Grameen Bank case study: Power of Innovation
Nguyen Ngoc Anh Thu, Le Quynh Nhu
In the 1970s, Professor Muhammad Yunus developed a method of poverty reduction by removing the fundamental barrier to lending to the lowest members of society: the necessity for collateral. To make the idea of lending that small amount to the poor a reality, Yunus founded Grameen Bank in 1983. By November 2004 the Bank had exceeded the number of loans of over US$4.4 billion to the poor. In 2006, Yunus won the Nobel Peace Prize for his pioneering work in microfinance.
In this essay, the authors explore the formation and operation structure of Grameen Bank using social business frameworks. At the same time, this essay evaluates the efficiency of Grameen Bank in terms of its positive impact on human capital by considering the historical context of its target beneficiaries.
I. Grameen Bank’s Story
The story of Grameen Bank began about 50 years ago. Prof. Muhammad Yunus – at that time, has graduated from a University in the US – still chose to return to Bangladesh. “I wanted to return and rebuild,” he said. “So I took a position at Chittagong University and began doing what I knew how to do: teach economics.” During the time he was working in Bangladesh, he made a survey trip to a village near his workplace – Chittagong University, where he received an unexpected offer.
“Can you lend me money? Just a few is okay” – the question that started the journey of Grameen Bank was from a woman named Sufia Begum, a 21-year-old poor villager, desperate to borrow 25 cents to feed herself (Mainsah et al, 2004). In the village where she lived – Jobra, most of the villagers’ jobs are making handicrafts out of bamboo and rattan. However, to have money to buy materials, they have to borrow from gangsters at exorbitant interest rates. The reason why they need to look for black credit is that traditional commercial banks do not want to lend money to the poor. It is too small and too risky.
In this unexpected context, a thought sparks in Yunus’ mind: What if he tried to lend them a loan? Forty-two women in the village were lent by Yunus the equivalent of $27, a very small number, with an extremely favourable interest rate: 0.07%.
The results were surprising: All 42 lenders were repaid on time. From there, Yunus gradually built a concept of “microcredit” and “microfinance”. With pleasant enthusiasm, he showed this concept to traditional banks. In return, these banks simply refused to believe and stated that the borrowers would never be able to organize themselves enough to repay the loans.
But Muhammad Yunus did not have the same thought. With the reputation of himself and other supporting organizations, Yunus borrowed money from the local bank to lend money to the poor. By 1982, 28,000 people had been granted loans. The success of the program helped Yunus establish Grameen Bank a year later. By November 2004 the Bank had exceeded the number of loans of over US$4.4 billion to the poor. In 2006, Yunus won the Nobel Peace Prize for his pioneering work in microfinance, proving his vision about the efficiency of microfinance is right.
II. The vicious circle of poverty
The vicious circle of poverty is a concept introduced by Ragnar Nurkse (1993). The whole idea of it is that a poor country cannot escape poverty by itself because there are many self-reinforcing disadvantages that make poverty remain. Nurkse (1953) explained, “For example, a poor man may not have enough to eat; being underfed, his health may be weak; being physically weak, his working capacity is low, which means that he is poor, which in turn means that he will not have enough to eat and so on. A situation of this sort relating to a country as a whole can be summed up in the proposition: ‘A county is poor because the country is poor’”.
Although this concept is mostly used to describe the situation in the least Developed Countries (LDCs), it is obvious that a similar situation happened in the case of poor individuals, or more specifically, in the case of poor villagers in Jobra – where Muhammad Yunus spent his field trip. These villagers, in order to escape poverty, had to borrow money from black credit. But because of that, the money they had to repay just keep stacked up, and the only thing they can do were keep working harder and harder on low-income level jobs to pay the debt, leaving no chance for them to actually make a better investment in businesses or education to escape the vicious circle of poverty. Muhammad Yunus has realized it.
In the traditional form of the vicious circle, the only way to escape it is through external intervention. The most common practice of external intervention is through lending systems, in which the richer countries and other financial institutions in the world lend money to poor countries with reasonable or no interest rates. Muhammad Yunus has found a similar way to help poor individuals.
III. The Grameen Bank Model
The reason why Jordan villagers cannot borrow money from the normal credit market but have to turn to the black credit market is simple: information asymmetry. Credit markets are plagued by information asymmetry. Lenders have to endure the risk of losing their money. This risk is tied to the repayment capacity of borrowers – who lenders, most of the time, do not even know. Therefore, the credit market often judges borrowers’ repayment capacity by their financial backgrounds. To reduce information asymmetry, the lender often requires the borrower’s collaterals. However, it also means that the poor – who cannot afford mortgages and do not have the financial means to build credit – are hindered by information asymmetry and are excluded from participating in credit markets.
Grameen Bank solved this problem through group-based credit. By grouping borrowers with similar backgrounds into one group, their behaviour including repayment patterns is tied to group responsibility, thus ceasing the need for collateral.
A group usually consists of five people who know each other, live in the same community, and are of similar age (AFCA, 2020). After the formation stage, they will join a training program where they are provided with the lending policy of the microcredit program. Afterwards, the group are verified by a senior-level staff member. The evaluation standards include knowledge and understanding of the program, and attendance rates during group training (AFCA, 2020).
The advantage of group lending is that it increases clarity and minimizes information asymmetry. In a group of borrowers who know each other and share common goals, their interests, and creditworthiness are tied together. Transparency is essential in this system. Loan selection and applications are discussed by all team members at the mandatory weekly meetings. All credit transactions are publicly administered, and decisions are made by consensus (Khandker, S., Khalily, B., & Khan, Z., 1994).
Figure 1: The value proposition canvas of the Grameen Bank
Only with a small amount of money, this microloan system reverses the age-old vicious circle of “low income, low saving & low investment” by injecting external capital into it, thus, enabling the poor to feed themselves and invest in future business prospects. In Bangladesh alone, one million people are lifting themselves out of poverty every year (87,000 per month) as a result of microcredit (Khandker 1998).
In addition, this system also provides a way for poor people to gain their trustworthiness through their repayment history. For poor people who never had a chance to borrow a loan before, this repayment history in the microloans system will potentially open the door to many future loans they might need.
In conclusion, Grameen Bank is a remarkable innovation. From a humanitarian point of view, Grameen Bank has lifted millions of poor people out of poverty. From an economic point of view, Grameen Bank has provided a significant shift in the allocation of financial resources: Not only the well-offs, the have-nots now are able to approach the financial channel and start participating in the business world with personal entrepreneurship. Empathy is apparently a crucial component of Grameen Bank’s success. Without empathy, Muhammad Yunus cannot realize the vicious circle of poverty that the villagers have suffered. Without empathy, Muhammad Yunus would be as sceptical as other commercial banks and never find a way to believe in their ability to thrive.
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