Credit derives from the Latin credere, “to believe.” In the mid-1970’s, the belief of one man, Muhammad Yunus, in the credit-worthiness of people living in poverty created the revolution in development practice now known as microfinance. Today, Yunus has assisted 6 million people and lent over $27 billion in micro finance.
Yunus, an economics professor in his native Bangladesh, received the Nobel Peace Prize on Friday. This accomplishment underscores the important role financial services can have not only on individuals and communities, but the world. Yunus developed the Grameen Bank after witnessing the life-threatening poverty surrounding him and after being unable to find any explanation or solution in his academic economic theories.
Quickly, he learned that “poor were not poor because they were stupid or lazy. They worked all day long, doing complex physical tasks. They were poor because the financial structures that could help them widen their economic base simply did not exist in their country. This was a structural problem, not a personal problem.” This finding echoes the beliefs of the founding fathers of credit unions in North America.
In many ways the situation today in Bangladesh mirrors that of the US in the early 1900s. Without tenable access to formal financial institutions, the poor either go without external assistance or they turn to “moneylenders” who, since they have a monopoly on the informal market, charge exorbitant rates essentially perpetuating and exacerbating the borrowers’ poverty.
Building a New Credit Model
Yunus examined conventional financial institution practice and then turned it on its head. He questioned the simplest yet most fundamental rule of banking – collateral. Financial institutions typically require borrowers to provide collateral as a guarantee of repayment; those in poverty have few assets to serve as collateral or to support the loan. The lack of assets serves as evidence that the borrower is financially irresponsible. The conventional system therefore assumes the borrower must not be credit-worthy.
Instead he argued that those that have the least need it the most and have the most incentive to repay. “The poorest of the poor work 12 hours a day. They need to sell and earn income in order to eat. They have every reason to pay you back, just in order to make another loan and live another day! That is the best security you can have … their life.”
For his new banking system, borrowers were required not to prove they already had assets to loan against, but rather the opposite—that they had few possessions. By asking borrowers to demonstrate poverty, Yunus sought to bring financial services to the most excluded and vulnerable poorest of the poor. To achieve this, he substituted social collateral for physical collateral. This new concept of social capital was created through a group-based lending system constituting small, self-selected groups of borrowers that were jointly liable for the loan. The group serves two ends: to ensure repayment through peer pressure and to create a supportive and encouraging network of peers.
Group liability, however, was not the only mechanism to ensure repayment. Yunus altered the traditional requirements for lending as well as the process. In an effort to make involvement the most straightforward and least psychologically intimidating, his lending system was structured on one-year loans, with equal weekly installments due starting one week after the loan is disbursed. He believed that having a routine builds confidence in the borrower; also, the frequency of repayment means the amount repaid is smaller, thus seeming like less of a financial burden. These seemingly minor adjustments to the conventional financial system revolutionized both financial services and development practice.
The Lesson for Credit Unions
Across America, marketplace issues are about more than price. It is a symptom of the fact that not all of a society's needs can be met by market-driven responses or state-supported programs. It is these gaps or needs that credit unions originally responded to, and to which they still can today.
As social entrepreneurs, credit unions can bring social, not just economic change, challenge private ownership models with commonwealth solutions and accomplish this in a democratic structure of accountability.
How can credit unions recapture their role as social entrepreneurs promoting community well being and economic democracy? We must identify emerging needs or ones not being met. Should loans for energy efficient automobiles enjoy lower rates? Should credit unions proactively seek financing for daycare centers in low-income areas, for public-private housing projects, for community retirement housing?
Responding to these and other unmet opportunities is how credit unions can define their uniqueness. Look to the community, ask the members, and initiate action. Isn't that how credit unions were begun in the first place?
Source: Banker to the Poor by Muhammad Yunus