micro-credit: what is the economics behind it

Discussion in 'Economics' started by pepper_john, Oct 14, 2006.

  1. This year's Nobel Peace Prize was given to the guy (Muhammad Yunus )who started the microcredit industry.

    On the surface, microcredit sounds like a great concept: make loans to these poor people whom the traditional banks will not touch.

    But, after scratching the surface, I find the whole things very fishy:

    1. The default rate: Yunus claimed the default rate is only 1.5%. This is much much higher than that for the comparable population sample in US.

    2. The interest charged on such loans is very high: 20%. This interest is comparable to those charged by loan sharks to poor people. To understand how high the interest is, unless a borrower can make more than 20% returns on such a loan, she is better off without it. In an economy that grows 5.7% (source, CIA factbook), I just don't see how many people in Bangladeshi can break even on such loans.

    Any comments?
  2. My comment is that one and a half percent seems low.
  3. There are people desperate to borrow money at any cost. Without the ability to earn a risk premium, who's going to lend it to them?
  4. Tuneman


    I must admit I was expecting a lower intrest rate for a defaut rate of 1.5%. But if this is true, I don't see why he should get a nobel peace prize. Sounds like a buisness man to me.
  5. Sounds like Grameen bank is the only lender. If so, why? Where is the competition and thus lower rates?

    Inflation sounds good. From 1994-2004, the annual rate of inflation was 3.73%, so why such a high 20% rate?

    Grameen bank has 6.5 million borrowers of micro-credit, so they can charge as much as they feel like I guess. The average loan is only $200, which is alot to the borrower but nothing to the bank if not repayed.

    Desperate people would pay 20%, so why the Noble Prize? Where is the selflessness? Where is the innovative idea? The bank should have been providing loans like this decades ago.
  6. just21


    The default rate is so low because they made a whole group responsibble for one persons debt. Social stigam to default and the rest of the group, who have borrowed money, are responsible for the debt of an individual. Very clever.
  7. Remember you are talking of Bangladesh where current savings interest rates in 7% -12 % depending on deposit period and if you want any big bank to give you loan the rates band is 12-17%. Inflation rate in Bangladesh is 6-7%

    So 20% for sub prime borrowers is not a bad deal.
  8. rwk


    This is from the Grameen Bank website: http://www.grameen-info.org/bank/GBGlance.htm
    - Although each borrower must belong to a five-member group, the group is not required to give any guarantee for a loan to its member.
    - Total number of borrowers is 6.61 million, 97 per cent of them are women.
    - Loan recovery rate is 98.85 per cent.
    - There are four interest rates for loans from Grameen Bank : 20% (declining basis) for income generating loans, 8% for housing loans, 5% for student loans, and 0% (interest-free) loans for Struggling Members (beggars). All interests are simple interest, calculated on declining balance method. This means, if a borrower takes an income-generating loan of say, Tk 1,000, and pays back the entire amount within a year in weekly instalments, she'll pay a total amount of Tk 1,100, i.e. Tk 1,000 as principal, plus Tk 100 as interest for the year, equivalent to 10% flat rate.
    - Grameen Bank offers very attractive rates for deposits. Minimum interest offered is 8.5 per cent. Maximum rate is 12 per cent.

    In summary, the commercial loan rate is 10%, about the midpoint in what they pay for deposits. There is no loan document and no collateral. Loans carry free life insurance. The bank is self-sustaining, requiring no government or charitable assistance. This is an example of free enterprise at its finest IMHO.

  9. I'm confused where you said "a whole group responsible for one person's debt".

    Do you mean another company (group) buys loans that are initially in default and after that only 1.5% still default to the original lender?

    It's clear that other people who borrowed money from the original lender are not responsible for any defaults.

    From the sound of your post it seems you're implying that the initial borrowers are subject to some kind of "floating" interest rate increase that would accomodate for up to 98 and a half of the initial loans????????

    I know that other companies may buy default loans . .. . in hopes that creditors will pay back at a late date. . .

    I think what happens is that only 1.5 % of the initial loans are not bought by those other "collection" companies.

  10. Alright so I actually read about the grameen bank and . . .

    just disregard anything I've posted in the thread . . . it had nothing to do with "micro-credit" as it's used here. . .
    #10     Oct 14, 2006