Microcredit is a common form of microfinance that involves an extremely small loan given to an individual to help them become self-employed or grow a small business. These borrowers tend to be low-income individuals, especially from less developed countries (LDCs). Microcredit is also known as "microlending" or "microloan."
Microcredit borrowers tend to be low-income individuals living in parts of the developing world; the practice originated in its modern form in Bangladesh.
In some instances, the microcredit was guaranteed by an agreement with the members of the borrower's community, who would be expected to compel the borrower to work toward repaying the debt. As borrowers successfully pay off their microcredits, they may become eligible for loans of larger and larger amounts.
The history of lending small amounts of money to those in need is by no means a new idea. It extends back as far as human's have used money for transactions. One of the earliest written-of examples goes to Jonathan Swift, author of Gulliver's Travels and A Modest Proposal, who lent small amounts of money to the poor in Ireland in the early 1700s.
But Microcredit has long faced the core difficulty of cost: small loans have higher overhead costs as a proportion of the loan, decreasing the loans profitability, and it is hard to predict who will repay a loan. And those living on $2 or less per day often do not have the collateral to put up as a guarantee for a loan. This changed in the late 1970s.
Microcredit in its modern approach was institutionalized in 1976 by Muhammad Yunus, an American-educated Bangladeshi economist who had observed that a significant percentage of the world's population has been barred from acquiring the capital necessary to rise out of poverty. Yunus set out to solve this problem through the creation of the Grameen Bank in Bangladesh. The Grameen approach is unique because the small loans are guaranteed by members of the borrower's community; pressure within the group encourages borrowers to pay back the loans in a timely manner. By 1996 Grameen had extended credit to more than three million borrowers and was the largest bank in Bangladesh, with more than 1,000 branches.
Part of Grameen Bank's success came from Muhammad Yunus' heavily promoted vision for microcredit's promise. Before Grameen Bank, the consensus of financial institutions was that it was bad to lend to those living on $2 or less per day because it would trap them in debt. But Muhammad Yunus' vision of microcredit helping those people exit poverty transitioned the perception of microcredit.