January 31, 1997

Donors and Policymakers Can Make Microcredit Work for the Rural Poor

Washington, D.C.--The Microcredit Summit, February 2-4, serves a valuable purpose in focusing international attention on credit for the rural poor and such programs as the Grameen Bank of Bangladesh, whose success at providing credit to 2.1 million poor women in 36,000 villages inspired an international movement to improve access to credit for the worlds poorest people. However, donors and policymakers should be cautious about the prospects of replicating the Grameen Bank or any other model.

Research by the International Food Policy Research Institute (IFPRI) on rural finance programs for the poor in 11 African and Asian countries found no single blueprint for success. The good news from the research is that improving poor peoples access to credit--through microcredit schemes and other approaches--could help raise incomes and relieve poverty in developing countries. This research, which has been conducted since 1991, represents one of the few comprehensive studies on the impact of credit on rural households. The findings provide ample justification for the appropriate involvement of donors and national governments in improving access to credit for the rural poor.

IFPRI research into a variety of rural financial systems suggests a set of general guidelines for developing rural financial markets.

Traditional banking practices dont work for the rural poor. Requiring borrowers to put up physical collateral and fill out substantial amounts of paperwork ignores the realities of the rural poor. Poor people cannot afford to risk their limited holdings of land or livestock, and illiteracy makes bureaucratic paperwork a daunting obstacle. Paperwork should be minimal, and "social collateral" such as peer monitoring must be used to determine the creditworthiness of the poorest people.

Local approaches work best. There is no single blueprint for providing financial services to the poor that works in every location. However, technical support and training for the poor are preconditions for success. Community financial institutions should be controlled by their members and encouraged to experiment with different approaches to providing financial services and with various savings strategies. Regulations to protect savings and to minimize loan defaults are necessary. But they should be flexible enough to recognize "informal" institutions and allow local organizations to set their own rules.

Interest rate subsidies are unnecessary. Poor people are willing and able to borrow at market rates. The obstacle the poor face, particularly poor women, is access to loans. Government can provide moderate subsidies to support the development of financial institutions and lower the costs of processing small loans, but interest and transaction costs should be borne by the customer.

More credit should be focused on agriculture. Farmers with access to credit use improved farming technologies. Most agricultural credit schemes failed in the 1970s and 1980s because traditional banking approaches were used. This left small landholders and tenant farmers without credit to finance their operations. Poor rural women, who produce most of their families food in developing countries, have always been neglected by banking institutions. New member-based institutions providing credit for agriculture are necessary in order to have a profound impact on poverty, because agriculture is the engine of economic growth and employment in most developing countries.

Rural finance alone will not relieve poverty. More credit does not necessarily mean less poverty. Appropriate policies and good governance are critical for creating an environment in which financial services can make a difference for the poor. People must be educated and healthy enough to use credit in productive activities. Efficient, functioning markets are also critical for small-scale farmers and entrepreneurs to obtain the inputs and outputs they need to produce and get their products to market. Investments in a social safety net, as well as roads, electricity and communications infrastructure, are necessary to enhance the impact of credit in relieving poverty.