Microcredit vs. Appropriate Credit

Microcredit initiatives often come into question when discussing poverty alleviation efforts. What are microcredits, how they are provided, and what their implications are will be discussed later. It is worth mentioning here that significant changes have occurred in the microcredit scheme since 2011.

Let's ask a question at this point: When did microcredit practices start in this region? Microcredit programs did not start after Bangladesh gained independence. They existed long before. Nobel laureate Rabindranath Tagore initiated a form of microcredit program, but he couldn't succeed in this field because he couldn't be strict about loan repayment. Even moneylenders used to provide a form of microcredit. They enforced strict installment payments through various means. The actual benefit to the borrowers was not considered.

Microcredit programs started in Bangladesh in the 1970s and expanded significantly in the 1990s and 2000s. Although various other credit schemes were introduced fundamentally, microcredit under the Microcredit Regulatory Authority (MRA) still exists extensively with fewer service charges than before and some other changes. I will first explain microcredit programmes and then discuss the modified arrangements and some discussions on appropriate loans.

Microcredit is typically offered for duration of one year, with a total of 46 installments covering both service charges and principal repayment starting from the week after loan disbursement. Many NGOs operating microcredit programmes that emphasize profit-making opportunities have been active, especially before 2010. In 2010, according to evaluations by the Microcredit Regulatory Authority (MRA), the standard service charge rate was generally between 35-50 percent. Microcredit was considered a lucrative business at a high rate of interest.

Additionally, until before 2011, the service charge was determined on a flat-rate basis, and the service charge for the entire year was calculated on the day the loan was disbursed, even though service charges and principal were included in each weekly installment thereafter. This meant that borrowers effectively held half the total loan amount for the entire year. As a result, the actual service charge rate doubled directly. Moreover, initially, borrowers were required to maintain a certain amount of savings, usually deducting 5 percent of the total loan amount provided, and had to keep a certain amount of money saved with the NGO providing the loan each week. Additionally, administrative costs ranging from 50 to 150 taka were typically charged for processing applications. Borrowers were also required to incur other expenses. A minimal (usually 3-5 percent) interest was paid on the savings collected from borrowers. The collected savings were either deposited in a bank or used to generate significant profits as microcredit. Taking all these considerations into account, the MRA calculated the aforementioned rate on the actual service charge.

Another alternative to the prevalent microcredit system was introduced by PKSF in 2010. However, as mentioned earlier, despite some changes, microcredit continues to be extensively practiced. To effectively implement microcredit programs, additional services are needed along with financial assistance. However, traditionally in Bangladesh, there was generally no provision of additional services along with microcredit. Furthermore, there was (and still is) no inquiry into how repayments are made—whether through selling property, consuming, or otherwise. It can be observed that the primary focus of microfinance institutions has always been their own sustainability rather than the development of the borrowers.

Merely by providing a small amount of money, impoverished individuals generally cannot break free from poverty. Poverty is multifaceted. Through microcredit, borrowers may improve their overall situation, but this was never (and still isn't) a guaranteed outcome.

Another mandatory aspect of microcredit is forming groups of borrowers, where each group typically consists of five members. While there is no collateral required for microcredit, group members serve as a form of collateral for each other. However, this method is effective only when the loan amount is relatively small; if the amount exceeds a considerable sum (like one or one and a half lakh), the group solidarity doesn't work, and members are reluctant to take responsibility for each other. It is evident that these group formations in microcredit mostly serve to keep borrowers small. In terms of advancing confidently towards self-reliance, where significant amounts of money are needed, microcredit is not very helpful.

Following the decision of the MRA, from 2011 onwards, a progressive method was adopted instead of a flat rate for determining service charges. Initially, the service charge was set at 27 percent, later reduced to 24 percent after several years, which still stands. The mandatory 5 percent savings collection practice at the time of loan disbursement was abolished. The application processing fee was set at 15 Taka.

Currently, microcredit operations are conducted in accordance with the guidelines of the MRA from time to time. Depending on the level of borrowers, special grants, ranging from 24 percent to 1 percent, 4 percent, 8 percent, and 18 percent service charges, are provided, excluding 24 percent for PKSF.

In microcredit programs, a specific amount of money is provided regardless of the actual requirement for completing a particular task. For example, if a poor individual seeks a loan of 40,000 Taka to start a small tea-biscuit shop, they may only be granted 20,000 or 25,000 Taka. They would then have to seek additional loans from other institutions for the remaining amount. Consequently, many individuals end up trapped in a cycle of borrowing from multiple sources, making it difficult for them to break free. Even if they do not borrow from other sources, the funds obtained from the proposed loan may not be sufficient for the intended purpose, leading to expenses elsewhere and creating difficulties in loan repayment.

Various research studies have shown that despite taking microloans in Bangladesh, the income of borrower families may have increased, but more than 10 percent of them still may not have risen above the poverty line. Research published in 2010 by the Washington-based Microcredit Summit Campaign revealed that from 1990 to 2008, only 9.4 percent of microloan recipients in Bangladesh rose above the poverty line. Similar results have been found in research conducted in other countries, including India, Mongolia, the Philippines, Bosnia-Herzegovina, Mexico, Morocco, and Ethiopia, by the Microcredit Action Lab and Innovations for Poverty Action in conjunction with the MIT Abdul Latif Jamil Poverty Action Lab (published in 2015).

Moreover, those who take microloans to uplift themselves out of poverty may still fall below the poverty line due to various reasons such as illness or death, natural disasters, etc. Thus, microloans neither effectively alleviate poverty nor ensure sustained poverty alleviation.

During my tenure as the Chairman of Palli Karma-Sahayak Foundation (PKSF) from 2009 to 2023, appropriate loan programs were initiated to exceed the limits of microfinance, guided by my directions. The fundamental concept of these suitable loan programs was to provide adequate proposals and perform activities for low-income families in lieu of small loans. The amount of money required for them to carry out these proposed activities was provided as loans, along with various necessary non-financial services. If someone needed one lakh taka, they would receive exactly one lakh taka, and similarly, if someone needed five lakh taka, they would receive five lakh taka, ensuring that loan recipients did not have to approach multiple lending institutions for the initiative's implementation.

For those who are extremely poor and capable of utilizing a certain amount of money effectively, the same amount is provided as a loan without the need for a microfinance format. Providing more loans than necessary could lead to ineffective utilization of funds. Under the appropriate loan program, PKSF initially arranged for loans up to a maximum of 10 lakh taka. Later on, the amount of funds for each loan was increased based on specific circumstances. Loans were disbursed according to the needs and feasibility of the borrowers.

One noteworthy aspect in the microfinance sector is the provision of weekly installments for loan repayment, starting from the end of the first week. This makes it challenging for borrowers because some time is required for the income-generating activities for which they have taken the loan to yield returns. Consequently, some borrowers separate the funds received as loans into weekly installments to facilitate repayment, which could reduce the amount available for investment. Alternatively, borrowers may use funds from other sources to make installments. However, ensuring timely repayment under the appropriate loan program involves discussing with borrowers to arrange installment payments conveniently. In the agricultural sector, loans can be repaid after the harvest.

Until my tenure as the Chairman of PKSF, the organization not only implemented various programs for appropriate loans and necessary non-financial services but also facilitated the creation of 2.7 million cottage and micro-entrepreneurs across different sectors throughout the country. Starting from 2010, PKSF embarked on a special program for innovation, primarily focusing on the cottage and micro sectors. Many of these entrepreneurs have successfully managed business operations along with achieving success. Some have even expanded their operations into larger arenas.

A significant addition to this transformative arrangement is the Union-based Integrated Human-centered Multidimensional Development Approach, known as Rural Development Program for Prosperity. By participating in appropriate loan programs and availing themselves of non-financial services, a large number of people who were once extremely poor or poor have been able to rise above the poverty line, become self-reliant, and progress steadily towards improvement. They are contributing to the significant transformation of rural economy and development.

A notable aspect of rural communities is that many people are now becoming and functioning as cottage or micro-entrepreneurs, with some already established in this role. As a result of these initiatives, rural economies are experiencing increased value addition. Many individuals involved in various cottage and micro-enterprises in rural economic activities are providing equipment for larger industries, and some are even producing goods. To effectively promote rural economic development, there needs to be stronger governmental programs for mechanizing agriculture, and particular attention should be given to fostering the creation of widespread entrepreneurship.

In order to identify those who have the potential to undertake initiatives, efforts should be made to recognize them and awaken their latent potential, providing necessary financial and non-financial support.

Lastly, it is essential to emphasize the need for appropriate arrangements for providing necessary non-financial services along with discontinuing the microcredit program. Moving forward, in order to advance the progress of impoverished individuals with low income, efforts should focus on fostering inclusive, sustainable development.

Regarding the microcredit program, I initially conducted an analysis of its ineffectiveness in alleviating poverty in a paper in 1983, which I further emphasized in a speech at a seminar organized by the Bangladesh Economic Association in 1995. I mentioned the content of my book published based on nationwide research in 2007. From 2009 to 2023, during my tenure as chairman of PKSF, I extensively observed and directed the microcredit program at the grassroots level, bringing about significant changes and providing guidance for notable improvements. PKSF and its partner organizations have effectively implemented and integrated all these ideas, transforming PKSF from a microcredit provider to a large-scale development institution. Many of PKSF's partner organizations have overcome the stigma of past microcredit-related controversies and gained recognition as genuine development institutions.

Author: Economist and Chairman, Dhaka School of Economics.
Transcribe: M A Khaleque