How to Boost Microfinance in the United States
Since it first emerged in its modern form in Bangladesh in the 1970s, microfinance — the practice of providing financial services such as credit, insurance, and savings accounts to low-income individuals or groups traditionally excluded from the banking system — has grown into a multi-billion-dollar market global industry. In 2018, there were around 140 million microfinance borrowers worldwide (80 percent of whom were women) with a total loan volume of USD 124 billion. In many ways this is not surprising. After all, over 1.7 billion adults worldwide are already financially excluded. These people have borrowing needs just like everyone else and often end up depending on their family and friends (whom they can only turn to a limited number of times) or moneylenders (who charge exorbitant interest rates). Microfinance enables people to take out appropriate small loans that are compatible with ethical business practices. The aim is to give people the opportunity to become self-employed. In accordance with the ‘Grameen model’, which originated in Bangladesh, many microfinance institutions (MFIs) conduct group lending. Research on microfinance has found that embracing microfinance is associated not only with better access to credit, but also with greater investment and profits in small businesses, higher household spending, and even enrollment of children in schools. Microfinance has not been the panacea to global poverty its most optimistic proponents once hoped for, and it poses risks such as mounting debt in already vulnerable communities, but it has significantly improved the lives of many low-income people around the world.
Is there a market for this in the US?
While microfinance has grown from its humble beginnings to over 140 million borrowers worldwide, it has not experienced the same explosive growth in the United States. Is that because there isn’t a big microcredit market in the country? The proportion of financially excluded people in the United States is certainly much lower than in developing countries like Bangladesh or Peru, where microfinance is thriving. But there is still a sizeable population of financially excluded Americans. According to a 2020 Federal Reserve survey, 5.4 percent of U.S. households (7.1 million people) were “unbanked,” meaning no one in the household had a checking or savings account with a bank or credit union . Another 13 percent were “underbanked,” meaning they had bank accounts but lacked adequate access to banking services, requiring them to turn to alternative sources such as payday loans to meet their financial needs. Collectively, nearly a fifth of US households have either no or an inadequate bank account. Not surprisingly, these rates are even higher among communities of color and immigrant groups. Over 40 percent of African American and 30 percent of Hispanic households were either unbanked or unbanked. These groups make up the bulk of the microfinance client base in the country. In addition, 92 percent of US companies are micro-enterprises, employing fewer than five people. These companies are responsible for more than 41 million jobs in the US, and millions of them report inadequate access to credit.
Is it suitable for the US market?
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Even if there is a potential market for microfinance, the question is whether it is suitable for developed countries like the United States. Many argue that practices like group lending require a level of social solidarity better suited to developing countries. To investigate this, the MDRC, a social policy research organization, conducted an in-depth study of those who borrowed from the pioneering microfinance institution Grameen Bank in Union City, New Jersey – mostly low-income Latino immigrant women. The study found that recipients were more likely to run their own businesses, experienced a modest increase in income, experienced fewer material hardships, such as having a job. B. Lack of money in the previous three months and could afford the essentials. They were also more likely to have a credit score, a “premium” Vantage score (an alternative to the FICO credit score), which gave them access to mainstream financial markets and lower interest rates, deeper relationships with members of their credit groups, and expanded social support systems. The study results showed that microfinance can help improve the lives of low-income people, even in developed countries like the United States.
The way forward – reform of regulatory frameworks
So if it can work here and there is a market for it, why is microfinance lagging behind in the United States? The biggest obstacle is the regulatory framework under which MFIs have to operate. They are subject to the same regulations — including usury laws and capital requirements — as traditional commercial banks, which exclude the communities that MFIs serve. MFIs serve a different customer base than traditional commercial banks, often without credit histories or collateral, which is why they are not served by commercial banks at all. As a result of catering to a riskier clientele, MFIs may not be financially sustainable and charge interest rates that usury laws currently allow.
The solution, then, is not to relax usury requirements in general, but to pay particular attention to the nature of the microfinance industry’s risk, to recognize MFIs as a separate category of financial institutions, and to have separate rules. Some developing countries with thriving microfinance sectors have recognized this and created a regulatory framework for MFIs that is separate from traditional banks. The United States should follow suit. While at first glance this might seem like charging higher interest rates for those on lower incomes, the nature of the risks MFIs are taking means they cannot survive charging the same interest rates as traditional banks. While MFIs may have to charge slightly higher interest rates than traditional banks (around 15 percent), in their absence – as the latter refuse to serve them – the unbanked may be forced to turn to payday lenders, who charge far more exorbitant rates ($400 Percent). or more). MFIs should also be subject to different capital requirements than commercial banks.
To be clear, while regulations for MFIs should be separate from those for commercial banks, regulations must exist and be rigorously enforced. The Federal Trade Commission Act and the Consumer Credit Protection Act should contain provisions recognizing MFIs as a special category of financial institutions that ultimately help protect borrowers from abusive debt collection practices. There should also be a body that serves as the supervisory and regulatory body to ensure the stability and solvency of MFIs in the country and conducts their inspections. MFIs should be required to submit internal audit reports on their interest rates and loan portfolios to this body. This oversight would create the transparency critical to the success of the MFI sector. The regulatory authority could be located at the federal level or at least initially left to the states. States could be allowed to figure out what type of regulator works best for their residents. There are some precedents for this. Industrial banks or industrial credit companies (ILC), for example, are exempt from the Bank Holding Company Act 1956. In Utah, commercial banks are regulated by the Utah Department of Financial Institutions, and the state has become a hub for these companies. Industrial banks have their share of critics who argue that the ILC exemption creates a loophole for commercial firms to own insured banks without being subject to federal regulations. But the principle of allowing states to set up their own regulators for MFIs could still prove prudent, and eventually the best practices of some of them could be adopted for a national regulator.
In short, while microfinance has grown exponentially around the world, its slower progress in the United States is due to the ill-fitting rules under which MFIs are forced to operate. Providing a separate yet accountable regulatory framework would help the sector expand, ultimately increasing access for underserved Americans and giving them better tools to improve their financial futures.
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women and economic growth
International Finance
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