What is a 'Microcredit'

Microcredit is an extremely small loan given to impoverished people to help them become self-employed.

Also known as "microlending" or "microloan."

BREAKING DOWN 'Microcredit'

Renee Loth wrote an article in 2002 for the Boston Globe entitled "Women Entrepreneurs," which explores how this type of loan possibly originated. In the article Loth suggests the system started in Bangladesh in 1976, when an economics professor loaned a group of women $27 to finance their own small business. Amazingly the women repaid the loan and were able to sustain the business.

How Microcredit Works

The concept of microcredit was built on the idea that skilled people in underdeveloped countries, who live outside of traditional banking and monetary systems could gain entry into an economy through the assistance of a small loan. The people such microcredits are offered to may live in barter systems where no actual currency is exchanged. The women in Bangladesh who received the microcredit, for instance, did not have money to purchase the materials they needed to make bamboo stools that they would in turn sell. The initial financing gave them the resources to begin production, with and understanding that the loan would be paid over time as they brought in revenue.

The structure of microcredit arrangements frequently differs from traditional banking where collateral may be required or other terms established to guarantee repayment. There might not be a written agreement at all. In some instances, the microcredit was guaranteed by an agreement with the members of the borrower’s community, who would be expected to compel the borrower to work towards repaying the debt. As borrowers successfully pay off their microcredits, they may become eligible for loans of larger and larger amounts.

There have been criticisms of microcredit and the way it can be misused. For example, in South Africa microcredit was introduced in some of the poorest communities to encourage people to pursue self-employment. However, the way it was introduced in some instances led to the funds being expended through consumption spending rather than the establishment or furthering of any form of business or employment activity. Further, the borrowers may find themselves with a magnitude of debt they cannot repay, even with the small-scale loans offered through microcredit. The problem being that the borrowers may not have a steady income source or plans to use the microcredit to create an income source for themselves that would allow them to pay back the financing. As a result, some borrowers resorted to selling off personal property and seeking new financing to cover their previous microcredit.

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