Hope on Credit

Regional ReviewQuarter 4, 1998
by Miriam Wasserman

In 1976, Muhammad Yunus, a charismatic economics professor, started an experimental project to reduce poverty in remote rural villages in Bangladesh. His success soon defied all expectations and went well beyond even his own initial ambitions. The scheme, which had been born in the informal economy of street peddlers, artisans, and other subsistence ventures, grew into a formal bank in less than a decade. Its remarkable results attracted the interest of experts from institutions like the World Bank and inspired people from developing and industrialized nations alike, including the United States. It was an unusual twist in a tradition of technology transfer, where methods, techniques, and ideas have usually flowed from the industrialized world to developing countries.

The essence of the project was the belief that tiny loans could enable landless peasants to escape poverty. Yunus was not the only one working on this idea. The beginning of microlending, as Jeffrey Ashe — an expert in the field — puts it, was like the invention of fire: It happened at the same time in settings as different as India and El Salvador. But the Grameen Bank in Bangladesh, which originated from the university research project Yunus started, soon became emblem- atic of microlending's success. Twenty years after it had begun, the experiment had evolved to become a formal bank with 1,118 branch offices in Bangladesh and loans in excess of $2 billion. It served more than two million clients, who were primarily landless villagers, 94 percent of them women — the most disenfranchised of the rural poor in Bangladesh. And, the proportion of the loans repaid, over 90 percent according to the World Bank and others, was comparable to that of the Chase Manhattan Bank, noted author David Bornstein in The Price of a Dream: The Story of Grameen Bank.

Moreover, while expanding at a breathtaking rate, the bank reported operating profits for almost every year between 1986 and 1997, with the exception of 1991 and 1992. And, although inexpensive funds and grants from donor agencies initially helped Grameen, increasingly it came to rely mostly on market resources. Beyond the financial results, World Bank experts found that Grameen was having an impact on poverty: Wages increased in villages where the bank operated, borrowers saw increases in their savings and in per capita consumption, and even the school enrollment of their children seemed to increase.

Propelled by the enthusiasm that Grameen and other developing country programs generated, microlending projects sprouted and spread around the world, reaching about 15 million people to date. In the United States, microlending programs began to appear in increasing numbers in the mid to late 1980s and received support from the government and the media. Yet, the transfer of lending techniques from the developing world to the economic and social environment of an industrialized nation posed significant challenges. It also raised questions about the differences between poverty in developed and developing countries, and about the difficulties of adapting institutions from one culture to another.

FERTILE GROUND

The inspiration for what eventually became Grameen Bank came from Muhammad Yunus's close contact with village life in Bangladesh. Studying the growing problem of landlessness among villagers, Yunus had found that, in many cases, peasants would lose their property after illness or a poor crop forced them to borrow money at rates as high as 600 percent a year. Lack of access to credit at reasonable rates also prevented the cash-strapped peasants from growing businesses, increasing their profits, or building up their wealth. For instance, rickshaw pulling was a common occupation among men, but most rickshaw drivers did not own the vehicles they operated. What they made after paying rental fees barely allowed for subsistence. If instead of paying rent they could pay back a loan, in a year they could own their own rickshaw and start building up assets — and maybe even another business for a second source of income.

The concepts behind microlending were hardly new. It had long been recognized that access to credit was crucial for creating and retaining jobs, promoting small businesses, and revitalizing neighborhoods. But lending money to the poor had traditionally been difficult. Small loans are expensive, as interest revenues are small relative to administrative costs. And historically many financial institutions have been wary of lending to the poor, since low-income people often lack collateral and established credit records.

So, Yunus and other microlending innovators sought ways to manage the risk and reduce the costs associated with lending to the poor. In the absence of any physical collateral to guarantee loans, they explored the use of "social collateral" — using peer pressure and social ties to ensure repayment. One way of doing this was to make loans to groups of borrowers rather than individuals and withhold future credit until all the members of the group had repaid their portion of the loan. In this way, group members had a strong interest in ensuring that fellow members paid their dues, by either supporting each other through unexpected difficulties or exerting pressure in case of delinquency. Since members needed to think carefully about whom they trusted in order to form a group, the lender's cost of screening applicants was reduced.

Another strategy developed to manage risk was "stepped lending." By starting with tiny loans — often below the level needed by borrowers — and promising access to larger loans on payback, lenders limited their exposure while creating incentives for timely repayment. In turn, clients who had no previous experience with borrowing had a chance to develop credit records from scratch and gradually build up confidence and experience before tackling larger risks.

These innovations borrowed heavily from informal traditional arrangements in developing countries where, in the absence of formal financial institutions, family members or close friends were sources of credit, and the pooling of resources was common. Some microlenders also blended rituals and traditions from the local culture into the lending process, and the results were unique lending protocols. For example, Grameen groups elected leaders and held mandatory regular public meetings where — aside from paying loan installments publicly — members did the Grameen salute, recited slogans, and, in some village centers, performed a series of physical exercises. The particular protocols varied from setting to setting, adjusting to local cultures. There are currently 79 Grameen replication projects in countries ranging from Bolivia to Uganda. The two largest of such projects, in Malaysia and Nepal, serve over 35,000 clients each. And, this listing includes only projects that receive funding from the Grameen Foundation — an organization dedicated to promoting Grameen-style antipoverty programs. Other organizations and institutions, including the World Bank and the U.S. Agency for International Development, have studied the Grameen example and derived lessons from its experience. They also learned from organizations such as ACCION International, based in Somerville, Massachusetts, which has been successfully promoting microlending in Latin America for over two decades. Using this knowledge, they have funded similar programs in developing countries.

ON DOMESTIC SOIL

With this international backdrop, the practice of microlending took off in the United States. It was not a completely new idea; small business loan funds had existed for many years, and Congress itself had recognized the importance of financial services in the development of strapped communities when it drafted the Community Reinvestment Act in 1977. But these initiatives had tended to focus on low-income housing, large commercial developments, or on relatively large businesses of up to 500 employees.

The really small businesses of one to five employees had not received much attention. However, the recession that began in mid 1990 seemed propitious for the growth of microlending in the United States. Downsizing in big corporations made many middle-class families feel economically vulnerable and increased the appeal of self-employment. Growing concern that the incomes of less educated workers were stagnating highlighted the need for ways to alleviate poverty. Yet, the effectiveness of government programs was under attack and welfare-to-work ideas were gaining momentum. Microlending, with its emphasis on personal empowerment and bootstrapping oneself out of poverty, was an appealing option for conservatives and liberals alike.

A number of Americans involved in microlending programs in developing countries decided to bring home the lessons learned abroad. Two of the earliest and most prominent organizations in the United States were founded or based in Massachusetts. Jeffrey Ashe established Working Capital in Cambridge in 1990, after a decade of experience with microlending in South America, Africa, and Asia. Today, his organization raises money by borrowing from banks and foundations, runs its own operation in Boston, and extends services through community associations in Massachusetts, New Hampshire, Delaware, Miami, and Atlanta. Likewise, Somerville-based ACCION International was galvanized to expand into the United States, where it targets a largely Hispanic market in New York, New Mexico, San Antonio, Chicago, San Diego, and El Paso.

The Domestic Clients

ACCION U.S. and Working Capital are not alone. The number of microlending programs grew rapidly in the 1990s and, the organizations have received federal support and funding, particularly from the U.S. Small Business Administration. At the last count in 1996, there were 266 organizations in 46 states, up from only a handful in the mid 1980s, according to the Aspen Institute. Over 170,000 people had been served and over $126 million had been disbursed in loans.

LEARNING BY DOING

But adaptation to the U.S. environment has not been easy. "This is by far the most difficult setting for doing a microenterprise program I've seen," says Working Capital's Jeffrey Ashe.

Microlending programs have thus far found it hard to achieve the scale and the financial independence they aspired to in the United States. ACCION, one of the largest and most successful microlenders in the country, reaches about 1,000 active clients, but would like to be reaching 5,000 borrowers, says William Burrus, senior vice president for U.S. Operations at ACCION. The percentage of operating costs covered by ACCION's U.S. programs ranges from 20 percent in New Mexico to 60 percent in El Paso, with the rest being covered by grants and donations from private and public sources. The programs that have been the most successful at covering their costs are those that have the largest client pools and operate in areas where the cost of living is lower, according to Robin Ratcliffe, vice president of communications at ACCION.

At issue is not loan delinquency. The repayment rate at ACCION U.S. is about 95 percent (it is about 98 percent in Latin America). Rather, running a business is much more difficult in an industrialized nation than in developing countries. Small businesses here must deal with regulation, taxes, insurance, health benefits, and the like, as well as more sophisticated competition. Thus, training, technical assistance, and support networks have proved crucial for the success of microenterprise owners and microlenders have evolved toward greater provision of these services. While such support reduces the risk of default, it is also extremely time- and labor-intensive, raising the microlenders' operating costs and limiting their expansion.

At the same time, competition limits the interest rates U.S. microlenders can charge. "You have credit cards moving down into the microenterprise markets; it is easier to get home equity types of loans; and even the banks themselves are pushing down at least to the top part of our market," comments Jeffrey Ashe.

Moreover, the number of potential small borrowers in the United States is relatively much smaller and more geographically dispersed than in developing countries, where microenterprises or the "informal economy" can make up between 60 and 80 percent of the economy. A developed economy has better established safety nets and offers many more opportunities for wage employment. And this has been especially true in this country over the last couple of years which have seen record low unemployment rates. As a result, microlenders have had to undertake more aggressive and costly outreach efforts in the United States.

Program strategies have evolved to meet the needs of particular U.S. market segments. Many programs help people who have higher levels of education and income than those of more traditional poverty-alleviation strategies. These programs tend to cater to already established businesses, emphasize credit, and offer a more limited amount of networking and training opportunities.

Other programs have chosen to specialize in serving welfare-to-work clients and people below the poverty line. They emphasize the training part of microenterprise assistance. "It's incredibly labor-intensive," says Mary Brown of Jewish Vocational Services, the largest of such programs in Boston. A high percentage of clients never get as far as starting their own businesses. Of those that do, many find that their new businesses are not the sole key to economic self-sufficiency, but a way to supplement the family's income, says Rutgers University professor Lisa Servon.

Furthermore, techniques effective in developing countries have not always been workable here. Most domestic microlending programs use some version of stepped loans, but businesses here have greater capital requirements and often need to get to the larger-sized loans faster, which puts the microlenders at greater risk. Group lending techniques have had a mixed reception. Only 20 percent of the programs that offer credit use group lending, according to the Aspen Institute. "People don't seem to want to participate in groups," says ACCION's William Burrus. "They are more individualistic and not used to operating in communal-type activities." So, most microlenders are making individual loans using methods much closer to bank lending — often requiring some form of collateral — but simplifying the underwriting to fit the size of the loan. Thus, U.S. microlending organizations have been going through a process of experimentation and learning as they figure out what works best here. And they are still working at it. "The first microloan was made by ACCION in Recife, Brazil, in 1973," notes Robin Ratcliffe. "But it really took another ten years of experimentation and model development to reach what we know today as solidarity group lending. It's what invention is all about."

REAPING RESULTS

Although microlenders are still perfecting their programs, the results of their efforts are beginning to show and the impact is most clearly seen at the level of individual borrowers. For Charlotte Tyler, after years of working "odd jobs," as she puts it, it has made a big difference. "I knew what I wanted but I did not know how to get there," she says. The Micro Business Development Program in Barre, Vermont, helped her figure out the finances and get a loan to produce fragrant and elaborate homemade ornamental soaps. Now, soap is her main source of income. But the road is not easy for a microenterprise owner.

Pat Foley was one of the first to join Working Capital in New Bedford, Massachusetts, and her experience illustrates both the success and the difficulties faced by these entrepreneurs.

Pat learned of Working Capital through an advertisement in the local paper. At the time, she was working part-time at property management. She was also making hand-painted clothing, which she sold at fairs, and was looking to expand this as a business. However, she had had some credit problems in the past and did not think banks would lend to her. "I was looking for a small loan, but when I went to Working Capital's informational meeting and heard about the whole package, I found it attractive," she says.

During the five and one-half years Pat has been with Working Capital, she has changed her line of business twice, searching for something that would be satisfying and also generate sufficient revenue. Her latest business might be it: She has just opened The Magic Palette, an art supply store near the site of a future art school in downtown New Bedford.

Throughout the business changes, Pat has received both support and advice from Working Capital, and has seen her loan amounts rise incrementally from the initial $500 loan. But Pat says that the greatest benefit she has received is not the loan money but rather the access to a business network she didn't have before. Pat's electrician, her insurance broker, her florist, and even the person who made the balloons for her grand opening were all contacts she made through Working Capital. She uses their services and they, in turn, pass out her cards and go to her store.

Pat has also learned a lot through informal advice, at workshops, and from volunteer business consultants. Now that she has received her first "big" loan of $10,000, the credit part of the deal has become more significant.

Pat's entrepreneurial spirit and the assistance that she has received have also had a small but visible impact on New Bedford. In a city that has lost 13,000 manufacturing jobs over twelve years and suffered the decline of the fishing industry, Pat's bright purple awning stands in the midst of boarded-up storefronts. Students gather at her store for art classes and local artists exhibit their work on her walls.

Still, success is not assured. Pat works about fifty-five hours a week and pays for her own health insurance. Currently, all her revenues are going back into the business, so she depends on what her husband earns as a contractor. But, if she can survive until students come to the new UMASS Dartmouth Visual and Performing Arts School, which is scheduled to open next year, she will probably have the security of a stable clientele.

As Pat well knows, running a microenterprise is not easy and is not for everyone. In developing countries, a tiny loan for a subsistence business may offer survival to a large number of people. In this country, it is more of an opportunity for those who have the drive to work for themselves and are willing to take the risks and put in all the effort it takes.

DREAMS AND OPPORTUNITIES

Microlending organizations in the United States will probably never reach the size or have the impact of an institution like the Grameen Bank in Bangladesh. And, total self-sufficiency is also unlikely.

Alleviating poverty, particularly in industrialized nations, takes more than correcting credit-market failures, as microlenders are well aware. "We have to be working with all the other housing, social, and human services poor people need," says Christopher Sikes, director of the Western Massachusetts Enterprise Fund.

Just as poverty solutions crafted in industrialized nations have not always worked as intended when transplanted in developing countries, microlenders have had to adjust their methods and strategies in the process of adapting to the U.S. environment. But, even when microlending is not used strictly as a poverty alleviation strategy, it can play an important role in making opportunities available to those who have the desire and determination to try their entrepreneurial hand.

Perhaps the biggest strength of microenterprise assistance is that it gives people the opportunity to learn firsthand what it takes to be an entrepreneur and the chance to aim for success. Even when the microenterprises do not succeed, the endeavor is not a total loss, as individual owners will have gained work experience and business knowledge that could be useful in the future or help in landing a job.

While results may have fallen short of their dreams thus far, those who started microlending in the United States have given people like Pat Foley and Charlotte Tyler an opportunity to bring their own entrepreneurial dreams to life. "What microenterprise development does is take an idea that is a person's own and make it manifest in the world. It is a place for people to check things out for themselves and find how they can best make what they want to be doing work for them. When they are driven by that, rather than a dollar, they are happier and more motivated," says Sikes. "That is the most powerful thing we can do."

U.S. MICROLENDING in brief

  • Microenterprises are considered to be the smallest of small businesses: those that employ less than five people and generate less than $250,000 in annual revenues. Many of those that seek assistance are sole proprietorships earning closer to $40,000 a year.
  • Typical businesses that receive microloans include apparel production, retail and wholesale product sales, professional services, catering, and day care.
  • Microloans generally range from $500 to $25,000, and are made for business development.
  • Loans tend to be complemented by training or technical assistance as well as networking.
  • Many owners work their businesses part-time to supplement the income from other jobs.
  • Funds come from bank credit lines, government sources, and foundations.

INSPIRATION: Entrepreneurship and Need

The reasons people go into microenterprises are as varied as the entrepreneurs themselves. After John Gingras was downsized from his job as a darkroom technician, he enrolled in massage therapy classes and took a three-month business course from the Micro Business Development Program in Burlington, Vermont. With this training, he started a massage-delivery company, Blind Faith Massage, and hopes to cater to businesses and health clubs. For Marguerite Knight of Ludlow, Vermont, it was a lifestyle change. After working for twelve years as a respiratory technician, she quit her full-time job to start a company that sells gifts for the home and garden. Working from home means she gets to see a lot more of her three-year-old daughter.

Lisa Servon of Rutgers University and Timothy Bates of Wayne State University studied the reasons people choose self-employment in microenterprises in the United States. Some end up in self-employment after unplanned life events such as divorce, pregnancy, or having been laid off. Others, particularly in rural areas, use microenterprises to supplement their income rather than move to places that offer better jobs. A minority are "true entrepreneurs," those who prefer to work for themselves even if it means longer hours and less money than they would earn in paid employment.

Regardless of their initial motivations, most microenterprise owners claim that they prefer self-employment because it offers greater flexibility, freedom, and control, and because they have pride in what they do, say Bates and Servon.

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