Can Microcredit Work in the United States?

In the past few decades, microcredit programs have been used throughout the Third World to promote grassroots entrepreneurship. The programs, which provide small-business loans of as little as $ 50, have helped literally millions of low-income people improve their material well-being. The Grameen Bank in Bangladesh, for example, has disbursed a total of more than $ 1.5 billion to about 2.4 million borrowers, with a default rate of less than 3 % . Such figures have helped to convince many that poor people aren’t necessarily bad credit risks. Microcredit’s success overseas has caught the attention of U.S. policy makers, business leaders, and charitable organizations. They see it as a way to reduce poverty in disadvantaged communities at home. But so far, the results of microcredit programs in the United States have been decidedly mixed. On the one hand, U.S. microcredit programs have helped many poor but ambitious borrowers to improve their lot. The Aspen Institute’s study of 405 microentrepreneurs indicates that more than half of the loan recipients escaped poverty within five years. On average, their household assets grew by nearly $ 16,000 during that period; the group’s reliance on public assistance dropped by more than 60 % . On the other hand, many U.S. microcredit programs have been limited in their outreach. Our survey of more than 33 loan programs in California, for instance, revealed that each program made only seven loans per year on average, and that too much available capital—about half of it—sat idle. Some program managers attributed the low volume of loans to a lack of viable proposals from people who would be likely to repay the money; others reported a lack of demand. Excessive overhead costs have been another big problem. One U.S. microcredit program in our study had annual administrative costs that were more than double the value of the entire portfolio. And high overhead costs did not translate into efficient collection of loan payments. The programs suffered loan losses that were as high as 60 % —and thus had to depend on external subsidies to stay in business. What has prompted these mixed results? First, U.S. programs aren’t aggressive enough in trying to attract potential microentrepreneurs. Program workers in developing countries literally go door-to-door to spread the word. By contrast, U.S. programs usually rely on newspaper ads and public service announcements. They are also slow to disburse funds: U.S. programs can take up to 90 days to provide the actual cash. Third World microcredit programs come up with the money in a week or less. Second, U.S. programs have a hard time finding creditworthy applicants. Many who do seek assistance lack small-business management skills and a large enough base of customers. Our survey of about 300 Los Angeles-area microentrepreneurs revealed, for instance, that almost 70 lacked those essential ingredients of “loan readiness.” Their situation contrasts with that of most microentrepreneurs in the Third World who can be, say, successful street vendors without much formal education or experience. They don’t have to compete with the convenience store on the corner or the department store at the mall. Third, the salaries of program employees in the United States are much higher than those of their counterparts in poor countries, and that ratchets up the overhead. U.S. programs also face legal limits on the interest rates they can charge, which further complicates their efforts to cover costs. Third World programs, by contrast, have much lower overhead and can charge interest rates that exceed 30 % . Those advantages give them a higher chance of attaining financial self-sufficiency. Fourth, high loan losses in some U.S. programs are often the result of poor managerial practices. Our research revealed that some programs lacked accounting and information systems for servicing loans, monitoring borrowers, and sanctioning defaulters. Borrowers who realize that a program’s management is lax are less motivated to repay their loans. Successful programs in developing countries are managed better. Latin America’s ACCION International, for example, has a policy of “zero tolerance” on loan defaults. The lender tracks defaults daily and cuts off access to services for borrowers who fail to repay on time. Can problems with microcredit in the United States be overcome? Our answer is a qualified yes. U.S. programs have considerable room to enhance their efficiency and outreach. But the needed changes require strong support from the sponsors of microcredit initiatives—entities as diverse as Citibank, the Ford Foundation, and the Small Business Administration. To encourage greater efficiency, sponsors need to develop more stringent operational standards regarding overhead costs per loan, the number of loans disbursed per staff member, and, perhaps most important, the time it takes for a borrower to receive funds. More rigorous standards must then be used consistently as benchmarks for evaluating organizational performance and making funding decisions. To bolster outreach, sponsors should verify that potential programs have a track record in the community and that they will make an intensive effort to recruit borrowers. The development community should focus on increasing the credit readiness of microentrepreneurs by helping them obtain management skills and access to new markets. For example, programs can help clusters of people who are producing similar products sell them beyond local markets—as the Grameen Bank does by helping weavers export their products to the United States. Ultimately, making entrepreneurs out of people who have few resources is a matter not only of increasing the supply of capital but also of nourishing the demand for it. Making entrepreneurs out of people with few resources is a matter not only of increasing the supply of capital but also of nourishing the demand for it.

Can Microcredit Work in the United States?

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