Microcredit refers to very small loans to low-income people. Because most microcredit clients have little or no collateral, microcredit providers instead turn to a person’s “social collateral” by working with groups of borrowers who guarantee each other’s loans. These small-denomination group loans were the first product offered by the microfinance sector and were provided to help those seeking to start or invest in a small business or agriculture. The idea is that productive businesses generate income that allows clients to repay their loans and begin to build assets to lift themselves out of poverty.
Research demonstrates, however, that microcredit is often used for a variety of purposes beyond business investment. Loans also help people cope with unpredictable incomes by making funds available to meet their basic needs and manage shocks, such as death or illness. Financial service providers are working to better understand the financial needs of low-income people and design products with those needs in mind.