November 5, 2020

What is microcredit?


The term “microcredit” should be familiar to most people in connection with economic development in developing and emerging countries, which make it possible for small businesses to start up businesses for the socially disadvantaged. This is not a really new invention. Because 150 years ago, Richard Han developed a cooperative model that was based on the principle of self-help and solidarity and on which many forms of microcredit in the third world are based.

The use of microcredit

The use of microcredit

This idea only returned to Europe in the 1990s. An increasing financial gap opened up due to the increasing number of start-ups who wanted to escape growing unemployment in those years. In the Netherlands, for example, private capital was therefore activated to enable business start-ups. A similar model was created in France in 1989. At the beginning of 2010, the German federal government commissioned the Good Finance community bank to set up a “microcredit fund Germany”.

However, many financial institutions sometimes use the term “microcredit” in a synonymous way for other types of small credit programs. However, these rarely include accompanying support, which is an integral part of the original. Because of the close ties between the microfinance provider and the small company, recommendations for improving business operations can be discussed with the owner at an early stage. So it is also possible to react better to possible crises and to counteract them.

In principle, the respective organizations themselves determine the amount of the loan. As a rule, the financing volume is between 1 and 25,000 USD. The lower limit of only 1 USD is deliberately set so low that it is really possible to realize the smallest of financing. In most cases, the loans start at a volume of 1,000 USD.

The most important advantage of a microcredit is that there is financing for small business start-ups. Because most of the established commercial banks reject such a small allocation for economic reasons. For them, the granting of such a small loan involves too much administrative effort, which causes more costs than can ultimately be generated. For microfinance providers, the cost of an award is usually financed through project funds or foundations.

Another advantage of a microcredit is the low bureaucratic hurdles that have to be overcome. The period between the application and payment of the amount usually only takes a few days. The interest rate of a microcredit program is, however, higher than that of specially designed support programs. But in the end, this interest rate is again lower than the overdraft interest on current accounts, which usually have to be used as a “emergency nail” in the case of financial cancellations.

But microcredits also have some disadvantages.


Because not all of these small loans are really well adapted to the needs of small and young companies. Some framework conditions can even be so drastic that it is strongly advised not to use them. For example, the term of the German Microcredit Fund is limited to a maximum of 3 years. With a maximum loan amount of USD 20,000, this results in a monthly installment of around USD 630 (depending on the interest rate). For a small business, this can quickly become a sword of Damocles.

Unfortunately, there are now also some dubious microfinance companies that often try to sell their own products, such as insurance or the like. Or there are alleged intermediaries who pretend to grant microcredit on a commission basis. Both cases are not permitted and are therefore inadmissible. For this reason, every interested party should look closely with whom he is dealing with.