Traditional banks are not interested in lending small of amounts of money to poor people with no collateral. Loans are issued based on credit scores. When poor people need loans they tend to have to rely on exploitive loan sharks. In the U.S. those with bad credit often resort to sub prime lenders such as First Premier, who factor in a default rate of around 25% when setting interest rates. Yet the microcredit loans initiated by Dr. Muhamaad Yunus through the Grameen Bank, which he founded in Bangladesh, have very low default rates of an average 2%.
Grameen microcredit loans are based on trust rather than collateral. Typically very small loans are issued primarily to women in a group system of five women. Each borrower is responsible for their own loan but no one within the group will be advanced credit if one group member is in default. This group system works successfully as the peer pressure involved encourages all members to repay their loans and assists in keeping default rates low.
The loans have always been issued without a grace period, with repayments due on a weekly basis. This helps to prevent the repayments being used to fulfil other monetary obligations or social demands. Over 95% of Grameen loans are issued to women as Yunus has found they are far better at honoring their repayments than men, as are concerned to use the funds for the good of the whole family. Yunus says “given the opportunity, women handle money more efficiently. They have long term vision; they manage money more carefully” whilst “men are more callous with money.” Yunus believes that “women are endowed with a tremendous sense of self sacrifice and try to get the best out of their money.”
Grameen Bank has a core set of principles which borrowers must adhere to: discipline, courage, hard work and unity. As the loans are extended to the poorest the bank encourages them to aim for certain standards such as improving their homes, educating their children and minimizing expenditure. It wants the poorest to rise out of poverty, and groups may take on larger loans collectively for bigger projects.
Faisel Rahman who founded Fair Finance studied the Grameen system before bringing microcredit to the U.K. He says that “default has nothing to do with income levels and everything to do with character.” When banks exclude the poorest then there is a sense of pride when those same people are able to access microcredit and prove that they were worth lending to.
Grameen microcredit loans have been a true success story. Given the opportunity to use credit as a means of becoming self sufficient has enabled many of the poorest families to improve the quality of their lives. The low default rates which Grameen microcredit loans attract is testament to the principles of lending based on character rather than collateral.