Microcredit: an institutional development opportunity.

• Author: Snow, Douglas

Abstract

The development of microcredit programs provides an opportunity to strengthen local institutions. Research has focused on the design and management of microcredit programs without enough attention to the institutional environment in which microcredit programs operate. Theory offers a framework for understanding the importance of linkages between microcredit programs and local institutions. These linkages lead to sustainability. Broadly defined, sustainability refers to a net positive flow of benefits to the local community. Microcredit programs embedded in local institutions have the best hope of becoming sustainable.

Introduction

Microcredit programs provide an opportunity to build sustainable local institutions. While much has been written about the design of microcredit programs and their impact on people's lives, little has been done to place the role of microcredit in an institutional perspective. But there is a body of institutional development theory that can be applied to microcredit (Leonard, 1982; Uphoff, 1986; Esman and Uphoff, 1988; Cernea, 1993; Ostrom, 1993; Howes, 1997). Two theorists, Elinor Ostrom and Norman Uphoff, among others, have contributed substantially to what we know about the role of institutions in effective economic development. Drawing from both economic theory and practical experience, these writers established development policy frameworks useful in designing programs to help the poor. Uphoff examines the advantages of various institutional arrangements in the design of development programs, while Ostrom uses economic concepts to explain the benefits of developing local institutions. While much of the theory has evolved from the study of developing countries, lessons learned apply to microcredit programs in the United States as well.

The conventional wisdom holds that programs to help the poor should be sustainable. But achieving sustainability is a particularly difficult problem in crafting economic development strategies. Microcredit programs can only evolve into sustainable institutions if they are linked, or partnered with local institutions: churches, postsecondary schools, local governments, credit unions, banks, established nonprofit organizations, service organizations, and job training programs. Microcredit programs operating without linkages to local institutions are less likely to be sustainable.

Just how "sustainability" is to be defined is a knotty problem. Broadly defined, sustainability is in direct opposition to quick fix or ad hoc options addressing a particular problem for a short period of time. All too often, quick fix solutions end up embedded in the lengthy catalog of government programs. Most of us have a pretty good idea of what sustainability is not. Sustainability is not achieved if programs do not meet the needs of the people that they are designed to help. Programs are not sustainable if their costs cannot be met over a long period of time. Without a commitment to maintaining, evaluating, and improving programs, sustainability cannot be achieved.

Sustainable programs are well-designed, in terms of operations and institutional relationships, and allowed sufficient time to demonstrate a positive effect. A great deal of research has focused on the design of microcredit programs. The size of the loan, the interest rate, the term, the use of peer group v. individual loans, to name the most prominent issues, occupy a sizeable portion of the literature (Snow and Buss, Forthcoming). The relationship of microcredit programs to existing institutions as an important variable in achieving sustainability has been neglected.

Sustainable Microcredit

Microcredit programs become sustainable institutions when net benefits to the community exceed total costs. Benefits accrue to the community when new businesses are successful and incomes increase. Microcredit fills a niche that banks do not always fill. Commercial banks are unable to economically administer microcredit programs. Neither are they in the business of training entrepreneurs. Without a credit report and a track record of business success, the poor do not look like good credit risks to commercial lenders. High costs and high risks combine to deter banks from entering the microcredit market. To take up where the market leaves off, microcredit programs generally have two objectives. First, they allow people access to small amounts of capital that would otherwise be inaccessible and, second, they provide a training ground for entrepreneurs, some of whom may expand their businesses to a point where they can utilize commercial sources for working capital.

Microcredit programs must access the appropriate clientele to accomplish their mission. However, outsiders with a desire to help the poor perform no better than commercial bankers. They do not know the local market for microcredit. To develop this information, they will incur both high costs and high risks. But linkages to local institutions can reduce costs and risks for micro-lenders. Except for those too poor to have any connection to local institutions, most of the poor are connected to local institutions in some form, even if it is only through the welfare office.

Local institutional development theory emphasizes the aspirations and know-how of individuals who, ultimately, make up the strength of a nation's economy and political structure. This, in turn, strengthens local communities (Ostrom, 1993). Microcredit sponsors present abundant anecdotal evidence (and some empirical evidence) of their ability to help the poor. What has not been demonstrated empirically is the importance of linkages between microcredit and other institutions in the United States, although there is some literature that deals with programs linking microcredit and local institutions in developing countries (Churchill, 1997; Malhotra and Fidler, 1997; Pederson and Kiiru, 1997). Theories of development stressing strong local institutional capacity predict a strong correlation with sustainability.

The rule for linkages to local institutions is simple: find institutions having comparative advantages (Uphoff, 1986). Institutions meet human needs. The closer the institution to the individual, the stronger its comparative advantage. Local leaders and the peer group of the microcredit clientele, through their relationships in local institutions, can identify the best candidates for microcredit programs. Churches, vocational schools, community colleges, fraternal organizations, service clubs, granges (in rural...