Microfinance: Simple but Brilliant

Why don’t big banks loan to the poor?

Unfair stereotypes clearly play a role. However, banks have lots of other reasons, too, some better than others. The simple yet brilliant Grameen group method allows microfinance to do everything that banks won’t – and do it better. Microfinance institutions (MFIs) in the U.S. and around the world typically have 97-99% repayment rates, way higher than those seen in the conventional financial sector.

The poor have no credit history: When banks make loans, they use a credit score to decide how risky a borrower is. If they start including people who have never before received loans, there is no way to tell the responsible borrowers from the irresponsible ones. It makes each loan a gamble.

The solution: The Grameen group method. When an entrepreneur wants a Grameen loan, she is sent back into her community and networks to find four other borrowers to complete her group. Banks may not be able to predict who is a responsible borrower, but neighbors definitely can. Grameen relies on the community-level knowledge of its clients to select the entrepreneurs with the brightest business ideas and the trustiest reputations.

The poor cannot offer collateral: They have few valuable assets (such as a house or a car) that they can offer as a back-up to banks if they don’t repay the loan. Banks say that a poor borrower could just take the money and run, with nothing to stop them.

The solution: Again, the Grameen group method. Borrowers are in groups with their friends and neighbors. If one borrower falls behind on her payments, she effectively prevents her group members from getting new loans. This inter-dependency encourages clients to follow through with their commitment. While the poor cannot offer an expensive house to guarantee their good faith, they do put their reputation on the line.

Each borrower works hard to make her whole group a success, so that she'll be eligible for future loans.

More loans = higher costs: The overhead costs involved in making many small loans lower banks’ profits. That’s because banks require reams of legal documents for each client.

The solution: You guessed it. Muhammad Yunus’s brilliant Grameen group method comes through again. Grameen banks rely on personal interactions with borrowers, making the red tape unnecessary. Group members meet weekly to monitor each other, examining receipts and financial records. Because each member’s access to future loans depends on the success of the group as a whole, everyone has a strong motivation to see that things are done by the book.