Microcredit challenge

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Assistant Professor

gpainter@usc.edu

and

Shui-Yan Tang

Associate Professor

stang@usc.edu

University of Southern California

School of Policy, Planning, and Development

Los Angeles, CA 90089-0626

* The authors thank the Southern California Studies Center for funding this research. We appreciate

The Microcredit Challenge:

A Survey of Programs in California

Gary Painter

I. Introduction

Beginning with the “War on Poverty” era in the 1960s and 1970s, alternative

credit programs have been used to extend credit to small businesses that were denied

access to the traditional banking sector. More recently, the US Department of

Commerce’s Economic Development Administration has created a number of local

revolving loan funds that extended credit to entrepreneurs in low-income communities.

The Small Business Administration (SBA) has also been lending to small businesses for

many years, especially those run by women or members of minority groups. In addition,

various state and local governments have also created loan programs targeting

entrepreneurs who have not been able to access the traditional credit markets. The State

of California, for example, has established regional programs that provide technical

assistance and guarantees for small business loans made by private financial institutions.

At the local level, many cities and counties throughout California have their own

ACCION International. The hope is that these programs will play a key role in poverty

alleviation and economic development of disadvantaged communities. With the recent

welfare reform, some also see microcredit as a potential tool for moving welfare

recipients out of the system (Stoesz and Saunders 1999).

Some recent studies show that, if effectively run, microcredit programs can help

borrowers to improve their economic conditions significantly. For example, a

longitudinal study of 405 poor microentrepreneurs recently completed by the Aspen

Institute indicates that 72 percent experienced average household income gains of $8,484,

and more than 53 percent moved out of poverty in five years (Clark and Kays 1999). On

average, household assets grew by $15,909, while reliance on public assistance was

reduced by 61 percent. Other recently completed studies on projects sponsored by the

Corporation for Enterprise Development (Raheim, 1997) and ACCION (Himes and

Servon, 1998) also revealed positive impacts on borrowers.

Despite positive clients impacts reported in these studies, Schreiner (1998)

One must be cautious when trying to generalize the results of existing empirical

studies. This is not only because of the methodological issues raised by Schreiner

(1999a, 1999b), but also because most of the existing studies have been based on the

experiences of a small number of microcredit programs or programs of a specific type.

As pointed out by several scholars (Hung 1999; Johnson 1998; Servon 1997), microcredit

programs in the US differ considerably from one another in terms of missions, target

clients, and lending methodologies. Since microcredit programs differ from one another

in many aspects, problems and impacts associated with one type of program may not be

the same for another type. To assess fully the potential of microcredit as a tool for

microenterprise development, one must draw on the experiences of a larger set of

programs with diverse features. Currently, almost all empirical studies on microcredit are

based on a few non-random cases and often anecdotal evidence. Empirical studies that

examine a substantial number of programs of various types at the same time are needed

microenterprise programs occupy another distinct niche that is not being served by the

larger alternative credit programs. For example, most microcredit programs may not be

stand-alone programs, but part of a larger organization that seeks to encourage

microenterprise development through a wide variety of strategies, of which credit is only

one of many (Servon 1997, 1999). Further, microcredit is seen not only as a tool for local

economic development, but as a tool for personal empowerment of the underprivileged

(Johnson 1998). These potentially different missions may lead to very different types of

operational and management structures. Thus, in our survey, we first seek to examine

whether microcredit programs occupy a niche different from other alternative credit

programs that lend to small businesses, and whether there are major differences in

lending methodologies and other services provided by the two types of programs.

Second, we seek to assess the performance of microcredit programs. As

mentioned earlier, much uncertainty remains regarding the impacts of microcredit

II. Data

Because of limited resources available for the research, we surveyed only

programs in California. California provides a fertile ground for this research because

programs in California serve a wide diversity of clients and businesses, in different social

and economic settings. Furthermore, as the most populous state and one of the most

diverse states in the US, California has the most microcredit programs. In the 1999

Directory of US Microenterprise Programs published by the Aspen Institute, 36 out of

the 341 surveyed programs are located in California. In comparison, New York, the state

with the second largest number of programs, has 21.

The survey was conducted in the Summer and Fall of 1998. To accomplish the

survey, we first compiled a list of possible alternative loan programs in California that

gave micro and small loans as part of their loan portfolio. This list of 87 programs was

compiled from various sources such as the 1996 Directory of US Microenterprise

Programs published by the Aspen Institute, The 1996-97 California Business Resource

than has been available in previous literature, it still suffers from selection bias as we

have no information on those programs that failed.

Each respondent was asked a series of questions to ascertain their funding

sources, client population, types of auxiliary services, operational features, and the

financial characteristics of their loan portfolios. The respondents were also asked to

assess the unmet needs of their programs.

III.

Microloan vs. Other Alternative Loan Programs

Do microcredit programs occupy a distinct market niche and exhibit different

operational features from other alternative loan programs? As evidenced from the

results of our survey, the answer is a qualified yes. Tables 1 - 4 present the results

showing the differences and similarities in how the programs operate.

As evidenced in Table 1, the loans provided by the two types of programs differ

in size and terms. Although microcredit programs by definition provide smaller size

nearly three times as many loans in both the past year and overall, but these differences

are not statistically significant.

Despite these differences,

there were some striking similarities. Both types of

programs have close to 50 percent of their respective loan funds currently not in use.

Further, both types are slow to both provide an application to clients and fund successful

applicants. The total time for a successful application to receive their money is over two

months. Finally, the interest rate charged by both types is similar (11 percent vs. 9.4

percent), although the rates are statistically different from each other.

The programs are also similar in their reasons for loan denial (Table 2). While the

larger alternative loan programs are more likely to reject loans because of problems in

credit history or inadequate cash flow, the only loan management reason cited, which was

microcredit programs tend to offer more training and technical assistance and to involve

borrowers more intensively in the lending process. Substantially more microcredit

programs offer class-room type instruction and one-on-one counseling, and more of them

implement training for peer groups and group liability for repayment.2 Furthermore,

more microcredit programs draw on volunteers for providing training. This suggests that

most microloan programs are not stand-alone programs, but part of a larger organization

that seeks to encourage microenterprise development (Servon 1997, 1999).

Second, microcredit programs tend to be less formalized in their lending

operations (see Table 4). They are less likely to provide funding in phases, to take legal

action against default, and to sell loans in secondary markets. As pointed out by some

commentators, such informalities may have caused some microcredit programs to be at

risk for higher rates of default and loan losses, because they lack the administrative

capacities for evaluating applicants, keeping track of repayment records, and going after

types are similar in their limited outreach, levels of idle capital, loan processing time,

dependence on government funding, and reasons for denying loans.

IV. Outreach and Sustainability of Microcredit Programs

How do microcredit programs in our survey fare in terms of the two institutional

level performance criteria of outreach and sustainability? The results of our survey show

that their achievements have been quite limited.

Outreach

A major appeal of microcredit in the Third World is its potential for serving large

numbers of low-income individuals who have limited access to the traditional banking

system (Otero and Rhyne 1994). Microcredit programs in the US, however, have much

smaller scale than many of the successful Third World initiatives.3 As evidenced in

Table 1, among the 16 California microcredit programs we surveyed, the average number

had utilized all of their funds, and the average loan fund utilization (measured by the ratio

of the average portfolio to the loan fund capitalization) was around 50 percent. In fact,

one program manager reported that despite having had a loan fund in place for three

years, the agency had not made a single loan. The manager cited three major reasons for

the lack of borrowers. First, many of its targeted clients, refugee immigrants, wanted

more than the program would loan. Second, many were able to obtain loans from friends

and relatives. Finally, many did not want to go through a thorough business planning

process in order to obtain a loan.

One of the reasons that the programs in our survey have less outreach than their

Third World counterparts is the differences in lending methodologies. In our survey,

only three out of 16 programs mentioned the use of group liability in their lending

operation. Some have suggested that the reason that US programs have shied away from

group lending is that many inner-city and low-income communities lack sufficient social

our survey are the most successful ones in California over the past 5 years because they

have not yet failed, yet they are all heavily dependent on external subsidies. Indeed, only

one percent of the overall funding for the programs is generated by “surpluses generated

from loan fees and interests” (Table 3).

Most Third World programs that attain high degrees of financial self-sufficiency

use decentralized branches to serve numerous borrowers and to involve them in various

loan-disbursement activities such as participant recruitment, and loan repayment tracking

and enforcement (Otero and Rhine, 1994; Morduch, 1999). These programs are able to

control the otherwise high administrative costs associated with making small loans. In

the US, most microcredit programs lack access to such reliable and free “help.” It is a

difficult task for these programs just to seek out potential borrowers, let alone involving

them in loan administration activities. In some programs, for instance, one or two loan

officers may be managing only a couple dozens of microloans per year.

Another reason for lack of financial sustainability is the unwillingness of

We also found that programs in the US are often faced with various constraints

that make it difficult for them to take advantage of operational features that have been

proven to be successful in the Third World. For example, as shown in Table 4, only a

few programs have adopted operational features identified by researchers to be key

ingredients for ensuring high repayment rates in Third World programs —progressive

lending, voluntary or compulsory savings, and bonuses for staff (Hulme and Mosley

1996; Morduch 1999).

Part of the reason that fewer programs in the US may have adopted these

operational features can be explained by their different circumstances. First, in many

developing countries, borrowing from a microcredit program may be the only means for

one to develop or maintain a business that provides for one’s livelihood. Losing one’s

eligibility for future loans may result in financial disaster. Progressive lending, in the

form of increasing credit limits for repeat borrowers in good standing, is a powerful

savings arrangements may be governed by various banking regulations that program

staff, who generally lack knowledge and background in banking and finance, are

reluctant to try.

Third, performance bonuses for staff are a key ingredient of an effective loan

collection system for successful Third World microcredit programs (Hulme and Mosley

1996). Such bonuses are rarely used by US programs, probably because high repayment

rates are usually not considered critical for their survival as most of their capital and

operational funds are derived from external subsidies. In addition, as the scale of most

US programs is very small compared with their Third World counterparts, performance

bonuses for staff are unlikely to be offset by additional returns generated by more

effective loan collection efforts.

V. Challenges Perceived by Program Staff

Source: www.researchgate.net

Category: Payday loans

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