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microlending

Contributor(s): Matthew Haughn

Microlending is the provision of small, low-interest loans to low-income individuals and groups. The practice is one element of microfinance -- the provision of banking services to customers that lack access to traditional financial services, usually because of poverty. 

Microloans are provided as a way of enabling lower-wealth entrepreneurs and business owners to improve their earning power through the acquisition of needed resources. Microloans are more commonly given to women because of greater perceived need and also, statistically, their better record of paying back loans.

Bangladeshi banker Muhammad Yumis invented the microlending model in 1983 when he founded the Grameen Bank in the town of Jobra. Yumis initially used his own money to provide microloans to people in need. Before microlending, such people had few options other than loan sharks, and borrowing from loan sharks almost inevitably left them worse off than before. Yumis won a Nobel Peace Prize in 2006 for his social efforts.

The microlending model has expanded into large, profit-driven financial institutions. In 2015, there were over 125 million recipients of microloans, of which 80 percent of which were women. The total of these loans was $5.2 billion.

This transition of microlending from small lenders to big banks has involved some changes to address the low margin and high cost of processing these loans. For example, banks have begun loaning to groups rather than individuals to reduce the cost per loan. Group lending also increases the likelihood of payback because of the effect of peer pressure.

Non-profit organizations (NPO) that offer microlending may offer better hope for the success of the model. A non-profit called Kiva offers funds from private individuals who choose to loan through its service. The organization boasts one of the highest microloan payback rates among all providers, despite the fact that the organization suggests that lenders write off unpaid loans as charitable donations.

Critics of microlending point out that it doesn’t elevate the overall status of low-income groups, despite anecdotal successes. Studies compiled by the American Economic Journal: Applied Economics indicate that many who manage to pay back the loans still get locked into exploitive debt cycles. On average, the economic situation of those receiving microloans has not been enhanced, according to the journal’s research, and the profitability of the businesses rarely improved.

This was last updated in May 2017

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