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Microcredit: Definition, Importance and Limitations


Small loans are known as microcredit loans. Microcredit, or microfinance, was developed to assist those without a stable source of income, credit history, or conventional financial resources. Microcredit plays a significant role in the growth of financial inclusion in India. In this programme, microcredit lenders provide simple access to formal credit to borrowers in semi-urban and rural areas of the nation. This article will explain the basics of the microcredit system, including its operation, its significance in the lending ecosystem, and more.

What is Microcredit?    

Microcredit refers to small loans that are provided to business owners, often with no or very little collateral. The purpose of these programmes is to help people start or grow their own businesses and they are an effective way to help fight poverty. These programmes are effective because they give borrowers access to funding, they might not have otherwise been able to get, and they also offer advice and resources to improve their chances of success. These loans, in general, have lower interest rates than those offered by banks and other conventional lenders.

Most loans through this program don’t require collateral. A typical microfinance company offers loans along with other products like savings accounts and life insurance. Microcredit programmes often allow flexible payback terms, although the typical repayment duration for microfinance organisations is one year.

Finally, the main goal of an average microfinance institution is to train potential borrowers in business and education. A microcredit plan, on the other hand, often just aims to give affordable capital to entrepreneurs who need it.

History of Microcredit

The concept of microcredit dates to 1983, when Bangladeshi economist Muhammad Yunus founded the Grameen Bank. He started the bank with the main goal of giving loans to people with lower socio-economic status so that the wealth gap in Bangladesh wouldn’t get worse.

Additionally, this line of financing gained traction in India during the 1990s and was formally introduced in 1994. The Small Industries Development Bank of India (SIDBI) was one of the first organisations in India to start offering microcredit.


How does Microcredit work?

Microcredit was founded on the premise that people with abilities and a more entrepreneurial mindset hailed from impoverished nations that did not always have access to financial services that met their needs.

Individuals who use microcredit services frequently operate on a barter system, in which one commodity or service is exchanged for another, without the use of money as a medium of exchange.

The modern concept of it is based on the Grameen Bank model, in which loans vary from $10 to $2,000. There may not be any written contracts for loans, and repayment can start right away. As individuals repay these loans, they build credit and are able to obtain additional loans.

Microcredit loans may also incur interest, and certain loans may require the borrower to set aside a portion of their income in an account as collateral. If the loan is returned, the entire balance in the savings account will become accessible.

Micro Loans meaning and terms

Similar to conventional lenders, microfinanciers must charge interest on loans and establish specified repayment plans with recurring installments. Some lenders demand loan recipients set aside a portion of their income in an account that can be used as collateral in the event that the borrower defaults. If the borrower successfully repays the loan, they have just accumulated additional savings.

Due to the fact that many applicants lack collateral, microlenders frequently group borrowers together as a buffer. After accepting loans, recipients collectively settle their debts. Because the success of the programme is contingent upon everyone’s participation, this provides a type of peer pressure that can aid in ensuring payback.

For instance, if someone is having problems using their money to start a business, they can ask the loan officer or other group members for assistance. Loan receivers begin to establish a positive credit history through repayment, allowing them to acquire larger loans in the future.

Interestingly, microloan repayment amounts are frequently greater than the average repayment rate for more conventional types of finance, despite the fact that microloan borrowers are frequently quite impoverished.

Importance of Microcredit

Microcredit is the term used to describe the distribution of small loans, usually to low-income people or groups who do not have access to conventional banking services. It is important for several reasons:

1. Poverty reduction

By granting those who might otherwise be excluded access to credit and financial services, microcredit can help alleviate poverty. As a result, people may be able to start small enterprises, produce revenue, and reduce poverty.

2. Empowerment of women

Women in many developing countries are frequently excluded from standard banking services; therefore, microcredit can be a crucial instrument for empowering women by providing them with access to credit and financial services. The social prestige of women who can start their own businesses will increase and they will become more economically independent.

3. Economic growth

By giving small business owners and entrepreneurs access to credit and financial services, microcredit can also promote economic growth in communities. This can encourage economic growth, boost productivity, and ultimately create jobs.

4. Financial inclusion

By giving those who are not eligible for standard banking services access to credit and financial services, microcredit can help to advance financial inclusion. By doing so, the risk of financial exclusion can be decreased, and financial stability can be encouraged.



1. Over-indebtedness

In some circumstances, borrowers may become over-indebted by taking out more loans to pay off their current debt. Borrowers may find it challenging to escape poverty because of this, which can create a vicious debt cycle.

2. High-interest rates

To compensate for the cost of managing microloans, microcredit firms frequently demand high-interest rates. Due to this, borrowers may find it challenging to repay their loans, and some may even fall farther into poverty.

3. Limited impact

Microcredit can be useful in assisting individual borrowers to launch small enterprises and produce income, but it may have a limited effect on reducing poverty at the local or national level.


In India, the progress of financial inclusion is largely dependent on microcredit. The small loan programme has assisted lower-income and socially disadvantaged classes in India in eliminating poverty during the past few decades by raising their standard of living. The vast majority of the Indian population lives in rural areas without access to regular financial services. Yet, financial services are necessary for low-income individuals to cover their fundamental necessities. As a result, microcredit has helped to reduce this gap. Even those from lower social classes can receive financial services through microfinance to increase their income and level of independence.


1. What is Microcredit?

Ans: Microcredit is the distribution of small loans to people or groups who don’t have access to covnentional banking services, usually in low-income communities.

2. How does Microcredit work?

Ans: Microcredit institutions provide small loans to borrowers, who use the funds to start or expand small businesses or other income-generating activities. Also, borrowers are typically required to repay their loans with interest over a set period of time.  

3. Who is eligible for Microcredit?

Ans: Microcredit is typically intended for low-income individuals or groups, such as small business owners, farmers, and female entrepreneurs, who do not have access to traditional banking services.

4. What is the impact of Microcredit?

Ans: By enabling access to credit and financial services for those who may otherwise be shut out, microcredit can be a powerful tool for fostering economic development and decreasing poverty.

5. What differentiates Microcredit from traditional banking services?

Ans: In contrast to traditional banks, microcredit institutions typically offer small loans with more lenient repayment terms and lower interest rates. They frequently offer additional financial services as well, including insurance, savings accounts, and financial education.

6. Is Microcredit always successful? 

Ans: No, microcredit doesn’t always work. Some of these programmes might not have much of an impact on reducing poverty, and borrowers might have to deal with high-interest rates and other difficulties like being over-indebted and social and cultural barriers.

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