Since it first emerged in its modern form in Bangladesh in the 1970s, microfinance – the practice of providing financial services such as loans, insurance and savings accounts to individuals or low-income groups that are traditionally excluded from the banking system – has become a multi-billion dollar resource. -global dollar industry. In 2018, there were approximately 140 million microfinance borrowers worldwide (80% of whom were women) representing a total of $124 billion in loans. In many ways, this is not surprising. After all, even today more than 1.7 billion adults worldwide are financially excluded. These people have credit needs like everyone else and often end up depending on family and friends (to whom they can only turn a limited number of times) or pawnbrokers (who charge low rates). exorbitant interest). Microfinance enables people to take out small, reasonable loans consistent with ethical business practices. The goal is to give individuals the opportunity to become self-sufficient. Following the “Grameen model” originating in Bangladesh, many microfinance institutions (MFIs) practice group lending. Microfinance research has found that adoption of microfinance is linked not only to increased access to credit, but also to increased investment and profits in small businesses, increased household spending and even in the schooling of children. Microfinance has not been the panacea to global poverty its most optimistic proponents once hoped for, and it carries risks like increasing indebtedness in already vulnerable communities, but it has dramatically improved the lives of many low-income people around the world.
Is there a market for it in the United States?
Although microfinance has grown from humble beginnings to reach more than 140 million borrowers worldwide, it has not experienced the same explosive growth in the United States. Is it because there is not a lot of market for microcredit in the country? The proportion of financially excluded individuals in the United States is certainly much lower than in developing countries like Bangladesh or Peru, where microfinance has flourished. But there is still a large population of financially excluded Americans. According to a 2020 Federal Reserve survey, 5.4% of U.S. households (7.1 million people) were “unbanked,” meaning no household member had a checking account or bank account. savings with a bank or credit union. 13% were “underbanked,” meaning they had bank accounts but lacked access to banking services, forcing them to resort to alternative sources like payday loans to meet their financial needs. Taken together, nearly one-fifth of US households are either unbanked or underbanked. Not surprisingly, these rates are even higher among communities of color and immigrant groups. More than 40% of African American households and 30% of Latino households were unbanked or underbanked. These groups constitute the bulk of the microfinance clientele in the country. Moreover, 92% of American companies are micro-enterprises employing less than five people. These companies are responsible for more than 41 million jobs in the United States, and millions of them report insufficient access to credit.
Is it suitable for the American market?
Women and economic growth
Even when there is a potential market for microfinance, the question is whether it is suitable for developed countries like the United States. Many argue that practices such as group lending require a level of social solidarity that is better suited to developing countries. To investigate this, the MDRC, a social policy research organization, conducted an in-depth study of those who borrowed from the pioneering microfinance institution Grameen Bank in Union City, New Jersey – mostly low-income Latino immigrant women. . The study found that recipients were more likely to operate their own business, see a modest increase in income, experience fewer material hardships such as running out of money in the previous three months, and afford the basic necessities. They were also more likely to have established a credit record, a “prime” Vantage score (an alternative to the FICO credit score) that allowed them access to traditional financial markets and lower interest rates, deeper relationships with members of their loan groups, and expanded social support systems. The results of the study demonstrated that microfinance can help improve the lives of low-income people, even in developed countries like the United States.
The way forward: reforming regulatory frameworks
So if it can work here and there is a market for it, why is microfinance lagging behind in the United States? The biggest hurdle is the regulatory framework within which MFIs are required to operate. They are subject to the same regulations – including usury laws and capital requirements – as traditional commercial banks that exclude communities served by MFIs. MFIs serve a different clientele than traditional commercial banks, often with no credit history or collateral, which is why they are not served by commercial banks in the first place. Because they cater to a high-risk clientele, MFIs may not be financially viable by charging interest rates that usury laws currently allow.
The solution is therefore not to relax the usury requirements widely, but to pay particular attention to the nature of the risk of the microfinance sector, to recognize MFIs as a distinct category of financial institutions and to provide separate rules. Some developing countries with thriving microfinance sectors have recognized this and established regulatory frameworks for MFIs separate from traditional banks. The United States should follow suit. Although at first glance this may appear to charge higher interest rates to low-income people, the nature of the risks that MFIs take means that they cannot survive by charging the same rates as banks. traditional. While MFIs may charge slightly higher interest rates than traditional banks (around 15%), in their absence – with the latter refusing to serve them – unbanked people may be forced to turn to payday lenders who charge much more exorbitant rates (400% or more). MFIs should also be subject to separate capital requirements from commercial banks.
To be clear, while regulations on MFIs should be separate from those on commercial banks, regulations should exist and be rigorously enforced. The Federal Trade Commission Act and the Consumer Credit Protection Act should contain provisions recognizing MFIs as a special class of financial institution that ultimately helps protect borrowers from abusive collection practices. There should also be an entity that serves as a supervisory and regulatory body to ensure the stability and solvency of MFIs in the country, by carrying out inspections of them. MFIs should be required to submit internal audit reports to this body on their interest rates and loan portfolios. This oversight would provide the transparency essential to the success of the MFI sector. The regulatory body could be at the federal level or left to the states, at least initially. States could be allowed to determine what type of regulatory body works best for their residents. There is a precedent for this. Industrial banks or Industrial Loan Companies (ILCs), for example, are exempt from the Bank Holding Company Act of 1956. In Utah, industrial banks are regulated by the Utah Department of Financial Institutions and the State has become a hub for these entities. Industrial banks have their share of critics, who argue that the ILC exemption is a loophole allowing commercial firms to own insured banks without being subject to federal regulation. But the principle of allowing states to establish their own regulators for MFIs might still prove prudent, and eventually the best practices of some of them could be adopted for a national regulator.
In short, while microfinance has grown exponentially around the world, its slower progress in the United States is due to the inadequate rules that MFIs are forced to operate. Providing separate, yet still accountable, regulatory frameworks would help the industry grow, ultimately increasing access for underserved people in the United States and providing them with better tools to improve their financial futures.
Women and economic growth