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WORLD REVIEW

III. SELECTED ISSUES

Microcredit: effects on rural poverty and the environment

INTRODUCTION

Lack of access to credit has plagued poor farmers and rural dwellers for many years. Rural people need credit to allow investment in their farms and small businesses, to smooth consumption, and to reduce their vulnerability to weather and economic shocks. Because they have little access to formal financing institutions, poor rural people follow suboptimal risk management and consumption strategies and rely on costly informal credit sources. Recognizing this, governments and international agencies created banks and lending programmes targeted at rural farmers. The track record of these programmes is mixed, especially with regard to reaching the poor. Reforms and innovations have emerged in recent years to improve credit market opportunities for the rural poor and increase the efficacy of rural finance.8

Microcredit helps the rural poor escape poverty by investing in small businesses and farms.

One such innovation is microcredit, or small loans targeting the poor, and this has transformed the way credit is viewed. Microcredit is intended to help the rural poor escape poverty by investing in their own small businesses and farms. Microcredit schemes overcome some of the problems of delivering rural credit to the poor by offering collateral-free loans at near-market interest rates, through community-based programmes operated by financing institutions or non-governmental organizations (NGOs).

Microcredit departs from traditional rural banking in three main ways:

Microcredit has not been portrayed as a substitute for agricultural credit, nor for traditional banking, as it is far smaller in scale and differently targeted than such lending. However, in its most modest form, it fills gaps in credit delivery that are not addressed by other providers; and, in its most ambitious form, it attempts to catalyse economic development that will reduce rural poverty.

THE HISTORY AND EVOLUTION OF MICROCREDIT

There are many antecedents to microcredit, which is a recently coined term that is applied to a diverse range of credit activities and types of institution. Locally managed credit arrangements have existed for hundreds of years and continue to serve small borrowers despite the advent of the "microcredit movement". Examples are rotating savings and credit associations (ROSCAs) and savings and credit cooperatives (SACCOs), both of which are found in communities around the world. Small loans to poor borrowers have also been part of the rural development strategies followed by many agencies and organizations since the early 1970s. The World Bank, FAO's Rural Finance programme, and major donors and other development agencies, including agricultural development banks, have incorporated small loan programmes and products in their rural finance strategies. Thus, microcredit is older than it appears at first blush, but the invention of the term "microcredit" as well as an organization to promote it globally and the high-level endorsement of specific outreach goals have recently elevated the movement to far greater prominence.

Borrowing through microcredit schemes is growing rapidly in developing countries.

Several events in the past five years have sparked a social movement that has led to the development of a microcredit industry. The movement has been led by people outside the mainstream of rural finance and development and has posed a strong challenge to orthodox approaches. In very few years, an assortment of established and startup credit providers, advocates, evaluators, researchers, trainers and donors have focused their energies on microcredit and - in some cases - have bet heavily on its success. Debates have emerged over fundamental philosophy and technical details of microcredit delivery. Adherents have produced a flurry of examples and studies to support their view that microcredit is a revolution in social and economic development that will pull people from the depths of poverty, while critics staunchly maintain that it is not a panacea for reaching rural (or urban) poor where other credit systems have failed.

In 1976, Muhammad Yunus founded the Grameen Bank, the world's best-known provider of microcredit. Some trace the origins of microcredit in its recent form to this event. Through the Grameen Bank, Yunus was able to institutionalize features that provide a model for many - although not all - microcredit providers today. Microfinance organizations (MFOs) and programmes have since flourished, including "Grameen replications" in 45 countries. Today there are more than 1 200 institutions providing microcredit at a national level,9 26 major institutions leading international microcredit programmes,10 and 7 000 to 10 000 local and regional organizations providing microcredit as all or part of their development efforts.11

In 1997, two decades after Yunus began experimenting with loans to women in poor South Asian villages, more than 2 900 individuals, representing 1 500 organizations and 137 countries, gathered at the Microcredit Summit in Washington, DC. Headlined by Heads of State and dignitaries from the global development community, the Summit launched a campaign to reach 100 million of the world's poorest families by the year 2005. The significance of the Summit was to bring a certain aura of celebrity to the goal of poverty alleviation through microcredit, and to create an institution whose mission was to promote this goal at the global level.

It is widely perceived that growth in microcredit programmes has been phenomenal. The total number of borrowers reported through the members of the Microcredit Summit grew by 50 percent between 1998 and 1999 to reach 21 million globally; 12 million of these borrowers live on less than $1 per day.12 The Grameen Bank alone has distributed $3 billion in loans to more than 2 million borrowers in Bangladesh, with $2.5 billion repaid to date.13 Despite the fast growth, many believe the microcredit industry is still in an incipient stage relative to the potential demand for its services.14 Moreover, microfinance is increasingly becoming less of a South Asian phenomenon. For instance, one donor is concentrating sustainable microfinance development efforts in Africa, "thereby pushing the frontier beyond what has been achieved to date".15

Table 3 shows the distribution of Microcredit Summit members, major donor grants and total disbursements by region.

A remarkable success story, or a new name for an old solution? What indeed are the impacts of microcredit and is it reaching its stated goals? Who benefits and who pays the costs of microcredit delivery? Finally, are there hidden effects - either good or bad - that should be recognized in our evaluation of what importance microcredit has as a development tool? This section describes the evidence and the arguments surrounding microcredit's broad impact to date.

Also discussed briefly is one "hidden impact" of microcredit delivery: its potential effect on the rural environment and natural resource use. Despite an escalating interest in microcredit and, more generally, microfinance, there has been almost no discussion about the relationship of these programmes to sustainable natural resource use. Given the primacy of poverty concerns over environmental protection, and the long-held tendency to take natural resources for granted, this oversight is not surprising.

Microfinance organizations are more flexible than formal banking institutions, but more structured than informal rural lenders.

But it may be critically shortsighted, especially for the rural poor who depend on the natural resource base for their livelihood.

Table 3

REGIONAL DISTRIBUTION OF MFOs AND GRANTS BY MEMBERS OF THE CONSULTATIVE GROUP TO ASSIST THE POOR (CGAP)

Region

Number of MFOs

CGAP grants (Million $)

Africa

988

7.1

Asia and the Pacific

822

7.0

Central/South America and Caribbean

335

9.2

Europe and North America

987

0.0

Near East and North Africa

n.a.

0.2

Eastern and Central Europe

n.a.

0.4

Global total (partial)

3 142

24.0

Note: Figures include all Summit Campaign members, including some that do not lend. Sources: CGAP. 1998. Focus (various issues). Washington, DC, World Bank; Microcredit Summit Campaign, 1999.

Table 4

CHARACTERISTIC FEATURES OF MICROCREDIT

Lending

Borrowers

Small loan sizes
Little or no collateral required
Non-credit services offered
Regular loan payments
Peer group liability
Donor-funded

Poor
Predominantly female
Low education levels
Geographical remoteness
Few assets
Agriculture-related occupations

HOW MICROCREDIT WORKS

Many variants of microcredit have emerged as the geographical reach, clientele and aims MFOs have expanded.16 Both in the conditions of lending and in the nature of the borrowers, microcredit is a hybrid of development tool and financial service. MFOs are more flexible in their terms of lending and repayment than many formal institutions, but more structured than informal lenders.

Microcredit aspires to:

The provision of a typical microcredit loan would involve the following steps:

FAO/17552

Group lending approach A training officer in Bangladesh
helps village women to improve their income-generating abilities
by making sarees to sell in the local market

- FAO/17552

Box 1

BORROWERS'
STORIES

Almost 1.2 billion people, or about one out of four, in the developing and transition countries live on less than
$1 per day - a globally recognized measure of poverty. Most of these people, including children, work long hours at physically demanding jobs just to survive. Many are entrepreneurs who run their own businesses in the "informal sector" and their lack of official standing prevents them from having access to formal credit sources. They turn to microcredit to purchase materials for weaving mats, sewing leather purses and baking bread, as well as to survive in times of emergency. Following are selected cases in which mircocredit loans have been used:
An $80 loan was used by a young woman to purchase clay and glazes for a small ceramics business in the Dominican Republic. Since 1987 the owner has received eight loans from the microfinance institution and now has seven employees.
A 22-year-old Pakistani woman lives with her husband and three children on his clerical salary and her occasional earnings from embroidery piecework. She received a loan of 4 500 rupees, which her husband took to the market to purchase two goats. The young woman maintains the goats while the loan instalment payments are made from her husband's salary. The goats are used primarily to provide milk for the children and the woman hopes eventually to sell them for a profit. She also uses the savings component of the microfinance programme.

In the Philippines, a 2 000 peso (about $52) loan was used to purchase two piglets. The loan
required weekly instalment payments of 88 pesos ($2.30) for six months. The piglets were fed table scraps, some garden produce and commercial feed. Both the weekly instalments and the purchase of feed had to be made out of household income. After six months, the fattened pigs were sold for 4 000 pesos ($104) each.
An Indian woman purchased small bangles and cosmetics to trade at the market with a working capital loan of 1 000 rupees ($24) She borrowed for 20 weeks at a 20 percent flat interest rate, paying instalments of Rs 60 ($1.42). She sells her wares at the market and door-to-door and earns about Rs 600 per week. After expenses, her earnings are Rs 120 per week ($2.84), half of which is devoted to the loan payment.
One study examined the profits obtained by microentrepreneurs who received loans from the Bangladesh Rural Advancement Committee (BRAC), a large Bangladeshi MFO.1 It found that there is a wide range of profits obtained from different enterprises. Poultry, potato cultivation, and net making were those with the highest profitability (about $21 per month), operating a grocery was in the middle category (profits about $12 per month), paddy cultivation and goat rearing earned the least (about $2 per month) and bull fattening was unprofitable.

1 H. Zaman. 1999. Assessing the poverty and vulnerability impact of microcredit in Bangladesh a case study of BRAC. Background paper for the WDR 2000/2001. Washington, DC, World Bank.

Most recipients of microcredit are poor families with small income-generating businesses or potential to start up such a business. While this would appear to exclude farmers, effectively the microcredit programmes in rural areas do not preclude loans for the purpose of enhancing food production, and many rural farm families are also involved in non-farm economic activities.17 Rural non-farm income is becoming an increasingly important share of total rural income, averaging 42 percent in Africa, 40 percent in Latin America and 32 percent in Asia.18 The types of enterprise that are supported by microcredit include handicraft production, simple agroprocessing operations, vending and marketing, rickshaw driving and, in some cases, the acquisition of improved farm inputs.

Small loans are used to finance non-farm rural activities, home gardening and small agricultural enterprises.

Table 5, shows the breakdown of microfinance loans (in value) in Bangladesh in 1997 and 1998, and the relative proportions provided by other lenders in Bangladesh in 1991-92. MFOs included the Grameen Bank, the Bangladesh Rural Advancement Committee (BRAC), NGOs and cooperatives. Formal lenders included the government, Krishi Bank and commercial banks; informal lenders included families, moneylenders, employers, input suppliers and others.

Table 5

SUBSECTORAL LENDING IN BANGLADESH, BY TYPE OF LENDER

Subsector

Percentage of loans disbursed by MFOs, 1997-98

Percentage of loans disbursed by informal lenders, 1991-92

Percentage of loans disbursed by formal lending institutions, 1991-92

Agriculture

12

22

23

Fisheries

4

n.a.

n.a.

Food processing

10

n.a.

n.a.

Small business

42

91

81

Cottage industry

3

 

 

Transport

3

19

39

Livestock

18

0.4

2

Other

7

49

27

1 Data are for small business and cottage industry combined.
Sources: Credit and Development Forum. 1999. CDF Statistics, Vol. 6. Dhaka, Bangladesh; and S. Khandker. 1998. Fighting poverty with microcredit. Washington, DC, World Bank. Categories do not match perfectly between the two sources and, because of rounding, totals do not add
up to 100.

HOW MICROCREDIT OVERCOMES BARRIERS TO CREDIT DELIVERY

The borrowing needs of the non-bankable population are addressed largely by informal moneylenders and other providers of informal finance - including rotating credit groups and savings associations. Microcredit does not replace these local sources of credit and savings but combines characteristics of such mechanisms, such as the information advantages of village moneylenders and the rotational lending of ROSCAs. These traditional mechanisms have fulfilled the primary role of credit delivery to the rural poor. However, the astounding growth of microcredit's philosophy and methods attests to the continuing existence of unmet needs. IFPRI19 reports a significant number of poor in developing countries as experiencing real borrowing constraints.

Microcredit fills a credit niche for certain population groups, especially women.

The barriers hindering rural credit delivery to the poor derive from the lack of institutions for monitoring and enforcing credit transactions in rural areas.20 The section entitled Political economy in the alleviation of poverty and food insecurity (p. 287 of this issue) describes some of the market and institutional failures that prompted the spread of microcredit directed at poor, rural populations. The author notes a history of credit market failures, including the capture of benefits by wealthy or politically advantaged élite groups and repayment disincentives. He also mentions several types of institutional failure, including the lack of practical mechanisms for reaching the rural poor.

The problems can be summarized as:

The novelty in rural credit introduced by microcredit is the way in which it tackles these well-known market and institutional failures. Microcredit attempts to overcome the market and institutional barriers and still be financially viable.

Information asymmetries are created when the parties to a transaction do not have access to equal information, thereby creating an advantage to the party with a greater amount of information. Such situations can arise either before a transaction takes place, when a borrower may appear to be less risky than she/he really is, and after the transaction has occurred, when a borrower may have an incentive not to repay the lender as originally agreed. To deal with the problem, lenders usually require borrowers to have good credit histories and meet other requirements (such as steady income) to ensure they are creditworthy, as well as requiring some collateral to be provided in exchange for granting credit. However, the usual remedies do not work with the borrower group aimed at by microcredit.

Microcredit resolves information asymmetries by creating peer group contracts in which liability is collectively accepted and regular payments are made at group meetings. In this way, peer pressure creates an incentive to remain current with loan payments, as well as to exclude those who might be considered poor credit risks.21 Sometimes loan payments adjust over time to correspond to a borrower's increased ability to pay back.

Low-potential profitability is the second barrier to loans for the poor. It reflects a bank's perceptions of the high costs, high risk and small market inherent in serving such a borrower population. At the individual level, such borrowers generally do not have steady or adequate income or any assets to seize, and they face great economic and cultural barriers to earning income. At the community level, they are relatively isolated - so it is expensive to provide financial services to them, and their market opportunities are few. The sparse population of potential borrowers in such areas also inhibits reaching economies of scale in the provision of financial services.

Microcredit resolves this problem through several practices. Many microcredit programmes provide - sometimes require - training and technical advice to borrowers in an effort to increase their incomes. These include literacy programmes, enterprise management and education in family planning and nutrition. These "full service" programmes try to increase the skills and capacity of their borrowers. The value of this is obvious, especially for poor women who lack experience and knowledge in running businesses.22 However, the costs are also high and must be supported by the interest payments of the borrowers, or by continued subsidies.

The provision of training and technical advice to borrowers is sometimes required as a loan condition.

High repayment rates are also important to microcredit's ability to lend to the poor. This is believed to be attributable to the emphasis on female borrowers, who are more responsible than men in making payments, and to the peer joint-liability system. Loan default rates for female borrowers are 3 percent compared with 10 percent for men in the same programmes.23 The Grameen Bank has repayment rates of about 98 percent, while other major microfinance organizations report loan repayment rates of 90 to 95 percent.24 This compares with rates of less than 50 percent reported by agricultural development banks.25 Even when the Grameen Bank's repayment rates are recalculated using a stricter definition of overdue loans that is more consistent with regulated banking practice, the repayment rate between 1985 and 1994 was 92 to 95 percent, and it has been slightly higher since then.26

Borrowers generally pay market interest rates for microcredit.

Figure 12

Microcredit programmes generally charge market interest rates on loans to support their high costs. One might expect the rates to be concessional, based on the subsidy that is often provided to the MFOs by donors. In fact, real interest rates are frequently higher than those of commercial banks, but lower than those of village moneylenders.27 This is a contributing factor to the formation of a market niche for microcredit borrowing, and it helps overcome high costs. An eligible borrower would rather obtain microcredit than pay the higher interest charged by other informal credit sources.

Despite these practices, the presence of financial support suggests that most MFOs are not profitable if they follow standard accounting principles. This is an area of great controversy within the industry and is discussed in more detail below.

Portfolio diversification is the third problem barring poor rural populations from access to credit. Lenders operating in a given community or region face covariant risks. Among the most likely reasons for loan delinquencies in a region or country is a natural disaster (such as the Bangladesh floods of 1998) or an economic downturn (such as the 1997 financial crisis in Asia). Such events affect microcredit borrowers more than other borrowers because of their greater economic vulnerability.

Poor rural borrowers are usually considered a high risk for lending institutions because of their vulnerability.

Box 2

MEASURING THE IMPACTS
OF MICROCREDIT

A great many studies have been performed in recent years, purporting to measure the impacts of microcredit. These have been done as a requirement of funding agencies, as an academic exercise and as a way of targeting funds better so as to achieve specific social or economic goals. Unfortunately, the results have been somewhat contradictory, fuelling debates over the effects and value of microcredit.

Different measures are used to assess the impacts of microcredit. The most common indicator is change in household income of the borrowing households. Also important are changes in assets, net worth and labour. The reason for this is straightforward: the primary purpose of microcredit is to raise people from poverty. The positive externality of poverty alleviation is the justification used for spending public funds on microcredit. Another common measure of impact is household consumption, which is a close proxy for income and is more easily measured in household surveys. Studies have measured changes in total household consumption, changes in food consumption and timing of consumption. Other indicators of individual or household welfare are also considered, such as change in school enrolment rates and health measures. Finally, indicators of empowerment and effects on women are measured.

Khandker1 surveyed three major microcredit programmes in Bangladesh for impacts. His results show an 18 percent increase in household consumption from microcredit borrowing by women, and an 11 percent increase in consumption when men are the borrowers (op. cit., p. 148.) He suggests that 5 percent of participating families can escape poverty each year because of the increased consumption resulting from microcredit. Other impacts of microcredit reported by Khandker are consumption smoothing, labour supply smoothing and improved child nutrition, especially for girls. However, Khandker warns that these effects will only be sustainable if microcredit is targeted at areas and economic activities with high growth potential. This is because of the emphasis among the poor to use loans for consumption purposes, which should eventually lead to production and income changes. Morduch2 examines the impacts of microcredit, being careful to exclude from the sample ineligible households. One reason is to avoid the problem of sample selection bias, which arises at the household level (when more creditworthy households enter the programmes), the village level (when better-off villages have access to microcredit) and the individual level (because success as a borrower will engender additional borrowing). Morduch shows no increases in consumption among microcredit borrowers, and sometimes reveals lower enrolment rates. He attributes this to his use of control groups that correct for the selection bias inherent in many microcredit programmes. He does find beneficial impacts through consumption smoothing among borrowing households, as well as an increased ability to diversify labour supply. These effects reduce the vulnerability of borrowing households compared with non-borrowing households.
(A summary of important impact assessments is provided in Table 6.)

1 S. Khandker. 1998. Fighting poverty with microcredit, p. 11 Washington, DC, World Bank.
2
J. Morduch. 1998. Does microfinance really help the poor? New evidence from flagship programs in Bangladesh. HIID, Harvard University (unpublished document).

Microfinance organizations have only partially resolved portfolio diversification problems. The peer group lending approach spreads the liability for repayment among the entire group of borrowers in a given village or peer group. This means that they accept esponsibility for each other's debts. While this approach does not overcome the risk of calamitous losses when a poor harvest or natural disaster occurs, it does reduce the risk exposure when losses are not widespread among borrowers.

Insurance products and emergency funds are also being adopted to address the lack of portfolio diversification. These sources provide compensation or additional credit during times of disaster, and they might include the suspension of loan repayment schedules until recovery is possible. This is analogous to the extra liquidity that a creditor might provide to a solid company undergoing a cyclical downturn, or to the action taken by central banks when the entire financial system undergoes stress.

During the Bangladesh floods of late 1998, the Grameen Bank and other microcredit lenders allowed borrowers to suspend payments on their loans until they were on a sounder financial footing. The savings component of microcredit programmes is sometimes used to finance such concessions. This is not a failsafe way to avoid losses. The risk of default does not evaporate when payments are postponed, and clientele facing frequent liquidity crises may never become current with their obligations. But this is one way in which microcredit lenders have shown flexibility in dealing with an institutional barrier that impedes credit availability to the rural poor.

EFFECTS OF MICROCREDIT ON BEHAVIOUR OF THE RURAL POOR

The primary aim of microcredit programmes is to alleviate poverty by increasing borrowers' earnings. In the process, there may be other impacts such as schooling and family planning decisions. It is difficult to determine the precise impact of microcredit because of the fungibility of loans. For the rural poor, in particular, it is difficult to separate out production and consumption decisions, since labour is the main productive asset and adequate nutrition is essential to work. Figure 12, p. 55, outlines the avenues through which microcredit directly and indirectly affects borrowers. Box 2 summarizes the empirical evidence for some of these changes from several major studies.

Table 6

EFFECTS OF MICROCREDIT ON SELECTED VARIABLES: THE RESULTS OF IMPACT STUDIES

Author

Morduch (1998)

Khandker (1998)

IFPRI (1998)

MkNelly (1997)

Zaman (1999)

Other1

Income/ poverty

No impact

Lower poverty; higher income

Higher income

Higher off-farm income

Smoothed

-

Net worth, assets

-

Increase when female borrower

-

-

Increase

Increase

Labour supply

Diversified

Increase for females; decline for males

-

-

 

-

Consumption

Smoothed

Smoothed; increased

More food; no smoothing

Increased food security

Smoothed

Smoothed

Enrolment

No effect/ lower

Higher for boys; no effect for girls

-

-

-

Better access

Health measure

-

Better child nutrition

-

No nutrition impact

Better child nutrition

-

Contraceptive use

-

Reduced

-

-

-

-

Female empowerment

-

-

-

-

Increase

Increase

1 Includes Jacoby (1994), Schuler and Hashemi (1994), Buckly in Hume and Moseley (1995), Foster (1995) and World Bank (2000) - these authors are cited in IFPRI (1998).

References: J. Morduch. 1998. Does microfinance really help the poor? New evidence from flagship programs in Bangladesh. HIID, Harvard University (unpublished document); S. Khandker. 1998. Fighting poverty with microcredit. Washington, DC, World Bank; IFPRI. 1998. Rural finance and poverty alleviation. Washington, DC; B. MkNelly. 1997. Freedom from Hunger's credit with education strategy. Sacramento, CA (unpublished document); H. Zaman. 1999. Assessing the poverty and vulnerability impact of microcredit in Bangladesh: a case study of BRAC. Background paper for the WDR 2000/2001. Washington, DC, World Bank.

Economic effects

Increased income. The evidence suggests that microcredit raises the income of participants (see Box 2 and Table 6). As income increases, secondary changes in the quantity, composition and timing of consumption, savings and asset-holdings will occur.

Borrowers sometimes use microcredit loans for immediate consumption needs.

Income diversification. Opportunities to diversify income are important, particularly for the rural poor, who are dependent on agriculture and subject to weather fluctuations and crop cycles, Income can be diversified into additional farm activities such as new crops and new or expanded non-farm activities.

Consumption effects. A share of microcredit loans is used directly to increase consumption. While consumption behaviour may change immediately, other impacts of microcredit borrowing may show up only in the long term. For instance, a reduction of vulnerability through increased food purchases in the short term may change long-term economic outcomes for poor rural dwellers. Given the low income levels of microcredit borrowers, increments in income are often spent on improved food, shelter and other basic goods.

Savings effects. Either through forced savings, or diversion from increased income, microcredit borrowers increase their savings. This allows them to smooth consumption, invest in earning activities and prepare for emergencies. Research shows that microcredit loans are used largely for investment purposes (e.g. 80 percent of BRAC credit in Bangladesh), such as investing in housing and other productive assets.28

Production effects. Credit provides the opportunity to begin or expand new non-farm activities, such as agroprocessing, food distribution, small-scale manufacturing, equipment repair and rental, tourism, mining and service sector activities. It can also change production methods in farming with yield-enhancing inputs. These changes in production lead to new and different employment opportunities for the borrowers as well as others in the community.

Discount rate. Credit provides a way to shift the timing of consumption to reduce vulnerability, thereby changing the discount rate that borrowers place on future income. The higher an individual's income, the less they are preoccupied with satisfying current consumption needs. It becomes possible to trade off some current consumption for a higher, more sustained future return.

Social effects

Empowerment of women. As a group, MFOs overwhelmingly focus on recruiting and extending credit to women, especially compared with the emphasis of other lenders.29

The reasons MFOs prefer to target women may differ. Women have higher payback rates and are reputed to be better credit risks, easier to discipline and more inclined to use the income they control for improving children's nutrition and education, and they have more unrealized entrepreneurial capacity.

Economic empowerment of female borrowers can lead to reduced fertility rates.

Some MFOs may simply wish to increase women's economic power.

Some evidence suggests that microcredit programmes may reduce fertility rates.30 This is not surprising, given the higher opportunity cost of bearing children for a successful female microentrepreneur, relative to a woman employed only in household or farm activities and where the child may be a more important source of labour. It may be that economic power, new information or a new support system has allowed women to take more control over childbearing decisions. Also, as women's income rises, child mortality rates usually fall, lessening the need or desire to bear as many children.

There may, however, be an even more direct avenue of influence on fertility from female participation in microcredit-related activities. This might explain cases such as Bangladesh, where fertility rates are plummeting, while child mortality remains high. Some MFOs provide, indeed encourage, family planning education as part of their programme and regular meetings. Participants with BRAC and the Grameen Bank, for example, are far more likely to practise contraception than the national average.

Collective action. MFOs forego traditional collateral and, instead, rely on participants' social collateral. Participants may be required to borrow in groups, act as mutual guarantors or receive loans that are contingent on others in the group paying their loans back. These group incentives and dynamics are reinforced through regular, often weekly, group meetings.

This social interaction has the effect of lowering the costs of collective action, which influences the provision of public goods, the use of common property resources and decisions about many other matters. Communication among participants greatly increases the chances of successful collective action. Ostrom, Gardner and Walker31 have shown in a series of experiments that, given the right institutional framework to communicate, poor people make productivity-increasing and cooperative decisions.

MICROCREDIT'S LINK TO NATURAL RESOURCES

If the goal of microcredit is long-term poverty eradication rather than immediate poverty alleviation, sustainable natural resource use must be considered, particularly for the rural poor. The effect of microcredit on the environment is not clear a priori; rather, who receives microcredit and the uses to which it is put determine the manner and degree to which microcredit affects the environment. The extent of these effects has not been studied carefully, but it may become more apparent as experience with microcredit impact assessment grows. While a certain degree of these impacts is to be expected from any credit delivery, the primary reasons for making this connection an explicit and conscious component of microcredit programmes are that the poorest tend to be the most resource dependent and women tend to be the primary natural resource stewards.

The net direct impact of microcredit on the environment is probably detrimental in the short term, as is most economic activity. But the need of the poor to generate income cannot be compromised or delayed. Thus, it is paramount to search for ways to mitigate harmful environmental effects. Direct efforts that promote environmental management and environmental products can offset harmful impacts. The net indirect impact is less easy to assess but, with the exception of increasing waste and by-products, other impacts such as increasing and diversifying income, targeting women, reducing fertility rates and facilitating collective action can be environmentally beneficial.

There are a growing number of programmes that are linking microcredit to environmental resources, either because they have realized that credit can promote their environmental agenda, or because they have discovered that environmental management can be good business and environmental products have a market. Further, choices are made in the methods used even for potentially harmful activities. Examples of such programmes are described in Box 3, p. 62.

Despite what we have learned about opportunities to enhance growth while protecting the environment, there is still a tendency to dismiss the relationship between microcredit and the environment. This may be an issue of scale. The cumulative effect, however, of millions of microentrepreneurs should not be ignored.

Box 3

INTERTWINING MICROCREDIT AND ENVIRONMENTAL GOALS

There are few examples of MFOs that explicitly tie environmental management to lending, although environmental practices often appear in the members' conditions of lending. This may be due in large part to the precedent set by the 16 conditions that the Grameen Bank encourages its borrowers to respect. Members pledge the following: "... we will keep our children and the environment clean, we will build and use pit-latrines [and], during the plantation seasons, we will plant as many seedlings as possible." These conditions have been copied by the hundreds of Grameen replicates around the world and they have laid the foundation for microcredit lending that embraces environmental objectives.

Microcredit and environmental factors are frequently coupled by conservation NGOs, or development NGOs with a conservation agenda. In some cases these organizations have microcredit capacity themselves, while others partner with more specialized credit suppliers, such as local or international banks or other NGOs.

There is also a small but growing group of MFOs concerned with producing "green" products or technologies. For example, Grameen Shakti is dedicated to providing renewable energy sources (e.g. solar panels, biogas digesters and wind turbines) to villages in Bangladesh that do not have electricity. Likewise in the Dominican Republic and Honduras, the solar-based rural electrification concept (SO-BASEC) uses microcredit to promote solar-based renewable energy.

Technoserve - Ghana

In Ghana, population growth is leading to encroachment on forest reserves near the Red Volta and Morago Rivers. Further, declining soil fertility is forcing agricultural activities to move closer to elephant migration corridors. For coexistence to be possible, the local communities will have to reduce their dependency on food crops and find other income-generating activities.

The NGO Technoserve (TNS), in collaboration with the Ghanaian Government and local organizations, is developing the marketing and processing of the shea nut, which grows wild on native trees. Shea butter has export potential for use in the natural cosmetics market (e.g. The Body Shop) for United States and European buyers. It is important as a native resource that supports sustainable development activities. In Ghana, TNS works with 300 self-employed women, who receive training and credit and organize themselves into groups in order to increase income-earning ability. The income earned by these women helps to support up to 2 100 family members.

The NGO is supporting the prefinancing of such women's groups by export companies - in essence, providing seed capital for the women to purchase materials. The women have difficulty in smoothing their income because they need cash when nuts are harvested and processed but they only receive income from sales later. In the past, the groups received loans from agricultural development banks, used the money to collect nuts, which they then auctioned before paying back the loan. However, only registered groups could afford this procedure. The process was slow and cumbersome, requiring guarantors and securities that frustrated the women's work and, ultimately, required high interest payments. Moreover, the slow response of shea nut exporters to tender bids for the purchase of shea nut stores (via auctions) resulted in further delays in the sale of the nuts, thereby increasing interest accumulation on the loans.

Through TNS, borrower groups avoid the necessity of registration and can obtain the prefinancing loan enabling them to approach the exporters themselves. They then gather nuts and supply the contracted volume. Access to working capital loans increases their ability to stockpile the nuts, add value through processing, increase income and create local employment.

TNS works with the export companies on behalf of the women's groups to negotiate the terms of contracts, coordinate activities on the ground in order to ensure that both parties are fulfilling their requirements and provide basic business training to the identified groups. All this helps the women involved to plan and assess the profitability of the shea marketing activities, as well as to determine how they might invest some of the profits to enhance their livelihood strategies.

PDA and PDI - Thailand

The Population and Community Development Association (PDA) is a well-established NGO in Thailand that uses the microcredit tool for environmental conservation and natural resource management. It was founded in 1974 with the aim of promoting family planning in urban and rural areas but, over time, its scope of work has enlarged. Today it covers income-generating activities and development in rural areas as well as sanitation, environmental conservation and educational training.

Population and Development International (PDI), an affiliate of PDA, has used microcredit to provide farmers with in-kind loans of seeds and fertilizers or cash, tied to specific environmental protection conditions. The interest rate on the loans is equivalent to the bank rate (1 baht/month). The value of the loan depends on village capacity as well as local interest in preserving the environment.

PDI uses microcredit to create savings groups, mainly comprising women. After taking out a loan, the women's savings groups choose between using the funds to leverage a larger bank loan (which can be up to five times the amount of the funds) or acting as their own credit organization, providing small loans to individual members of the savings group.

The Western Forest Complex (WFC) project in Thailand's Kanchanaburi Province began in 1996. Its purpose is to decrease deforestation in the long term, while increasing the level of conservation awareness in the short term. The project is financed by local and international funds and targets 15 villages in the western part of the country.

In this project, PDI uses microcredit to implement sustainable, alternative livelihood practices with the aim of reducing dependency on natural resources, especially in areas affected by slash-and-burn agriculture. In particular PDI encourages planting of native trees and fruit-trees by providing credit in-kind in the form of saplings. The programme offers saplings and training to a farmers' conservation group, which distributes trees to individual farmers. In return, farmers agree to refrain from clearing more land. If a planted sapling dies within one year, the farmer pays back the group that received the sapling.

Significant results have been achieved in a few years. One thousand seedlings have been planted each year. Beneficiaries have increased their knowledge and practices of agricultural activities such as fruit gardens and animal husbandry. Farmers have substantially decreased their use of chemical inputs in agricultural activities as well as their gathering of non-timber forest products. The future aim of the project will be to solidify the pilot activities into sustainable operations that can be implemented and managed directly by the farmers, eventually forming cooperatives for selling and buying trees without the need of intermediaries.

CURRENT DEBATES ABOUT MICROCREDIT

Neither the growth nor the reception of the microcredit movement has been without controversy. Like most development efforts, particularly those that compete for scarce donor funds, there are disagreements over the appropriate role and vision of microfinance. The three most vociferous debates concern the financial sustainability of microfinance organizations, the targeting of the poorest of the poor, and impact assessment.

There is concern that some MFOs are dependent on donor subsidies.

Financial sustainability. Microcredit is provided by a range of organizations, from commercial banks to local NGOs, whose goals range from profit maximization to long-term poverty eradication. With this range of objectives, it is not surprising to find that programmes vary tremendously in their approaches, functions and underlying philosophy. Some of the debates are indicative of a healthy and maturing industry, such as questions about assessing credit risk, appropriate information systems, responding to natural disasters, providing for refugees and monitoring and evaluation. At root, however, a fundamental philosophical divide has emerged within the industry regarding the emphasis on "poverty alleviation" as opposed to "financial sustainability". The subsidy to MFOs has been a subject of debate, with many financial specialists and donors insisting that subsidies must be removed.

Arguments for an emphasis on the goal of financial sustainability tend to:

Arguments for an emphasis on the goal if poverty alleviation maintain that:

In the past few years, major donors have imposed time limits on the subsidies that they offer for microcredit programmes in the hope that MFOs - whether they be public or private - will eventually achieve financial sustainability. For CGAP recipient organizations, that period is five years. The Grameen Bank reduced the subsidy proportion of loans outstanding from between 22 and 23 percent in 1986-87 to 8 percent in 1993-96, while rapidly expanding their clientele.

Targeting the poorest.The second debate currently raging in the microcredit world revolves around targeting the poorest. There are some who question whether it is appropriate to lend to poor people who cannot meet normal standards of "bankability", especially with donor funds. The crux of this debate concerns the ability of very poor people to pay back loans and avoid further cycles of impoverishment.

Arguments for targeting the poorest maintain that:

Arguments for not targeting the poorest maintain that:

Impact assessment. The third major controversy concerns whether it is necessary to devote resources to measuring changes in the behaviour of microcredit borrowers owing to their ability to borrow funds. Impact assessments have become a requirement of most lending programmes, and yield a confusing array of results.

Several major impact reports are summarized in Box 2, p. 56. They generally show beneficial effects on income and consumption; however, there are substantial methodological disagreements remaining. Efforts have been spent in recent years on establishing best practices, monitoring systems and reporting requirements for MFOs. These practices should do much to resolve the remaining disputes regarding the impacts of microcredit.

It is clear that the maturation of MFOs reveals an economically viable market among clientele that do not need subsidies to carry out their economic activities. Many of these microcredit borrowers thrive merely from having access to credit and/or other services provided by MFOs. It could be argued that these clients do not need subsidized microcredit, nor perhaps the training and education that sometimes comes with it. It is also clear by now that there are microcredit borrowers who succumb to a cycle of increasing debt, or who face other difficulties in maintaining the demands of financial responsibility imposed by MFOs. It could be argued that these clients would be better served by other development approaches and tools.

Finally, there is a group of clients and potential clients for whom subsidized microcredit provides an opportunity to move out of poverty, but at a pace consistent with their income-generation abilities and the economic capacities of their region. MFOs can cite a multitude of examples of these borrowers or former borrowers who have successfully used their microcredit to become more financially stable. For this group, an excessively swift removal of subsidies would be a mistake.

FAO/17873

Loan repayment patterns In debt repayment, the poor
perform as well as, if not better, than higher-income
borrowers

- FAO/17873

CONCLUSION

Microcredit has introduced some major innovations in development and rural finance approaches. Its long-term potential to free people from poverty is not yet clear. Studies indicate that microcredit should be targeted at those borrowers who have the potential to carry out sustained economic activities and who are credit-constrained. The limited potential of many borrowers to absorb additional capital may also limit the positive economic growth and poverty-reducing effects of microcredit.

Microcredit is sometimes used to prevent or mitigate environmental damage.

Further analyses should consider the long-term outcomes for individual borrowers and the contribution made to the development of villages and rural communities. It is important to use local knowledge of the demand for economic activity when identifying appropriate microenterprise and other borrowing purposes, and to be aware of the opportunities as well as the risks. Microcredit, like other forms of credit, can result in environmental degradation and loss of natural capital. However, a conscious approach to the use of microcredit could hold potential for mitigating that damage and may even lead to environmental improvements. Further empirical work will identify whether or not the environmental impacts of microcredit justify its use as a tool for sustainable development.


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