What is a 'Microcredit'

Microcredit is an extremely small loan given to impoverished people to help them become self-employed. Microcredit is 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 the group's own small business. 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 to whom such microcredit is offered may live in barter systems where no actual currency is exchanged. The women in Bangladesh who received microcredit, for instance, did not have money to purchase the materials they needed to make the bamboo stools that they would, in turn, sell. The initial financing gave them the resources to begin production, with an understanding that the loan would be paid over time as they brought in revenue.

The structure of microcredit arrangements frequently differs from traditional banking, wherein 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 toward 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.

Also, the borrowers may find themselves with a magnitude of debt they cannot repay, even with the small-scale loans offered through microcredit. The problem is that the borrowers may not have a steady income source, or they plan 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 have resorted to selling off personal property and seeking new financing to cover their previous microcredit.

RELATED TERMS
  1. Muhammad Yunus

    Muhammed Yunus is a professor of economics awarded the Nobel ...
  2. Term Loan

    A term loan is a loan from a bank for a specific amount that ...
  3. Asset Financing

    Asset financing uses a company’s balance sheet assets, including ...
  4. Hard Money Loan

    A hard money loans is a short-term loan backed by the value of ...
  5. Unsecured Loan

    An unsecured loan is a loan that is issued and supported only ...
  6. Origination

    Origination is the process of creating a home loan or mortgage.
Related Articles
  1. Personal Finance

    Home Improvement Loans: What Are Your Best Options?

    If you plan on taking out a home improvement loan, you should know what your options are and which ones might be best for your situation.
  2. Personal Finance

    Should You Lend Money to Family or Friends?

    Find out how loaning cash to help family or friends can put a strain on your relationship and your bank account. Learn how to make family loans safer.
  3. Retirement

    Borrowing From Your Retirement Plan

    Left with no alternative but to take money out from your retirement savings? Here are some guidelines.
  4. Personal Finance

    How Women Uniquely View Finance and Investing

    Understanding gender differences on financial-related issues and how they are changing over time is fundamental to understanding the investing world.
  5. Personal Finance

    The Best Way to Borrow

    There are many ways to secure funding. Find out the pros and cons of each way to borrow.
  6. Personal Finance

    How To Apply For a Personal Loan

    Learn about different avenues for applying for a personal loan, and learn valuable tips to help you get your personal loan application approved.
  7. Small Business

    Lending Clubs: Better Than Banks?

    If you need to borrow money and your credit is making it tough, this new option may be just what you're looking for.
  8. Personal Finance

    How to Get Your Student Loans Forgiven

    The prospect of debt forgiveness may seem like a dream come true. In reality, though, not that many people end up being eligible.
  9. Personal Finance

    College Loans: Private vs. Federal

    Not all student loans are the same. Learn the difference between federal vs private student loans.
Trading Center