How does microcredit help low-income people?
It is a system that allows people from low-income brackets to take out loans with low interest rates in order to support themselves. The term also refers to when creditors lend small amounts of money to those with a credit history so bad that they can’t take out loans from banks.
Recently, Korea launched a microcredit foundation. This will allow people with poor credit to borrow money with low interest rates without a security deposit, which borrowers must usually make to show their commitment to paying off a loan. People get poor credit ratings when they fail to pay bills or repay debts.
The Korean microcredit foundation plans to go into operation in June so that low-income families and people with poor credit will be able to borrow money to start their own businesses. These are people who have an unstable income or have borrowed money from a bank in the past and failed to pay it back.
But why is the central government launching a microcredit foundation now when banks and other financial institutions continue to advertise loan products?
When people are urgently in need of money, they visit banks first, but banks are picky about giving loans.
In Korea, most banks require borrowers to put up their property as collateral when they take out loans just in case they fail to pay them back.
Banks don’t want to lose money. For this reason, it’s hard for people who don’t own homes or land to take out loans from banks.
Banks lend money at low interest rates to people with high annual salaries. However, banks aren’t as willing to lend money to people in debt or who have no records of financial transactions with banks.
Imagine that your friends or family want you to lend them some money.
If they are good at keeping promises, you’d be more likely to lend to them. But if they don’t keep their promises, you probably wouldn’t let them borrow money from you.
In the same way, maintaining good credit is very important. Just as not everyone is good at keeping promises, some people have good credit, while others do not.
People who cannot get access to traditional bank loans because of bad credit need to find others who will allow them to borrow money. Such sources include private lenders.
These days, people see many TV commercials about loan plans saying, “We’ll lend you money.” These are advertisements from private lenders, who are less strict about giving loans than banks.
Unlike conventional banks, private lenders charge up to 49 percent higher annual interest rates. Most conventional banks charge less than 10 percent per year in interest. If a person borrows 1 million won ($1,007) from one of these private lenders, they must pay 490,000 won in interest per year.
However, people who have credit so bad that even private lenders reject their applications must resort to borrowing from loan sharks, who charge a whopping amount of interest — between 60 and 100 percent per year.
Based on their credit status, people pay different amounts of interest to banks. However, when people are under the burden of a high interest rate, there are side effects. Let’s take a man named Mr. Kim as a hypothetical example.
Let’s say Kim is a small business owner who sells his goods in a market. He’s currently 1 million won in debt, money he borrowed from a loan shark to start up his business about one year ago at an annual interest rate of 70 percent. Kim took out this loan back when business was bad for him.
With 1 million won, Kim has restarted his business and earned 200,000 won last year, but now he needs 500,000 won more to pay the interest on his loan.
If Kim wants to keep his business running this year, he needs to borrow 1 million for business costs and another 500,000 won to pay last year’s unpaid interest. After borrowing a total of 1.5 million won, Kim has to pay 1.05 million won as interest per year.
Thus, the amount of interest is almost the same as the amount Kim originally borrowed. People often get caught in this kind of vicious circle when they borrow money at high interest rates from loan sharks.
If Kim could borrow money with a 5 percent annual interest rate, his situation would be very different.
With a 5 percent annual interest rate, Kim needs to pay 50,000 won in interest per year. Then he can save 150,000 won out of his total income of 200,000 won. He could then borrow 850,000 won the next year.
Microcredit helps low-income people support themselves. However, this type of small loan is hard to find, even though many people are interested in microcredit.
Korea currently has more than 7.2 million credit delinquents who cannot get access to traditional bank loans. In order to lend to those credit delinquents, a lender needs a huge amount of funds.
Since microcredit is not a lucrative business, the central government has taken on the responsibility of launching it here. About 200 billion won worth of money from inactive bank accounts and unclaimed insurance will be used for microcredit.
By allowing them access to microcredit, the Korean government expects poor people to overcome poverty and lead better lives. Narrowing the gap between the haves and have-nots will allow low-income people to contribute to the nation’s economy by becoming economically productive.
A professor of economics at the University of Chittagong in Bangladesh built the microcredit prototype in the 1970s. His name is Muhammad Yunus.
Yunus started to lend money to a group of women burdened by debts with high interest rates back in 1976. Yunus lent a mere $27 to each woman.
After borrowing money with low interest rates from Yunus, these women were able to start new lives by making handicraft goods. During the three years that followed after Yunus made the loans, he saw more than 500 households succeed in overcoming financial difficulty.
Eventually, Yunus launched Grameen Bank in 1983. He has been expanding the business ever since. Grameen means “village” in Bengali.
Yunus lends money to people without any collateral, but more than 99 percent of borrowers pay back their loans. As an increasing number of less-fortunate people have started to earn and pay back their loans, Yunus has been able to lend more money to more poor people.
In 1993, Grameen Bank went into the black for the first time, finally pulling itself out of the red. As of February, the bank had lent more than $6.3 billion to more than 7.43 million people.
One notable fact about Grameen Bank is that more than 97 percent of its borrowers are women. Yunus attributes this to his perception that women are more likely than men to use the money for the family’s benefit.
Yunus received the Nobel Peace Prize for his method of giving new opportunities to poverty-stricken people in 2006.
After Grameen Bank’s success, many countries across the world began to launch microcredit programs. Grameen Bank recently started business in the United Sates.
In Korea, a couple of organizations grant small loans to low-income families at low interest rates. These include the Microcredit Joyful Union and the Social Solidarity Bank.
By Kim Won-bae JoongAng Ilbo [so@joongang.co.kr]
with the Korea JoongAng Daily
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