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Microcredit strategies for assisting neighborhood businesses

Gregory Claxton
last updated: March 22, 2005


Neighborhood businesses provide important services in American inner cities, both directly to residents and functionally within inner-city economies. They are critical to the ability of local economies to circulate any money that comes in from outside of the neighborhood and multiply. However, the same process that eliminated export-oriented jos also decimated neighborhood businesses, reducing not just jobs, but also ways for residents to develop employment-related human and social capital. [1]

Microcredit and microentrepreneurialism can be one part of a broad strategy for revitalizing inner city economies. They represent a long-term, small-scale tool for empowering individuals and helping rebuild a base of business skill and entrepreneurial culture. Microcredit is a well-established strategy for encouraging small business development in Third World cities. It has recently been brought into the US with the goal of boosting inner city entrepreneurs, with mixed results. The entry will review how microfinance can help neighborhood businesses, including what microfinance cannot (or should not) do, and how its success might be judged.

Development of Micro-credit

Micro-credit was first introduced with the Grameen Bank in Bangladesh and ACCION International in Latin America. These groups worked in both urban and rural areas, and often developed programs specifically targeting microentrepreneurs who were women. The primary strategy of these lenders was to replace traditional collateral with substitutes that still serve to ensure that borrowers do not default on their loans. The most widely hailed innovation was group-based lending, where small groups of borrowers team together to provide peer support, as well as social sanctions for failure to make payments on the loan. Sometimes one member's default on payments affects the other members' ability to get further credit; sometimes, the group exerts only social pressure on defaulting borrowers. These serve as enforcement mechanisms, replacing the role that defaulting on collateral plays in traditional lending. These innovations helped micro-credit programs in developing countries achieve rates of loan repayment of up to 97% [2].

Shore Bank of Chicago, an early prototype of microcredit programs, was founded in the mid-1970s to provide loans to primarily blue-collar minorities to invest in improving dilapidated houses. In fact, the experiences of Shore Bank helped form the basis for Grameen Bank's program. [3] Beginning in the mid-1980s, community developers began to import microcredit programs back into the United States, in a variety of settings, from inner city immigrant communities to rural Native American communities. For example, the Neighborhood Enterprise Program, founded in 1989, worked primarily with low-income African-American and white women. The Community Enterprse Program (CEP) worked with Asian and Armenian refugees on public assistance. First Change, a network of affiliated programs, worked with primarily Latino women who were already marginally self-employed to improve their business standing.

Difficulties with microcredit in the US

So far, the results have been mixed. The programs have generally not been self-sustaining (though, some programs are not constituted with that goal) and they have been much less successful in preventing defaults on loans. In part, this is a result of how the programs target populations (some focus more on new entrepreneurs or the unemployed, instead of individuals running small, but undercapitalized, enterprises). However, it is also in part because some of the tools used in developing countries where microcredit methods were first devised are not appropriate in all U.S. contexts. How these issues affect program structure and repayment are discussed in this section.

Many programs have suffered because of difficulty in understanding who they are trying to help. Are loans targeted to existing entrepreneurs or new ones? Are lenders focusing on a particular community? What resources do the entrepreneurs have, personally as well as within their communities. Are borrowers recently unemployed or the working poor? Finally, are there cultural constraints that shape how borrowers perceive the financial resources? For example, one study found differences between Hispanic and African-American borrowers in their willingness to borrow money from family members and their willingness to use credit cards to finance business activities. [4]

Many lenders also have had difficulty using the tools developed originally for microcredit to manage the riskiness of their loans. In particular, they have often had difficulty using peer groups in lieu of tangible collateral. Some programs have had more success with alternative ways of assessing risk (for example, landlord references or proof of car or utility bill payments) and with replacing the informal screening and understanding that lenders have in the developing world with formal administrative procedures. Unfortunately, these formal procedures tend to raise the cost of these programs. [5] Additionally, some programs have had difficulty establishing credibility with borrowers, and are unable to overcome the wariness with which some borrowers approach financial institutions. This wariness may due to discrimination, the perception of discrimination, or past experiences in which the borrower was overwhelmed with paperwork. [6]

Many programs have also had difficulty crafting appropriate technical and training materials. In some cases, programs require training that is inappropriate for some borrowers. This is particularly the case for established businesses who need working capital to quickly take up an opportunity or deal with an immediate crisis. For these borrowers, training requirements may slow down access to credit until it is no longer needed. Additionally, some training programs have been found to be too generic to be useful, or to focus on self-empowerment at the expense of business skills. In particular, many borrowers who are new to business management do not acquire the skills needed to assess their business plan's likelihood of success, which in turn leaves them less equipped to profit and pay off their credit. [7]

Finally, many programs have been found to have structural problems. For example, many programs are not set up to be self-sustaining, and rely on infusions of funds from outside. This weakens their need to focus on loan repayment, which in turn may weaken their focus on helping borrowers create successful business strategies. Alternately, in weaving together many funding sources, program administrators may be forced to do with incompatible goals, each associated with a different funder, causing the program to lose its focus.

Toward sound practices for microcredit in the US

Dunford [8] argues that practices in microfinance in the U.S. are still emerging, as programs shift from models based on developing world imports to models uniquely suited to U.S. contexts. Therefore, the notion of a "best practices" of microcredit is inappropriate, and that instead it is better to search for "sound practices," that are suited to differing circumstances.

The most important element for success in a microcredit program is to have a clear understanding of who the target population is that you're trying to help, and what their needs are. From this understanding, the rest of the program will flow. Are they new entrepreneurs, or do they run existing businesses? Are they the working poor, who need micro-enterprises to stabilize their income? What are their training needs? Does the community have have sufficient social capital that trust can be established within peer groups? How much apart of the community is the lender? Can it capitalize on that closeness, or will it need to build trust in its early loans? What alternative methods does the community have to demonstrate credit-worthiness? [9]

Given a close knowledge of the target population, the lender can begin tailoring loans to the specific needs of different borrowers. For example, ACCION offers a stepped loan package that increases loan sizes based on demonstrated payback records and increasing capacity to absorb debt. After a self-evaluation, ACCION also began offering moderately larger loans to single borrowers (that is, borrowers not part of a peer group) who were already engaged in growing micro-enterprises, but who still have trouble accessing traditional credit.

It is also important to create a welcoming environment for borrowers. ACCION, for instance, has found that many borrowers must overcome a great deal of insecurity and the perception that they will not be successful in applying for a loan, before they approach a lender. It is important for lenders to make it as easy as possible for potential borrowers to get to them. Out of this insight, for example, ACCION relieved its loan officers from back office duties, and directed them to work more closely with borrowers and potential borrowers. Such a shift in focus for loan officers will also help them conduct more in-depth pre-loan interviews, which both allows for a better assessment of the risk of the loan and for a greater understanding of what the borrower's needs are. Further, they will also be able to maintain contact with borrowers after the loan has been made. Post-loan contact communicates to the borrower the importance of paying back the loan. It also allows the loan officer to monitor potential problems that the borrower is having, so that they can intervene to help the borrower before they reach a crisis point. [10]

Frequently, borrowers need not just credit services, but savings services as well. Building a relationship through microcredit can allow lenders to provide advice and assistance to the borrower in savings, to further sercure their financial situation. Lenders can also benefit from focusing more narrowly on these credit and savings services, and offering training and technical expertise through partners who specialize in those programs. Because these are different activities, both groups may be more successful if they can focus on one aspect, and work together to bring improvements to their respective services to their clients. [11]

Finally, it is important to understand what the benefits can be from using microcredit. The obvious benefits are the tangible results of using the microloan. However, these programs can also be used to build social and human capital for participants, not by diluting the focus of the microcredit program, but by using these as tools to achieve an end. As borrowers work through the process over time, this capital will become more and more general, allowing them to use it in other situations.

Microcredit and economic development

Microcredit is a not a typical economic development strategy. Normal economic development indicators, such as number of jobs created, are inappropriate, both because of it's small scale and because its effects are neither quick nor dramatic. It's most immediate effects are not strictly economic development outcomes, but support social welfare and individual empowerment and stability goals. This suggests that microcredit programs can be administered and evaluated on a social welfare basis. However, because in the long term, they can support economic development, they should be included as part of a comprehensive economic development strategy. [12]

Fully-formed microcredit programs provide comprehensive help to inner city businesses. They provide access to credit (economic capital); they often provide training and technical assistance, particularly in starting and managing businesses (human capital); and they provide a way for micro-entrepreneurs to connect with other business owners, sharing experiences and skills that are not easily taught (which can become social capital). Microcredit programs can be funded on a social welfare basis, promoting the individual benefits they provide, even while they help communities develop the culture and skillset needed to recreate thriving neighborhood businesses.

More resources


[1] McLean, Beverly and James Bates, 2003. "Financing Neighborhood Businesses: Collaborative Strategies," in Sammis B. White, Richard D. Bingham, and Edward W. Hill, Financing Economic Development in the 21st Century, 2003, p185-208.
[2] Bhatt, Nitin and Shui-Yan Tang, 2001. "Making Microcredit Work in the United States: Social, Financial, and Administrative Dimensions," Economic Development Quarterly, vol. 15, no. 3, August 2001, p229-241.
[3] Polakow-Suransky, Sasha, 2003. "Giving the poor some credit," The American Prospect, Summer 2003, p19-21.
[4] Burrus, William, 2002. "Microenterprise Development in the United States," Journal of Microfinance, vol. 4, no. 1, Spring 2002, p81-98.
[5] Bhatt, Nitin and Shui-Yan Tang, 2002. "Determinants of Repayment in Microcredit: Evidence from Programs in the United States" International Journal of Urban and Regional Research, vol. 26, no. 2, June 2002, p360-376.
[6] Ashe, Jeffrey, 2000. "Microfinance in the United States: The Working Capital Experience—Ten Years of Lending and Learning," Journal of Microfinance, vol. 2, no. 2, Fall 2000, p22-59.
[7] Bhatt, Nitin, 2002. Inner-City Entrepreneurship Development: the Microcredit Challenge. ICS Press: Oakland, CA.
[8] Dunford, Christopher, 2000. "In Search of 'Sound Practices' for Microfinance," Journal of Microfinance, vol. 2, no. 1, Spring 2000, p6-12.
[9] Bhatt, Nitin and Shui-Yan Tang, 2001. "Making Microcredit Work in the United States: Social, Financial, and Administrative Dimensions," Economic Development Quarterly, vol. 15, no. 3, August 2001, p229-241.
[10] Burrus, William, 2002. "Microenterprise Development in the United States," Journal of Microfinance, vol. 4, no. 1, Spring 2002, p81-98.
[11] Bhatt, Nitin and Shui-Yan Tang, 2001. "Making Microcredit Work in the United States: Social, Financial, and Administrative Dimensions," Economic Development Quarterly, vol. 15, no. 3, August 2001, p229-241.
[12] Servon, Lisa J. and Jeffrey P. Doshna, 1999. "Making Microenterprise Development a Part of the Economic Development Toolkit." Rutgers University: New Brunswick, NJ.