed to spur entrepreneurship. These individuals lack collateral, i.e. (in lending agreements) a borrower’s pledge of specific property to a lender, to secure repayment of a loan. Microcredit is a part of microfinance, which is the provision of a wider range of financial services to the very poor. The financial innovation of microcredit has originated – at least that is the general consensus – with the Grameen Bank in Bangladesh. In that country, it has successfully enabled extremely impoverished people to engage in self-employment projects that allow them to generate an income and, in many cases, begin to build wealth and exit poverty.

The system of the Grameen Bank is based on the idea that the poor have skills that are under-utilized. A group-based credit approach is applied which utilizes the peer-pressure within the group to ensure the borrowers follow through and use caution in conducting their financial affairs with strict discipline, ensuring repayment eventually and allowing the borrowers to develop good credit standing. The bank also accepts deposits, provides other services, and runs several development-oriented businesses including fabric, telephone and energy companies. Another distinctive feature of the bank's credit program is that a significant majority of its borrowers are women.

Professor Muhammad Yunus, who launched a research project to examine the possibility of designing a credit delivery system targeted to the rural poor, can be seen as the founder of the Grameen Bank.

Due to the success of microcredit, many in the traditional banking industry have begun to realize that these microcredit borrowers should more correctly be categorized as pre-bankable; thus, microcredit is increasingly gaining credibility in the financial services sector. Many large finance organizations are now considering microcredit projects as a source of future growth, which is interesting, given that almost everyone in larger development organizations speculated on the likelihood of failure of microcredit when it was begun.

The United Nations declared 2005 the International Year of Microcredit and in 2006 received Professor Muhammad Yunus – in recognition of his efforts – jointly with the then independent Grameen Bank organization the Nobel Piece Price.

In the course of the financial crisis many small companies and entrepreneurs around the globe had problems to get access to a loan. This is especially true in Spain where the real estate market collapsed. La Caixa, the biggest savings bank in Spain, who founded in 2007 with Microbank the first European bank, specialized on microcredit, is very well positioned to help those in need of a small credit. The bank also proved that it can be a very profitable business. In their first two years of existence they financed 48813 projects with a volume of 331.8 million Euro (~ 480 million USD). Of course the financial crisis caused reluctance in new investments and company foundations. Nevertheless, the business of the bank is steadily growing. Microbank, also called “the social bank of La Caixa” generated a net income of 5.2 million Euro (~ 7.5 million USD). Half of the money went to families to overcome their current financial shortages, the other half was put into company projects.

According to a study by Esade, a Spanish management firm, 84% of the company projects financed by microcredit from the Microbank proceed successful. Furthermore, every fifth company hired 3 or more additional heads for their workforce.

I believe that – as a direct consequence of these successes –financial institutions and governments will become more and more interested in this concept to open up new revenue generating possibilities and respectively overcome problems with high unemployment. Needless to say that this will go hand in hand with new process and reporting requirements for the microcredit business.