Microcredits: A Completely Wrong Path?

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In the first part of my series of articles, the principle of the microcredit system was explained. However, there is now strong criticism of this idea.

The reports of the proponents of the microcredit system – starting with its main protagonist, Muhammad Yunus, the founder of the Grameen Bank – are full of case studies of women who have successfully emerged from poverty with microcredit. But the reality seems to be different. Has the well-meant “helping people to help themselves” turned into a capitalist business model that is destroying modest livelihoods?

There are now numerous studies that have investigated the effectiveness of microcredit. The result is disappointing:

A systematic analysis of all microcredit evaluations available until 2011 even came to the conclusion that there is no robust evidence for the poverty-reducing effects of microcredit,” writes Oliver Schmidt in ‘Zeit’.

Kathrin Hartmann, a German journalist and author, could hardly find any positive effects: “In the 1990s, the Bangladeshi anthropologist, Aminur Rahman, for example, discovered  that only 5% of micro-borrowers receive income from companies that they had built up with the loan.”

Journalist, Gerhard Klas, published an extremely comprehensive review in 2011 with the book “Die Mikrofinanzindustrie” (The microfinance industry). His verdict is also devastating: in practice, only a very small percentage of female borrowers (as shown in Part 1, microcredits are almost exclusively given to women) have actually managed to build a better life, most have slipped into even deeper poverty than before.

So, what’s wrong? The first problem is the level of interest: microcredit banks are not charitable organisations, they must at least cover their costs. Due to the high administrative and consulting expenses in the microcredit business, this leads to extremely exuberant interest rates, which, according to Gerhard Klas, amount to around 38% – even here in Austria, you pay only one-third of that even for an overdraft with bad terms.

Klas also accuses the banks of concealing the real costs of the loan to the borrowers: “Many MFI customers [= microfinance institutions], usually a high percentage of illiterate people, are not even informed about how high the interest rates they actually have to pay for their microloans are,” he writes in “Die Mikrofinanzindustrie” (page 30). In addition to the nominal interest rate, which is already around 20% per annum, there are also considerable fees and an amount that would have to be saved at the lending bank.

Problem number two: many of the borrowers do not invest the loan amount in setting up a company, as originally planned, but use it for basic needs, such as food or medical care.

With the loans, the “holes” in the family budget are filled. This often sets a debt spiral in motion: many borrowers are unable to pay interest and repayment installments from their income and take out new loans in return, one loan is repaid with another – usually by another bank. The result is a chain of loans that must be taken out on increasingly unfavourable terms. However, most microloans are actually repaid in this way and polish the banks’ statistics as “success cases”. In this way, the repayment rates of over 90%, with which the microcredit banks demonstrate the success of their model, come about.

Such credit accumulations are apparently widespread: “Just a few years ago, 40% of borrowers were in debt to more than one microfinance institution. Today it is already 70%,” said Lila Rashid, head of the microcredit supervisory authority in Bangladesh in 2010, quoted in “Südwind Magazine”.

Above all in Bangladesh, the “mother country” of this idea, far too many microcredit banks are now active and they are in strong competition with each other. Loans are granted without much scrutiny, and installments and interest are often collected using other methods. The idea of microcredits has degenerated into a profit-oriented business model on a large scale in this country: “Bangladesh [..] has over 160 million inhabitants. [..] Almost one-fifth of them – 30 million – are customers of a microfinance institution,” wrote Klas in 2010 in “Südwind Magazine”. Unfortunately, more recent figures could not be found, but the problem has likely worsened even more.

The credit brokers – i.e. the bank employees who look after the customers and are actually supposed to provide intensive advice – are generally overworked and are under pressure to broker as many loans as possible and process them successfully in order to keep their job: “Employees often have to work longer than 12 hours a day – under great time pressure. For ‘individual advice and support’ (…) there is no time,” according to”Die Mikrofinanzindustrie” (page 39).

The mood among bank employees and their clients is, therefore, often tense, even the threat of violence and the arbitrary confiscation of property is reported. Gerhard Klas describes a typical case in “Südwind Magazine”: “Roshida Kathoom rescheduled debts, borrowed money from neighbours, took out further loans from other providers. Since then, the 38-year-old has not been able to get out of the debt spiral. One day, when Grameen Bank employees drove up on their motorcycles and threatened her because of her default payments, her husband went to the lenders in the village, who charge over 100% interest. Finally, the couple had to sell half of their land – a quarter of a hectare on which beans, guavas, coconuts, and papayas were grown.”

Many critics consider the system to be fundamentally misguided because microcredits have shifted the debts that were previously the national debts of developing countries to the private level. The talk is of a “privatisation of poverty”.

The fact that large international banks such as Deutsche Bank, Morgan Stanley, Citibank and Credit Suisse have now also entered the microcredit business proves that lending to very poor people is profitable.

As such, a profit-oriented capitalist model has been built on the backs of the poorest: “Microcredits do not serve the poor, but global financial capital. They are not an act of humanity, but the concentration of neoliberal development policy: the high national debt of poor countries will be extended to the individual,” Kathrin Hartmann stated in the Frankfurter Rundschau in 2012. The concept that people in developing countries could free themselves from poverty as independent small entrepreneurs simply does not work, Hartmann continued:

The fundamental misconception of neoliberal development aid, however, is that everyone can free themselves from poverty as entrepreneurs. It is nothing more than the idea of a one-man business1, which has failed magnificently even in rich Germany.

So do microcredits have the opposite effect to their actual intention? Is capitalism again part of the problem and not a contribution to its solution? Or can the system make a significant contribution to poverty reduction with some improvements? Read more in part 3 of the series!

1 a business founded by someone who is employed and provided with subsidies from the State

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