Increasing microlending potential in the United States through a strategic approach to regulatory reform.

AuthorRichardson, Molly
  1. INTRODUCTION II. BACKGROUND A. A Brief History of Microcredit and Its Success in Developing Countries 1. Functions and Effects of International Microlending 2. Microlending's History and Successes 3. Microlending and the Market B. Background on Microcredit in the United States 1. History and Overview of Microlending in the United States 2. Microentrepreneurs and the Need for Microcredit in the United States 3. Regulation of Microcredit in the United States C. Differences Between U.S. and International Microcredit Markets 1. Logistical Limitations 2. Theoretical Limitations III. ANALYSIS A. Current Regulations Affecting Microlending 1. The Community Reinvestment Act 2. Interest Rate Regulations 3. Capital Holding Requirements IV. RECOMMENDATIONS A. Promising Regulatory Reforms to U.S. Microlending 1. Exempt Microlenders from Interest Rate Caps 2. Amend Minimum Capital Holding Requirements to Accommodate the Higher Risks Involved in Microlending 3. Adopt Microlending Methods Consistent with the Realities of the U.S. Market B. How Microlending Reformers Can Most Effectively Enact the Desired Reforms 1. Presenting Microlending in a Market Context 2. Presenting Microlending as a Way to Lessen Reliance on Governmental Assistance V. CONCLUSION. I. INTRODUCTION

    After 30 years of lending money to poor people in developing countries to encourage entrepreneurship, microfinance institutions (MFIs) have become generally accepted in the international community. (1) The United Nations named 2005 the International Year of Microcredit. (2) President Bill Clinton sang its praises. (3) Microlending has appealed to both liberals and conservatives in U.S. government. (4) Muhammad Yunus, and the Grameen Bank he founded, were recently given a Nobel Peace Prize, and Business Week named Yunus one of "The Greatest Entrepreneurs of All Time." (5) Many international MFIs have become self-sufficient and enjoy repayment rates in the high 90 percentages. (6) Microloans have supplied billions of dollars in small loans to millions of people struggling to start and expand businesseS. (7) Despite this international success, microcredit efforts in the United States are nowhere near self-sufficient, face high default rates, and are not meeting microentrepreneurs' needs.

    This Note explains microlending in general, and then examines its implementation in the United States. It then analyzes why U.S. MFIs have not reached self-sufficiency at the same levels as international MFIs. Next, this Note examines the various proposals different scholars and practitioners have offered to address the limitations of microcredit in the United States. This Note next recommends the most promising solutions, which center on regulatory reform. The proposed regulatory reforms aim to strengthen the sustainability of microlending in the United States. The Note then offers a practical political strategy to implement these reforms--something largely missing from academic literature on microlending in the United States.

  2. BACKGROUND

    This Part explores the history of microcredit, both abroad and in the United States. It then explains U.S. microlending in more detail, and outlines the demand for more sustainable microlending practices in the United States. Finally, this Part explores the U.S. regulations that most directly affect microlending practices.

    1. A Brief History of Microcredit and Its Success in Developing Countries

      Since their inception in the 1970s, MFIs have offered economic opportunities to poor people, in part by lending small amounts of capital to borrowers who use it to fund their small businesses. (8) MFIs generally lend to microbusinesses, which are businesses with five or fewer employees. (9) MFIs offer many different services, (10) but this Note focuses specifically on the microlending function of MFIs. This Part will briefly explain the process and history of international microlending.

      1. Functions and Effects ofInternational Microlending

        Commercial banks in developing countries generally serve less than 20% of the population. (11) Microcredit institutions step in to fill the void in the lending market by offering small loans, ranging from roughly $10-$1000, to poor people attempting to start businesses. (12) The borrowers are people to whom traditional financial institutions will not lend because of the high transaction costs and high risks associated with lending to microentrepreneurs. (13) Borrowers' incomes and quality of living often increase as a result of receiving these loans. (14) The duration of the loan is typically less than two years, and microlenders usually require that the loan be used for productive capital purposes rather than consumption. (15) Acceptable uses include purchasing raw materials and supplies like food ingredients, sewing machines, or more recently, cell phones-materials necessary to start and expand the business operation. (16)

        Microlending institutions typically do not require borrowers to give collateral or undergo credit checks, but instead rely on alternative methods to reduce risks associated with lending. (17) For example, the Grameen Bank (18) relies on peer lending circles. (19) These lending circles use social pressure to encourage borrowers to repay, since, in some cases, the group has joint responsibility for the loan or cannot obtain another loan until one borrower has repaid. (20) Other methods include information gathering about a potential borrower, joint liability contracts, short term contracts, or "loan ladders," which increase subsequent loan amounts after each repayment. (21)

      2. Microlending's History and Successes

        In its relatively short history, microcredit has reached a vast number of poor people in over 100 developing countries throughout South and Central America, Africa, and Asia. Between 1997 and 2006, ACCION International (ACCION), (22) a premier microfinance organization, lent $12.3 billion to 4.94 million people, with a repayment rate of 97%. (23) Similarly, the Grameen Bank loaned more than $750 million in a two-year period, with a 97% rate of repayment. (24) Such high repayment rates show that many international MFIs have reached self-sufficiency. (25)

        ACCION and Muhammad Yunus, founder of the Grameen Bank, claim to have both independently pioneered the concept of microcredit. (26) In the early 1970s, ACCION volunteers struggled to address the high unemployment rates in South American cities. (27) Unemployed urban poor in these cities started their own enterprises selling hand-woven belts, handmade pots, or vegetables. (28) ACCION staff observed that local loan sharks charged the entrepreneurs outrageous interest rates, which usually left borrowers broke. (29) In response, ACCION offered small loans with lower interest rates to small business owners, thus "launch[ing] the field of microcredit." (30)

        Around the same time, economist Muhammad Yunus was exploring the potential for small loans to ease poverty in developing countries. (31) In 1976, Yunus was a professor and head of the Rural Economics Program at the University of Chittagong. (32) As part of his research with the program, he initiated a project to study the "possibility of designing a credit delivery system to provide banking services targeted at the rural poor." (33) After seeing the effects unemployment and poverty had in Bangladesh, he loaned $27 to a group of women who made bamboo furniture. (34) Based on their success and subsequent repayment, he expanded this concept of microlending and eventually formed the Grameen Bank, a nongovernmental organization (NGO). (35) In 1983, Bangladeshi legislation made the Grameen Bank Project an independent bank. (36) Currently, 90% of the bank's shares are owned by borrowers, and 10% are owned by the government. (37) Today, the Grameen Bank extends loans to nearly two million borrowers in Bangladesh. (38)

        During the 1970s, NGOs and donor groups began to offer microcredit in developing countries. (39) NGOs and donor groups still make up the majority of microlenders, but the number of commercial microcredit providers is increasing. (40) Commercial suppliers range from commercial banks that modify their traditional lending practices, to credit unions, to commercialized NGOs that become licensed as financial institutions. (41) For example, the Postal Savings Banks represent a typical MFI--they reach poor rural areas by locating offices in rural postal offices. (42) Postal Savings Banks operate similarly to traditional commercial banks, except that they offer more flexible loan terms. (43) Most MFIs seek grants from international development banks and the government, and many are starting to solicit private investors in an effort to reach self-sufficiency. (44)

      3. Microlending and the Market

        Some scholars and practitioners have debated whether microlending occurs within or outside the market--whether the practice of microlending has "embraced market mechanisms or has ... elaborated other disciplinary mechanisms." (45) Some see MFIs as working within the existing global market, while others see MFIs as creating their own "faux markets for the poor." (46) Some have questioned whether MFIs would be necessary at all if traditional lending institutions found lending to the poor to be profitable. (47) Since microlending processes--supplying capital and requiring repayment--involve market principles, however, and not government subsidies, this Note examines microlending within the market framework. Under this perspective, microlending occurs in a capitalistic, efficient system and not in a vacuum. Further, many MFIs have found microlending to be a profitable enterprise. For example, the microlending division of Bank Rakyat Indonesia reported $200 million in profits, (48) and the Grameen Bank reported $20 million in profits for 2006. (49)

        Within this market context, microloans seem to be a hybrid of both banking and venture capital principles. (50) MFIs utilize banking terms like credit...

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