Applying Microcredit to America
This winter I read Muhammed Yunus‘ Banker to the Poor to gain a better understanding of how he built a successful system of microcredit in Bangladesh. To succinctly summarize, Yunus extended loans under $250 to women living below the poverty level. Yunus believed women are naturally inclined to use the money for their family while men are naturally inclined to use the money on themselves, forming the premise of Grameen Bank. Although minor, access to credit allowed these women to slowly pull their families above the poverty level and provided their children with ambitions of an education and better life. This model works because Grameen Bank borrowers know that this is the first, last, and only chance to elevate their social status. And RGE Monitor provides additional insight into why microcredit has been successful.
Translated into English, a little bit of credit acts as a catalyst for women outside the labor market, turning them into economically productive individuals. Once they become economically productive, they can pay back small loans. But they’re not productive enough to pay back medium-sized loans.
To put it another way, the interest on a microloan isn’t really return on capital, it’s return on labor. It’s just that without a tiny bit of capital, the labor is nascent and can’t be tapped. That’s why microcredit works, and why larger loans are much less popular.
- Why microfinance works, economics notwithstanding
Despite relative success worldwide, microcredit has not seeded itself in American culture. Proceeds of microcredit loans are typically used to acquire raw materials for an intial batch of finished goods or tools required to perform a service. In order for this model to work in the United States, borrowers would need to be living below the poverty level and have no access to credit. In other words, Borrowers must feel a sense of urgency to repay these loans. But typical microcredit lenders in America are providing loans in excess of $10,000 to borrowers with bad credit. Having had access to credit in the past, typical American microcredit borrowers do not feel that sense of urgency.
Before leaving Philadelphia, I asked a trusted business advisor why the Grameen Bank model isn’t widely used in the United States. It was his opinion that high costs associated with forming a business lead to a slow absorbtion rate. This provides a barrier to entry that prohibits would-be entrepreneurs from selling their handmade goods or providing their services. Undeterred, I’ve been evaluating solutions since that conversation.
Tonight I had a sudden moment of insignt on the subject stemming from an innocuos conversation about my new home in South Florida. Chatting with my roommate, we explored the similarities and differences of the area to our respective home towns. As both of us are from up north, the promise of endless summers is the most notable difference and our mutual draw to the area. We continued our discussion and I noticed the absence of squirrels and pigeons. I spent the first 27 years of my life in the northeast corridor, and cannot recount a day when I didn’t see at least one of the aforementioned animals in my daily routine. But in my brief time here my mind has been preoccupied with the process of moving and I failed to notice their absense. And it hit me. What if the barriers to entry of starting a business in the United States were removed?
In my opinion, a microcredit organization could be formed by relying on two distinctly different funding sources. First would be grants used to pay the upfront monetary expense and clerical cost of forming a business. It is reasonable to expect Borrowers below the poverty line are unable to read or write, and would be unable to form a business on their own accord. If a microcredit organization provided a legal business shell as a service for its customers, this could potentially make loans under $250 a viable form of credit in the United States. The second funding source would be fees and interest on the loans themselves. Loans would originally be funded by private investment, and the proceeds would be reinvested in the company to build equity, provide capital for additional loans, and eventually reduce reliance on outside funding.
Although effective APRs on the loans would be higher than traditional funding sources, they would fall far below the predatory APRs of payday loans.
Posted on July 15th, 2009 | By: bootstrap economist | Filed under Banking
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