Power of Microcredit: the Yellow Brick Road to Financial Inclusion

Introduction

1.4 billion adults are regarded as “unbanked”; they have no account at a financial institution and they do not have access to formal credit or loans (Klapper et al. 2025) ^[1]. 41% of formal small and medium-sized enterprises (SMEs) have unmet financing needs (World Bank; International Finance Corporation 2022) ^[2]. In the conventional banking world, there is limited access to loans for small businesses and those who are financially vulnerable. Many small businesses lack sufficient collateral and they rarely have a long track record of profitability. Moreover, due to their short financial history, they are considered to be risky, resulting in higher interest rates on their loans. Greater financial pressure from higher borrowing costs constrains their profitability further. Additionally, poorer individuals do not have high credit scores or any assets to use as collateral when taking out loans, resulting in a seemingly unbreakable cycle of poverty.

Microcredit and the Alleviation of Poverty

Microcredit (lending small amounts of money to new businesses/people in the developing world) has major potential as a transformative development tool. It can provide the financial foundation needed to break the intergenerational cycle of poverty. By helping the poor have a proper source of financial support, small businesses can access capital to increase their production and generate income for the economically disadvantaged (United Nations Development Programme 2022) ^[3], resulting in the poor becoming more self-sufficient and achieving a greater quality of life. 

The provision of microloans to family-owned enterprises allows families to purchase tangible assets such as livestock and crops, aiding their financial independence during times of financial hardship and reducing their vulnerability to extreme poverty. Ownership of these assets facilitates the selling of higher-value goods and enables these financially vulnerable people to generate a stable income, cover their household expenses and have a living store of wealth. Therefore, microcredit can be used to put an end to the everlasting cycle of poverty. 

Furthermore, microcredit can be effectively employed to reduce poverty in target groups such as women. Empowering women is one key way poverty can be reduced in developing countries. In order to diminish income poverty, women must have access to education, asset ownership, decision-making power on children’s health and education, and access to medical facilities (Wei et al. 2021) ^[4]. Microcredit helps women start businesses, generate independent earnings and obtain more control over their household expenses. Giving women the power to contribute financially leads to lower poverty rates and increases women’s economic equality. Evidently, in Latin America, an increase in the number of women in paid work between 2000 and 2010 accounted for around 30 percent of the overall reduction in poverty and income inequality (Oxfam International 2025) ^[5].

Role of Microcredit on the Economy

Microcredit is one effective way to boost economic activity in the long term. The provision of microloans provides a foundation for the economically vulnerable to start micro enterprises and transition from working in the unregulated, informal sector into the formal, stable areas of the economy. Ensuring the fulfillment of SDG 8 (decent work and economic growth) is a significant benefit of improving the availability of microcredit in an economy (Sustainability Directory 2025) ^[6]. Boosting microfinance in developing countries improves working conditions and combats female unemployment. This is evident in the fact that the combination of women’s entrepreneurship training and a start-up loan resulted in increased self-employment and business expansion for female clients of IMON in Tajikistan (International Labour Organisation 2015) ^[7]. 

A lot of microloans depend on social collateral, where social ties and group pressure are used instead of a physical, tangible asset (Schuster 2015) ^[8]. The concept of social collateral depends on a group lending model where the group is socially responsible for the loan repayment. The borrower is compelled to pay back the loan due to the threat of having a bad social reputation in the case of default. Social collateral encourages borrowers to generate more income from their small businesses. Consequently, from a country’s perspective, creating stable lending environments boosts economic growth for a country by ensuring a reliable flow of credit. More access to credit enables broader economic participation, allowing new SMEs to enter the market, generating more jobs and increasing national output, greatly benefiting developing countries with high unemployment and poverty rates. 

Systemic Limitations of Microcredit

While microcredit systems are successful at promoting wider economic participation, microloans often finance identical small businesses such as food vendors or auto-rickshaw driving. Although businesses like these allow the economically vulnerable to become financially independent, they limit the potential income for these people and do not provide them with high-growth venues. Consequently, the loan recipients become stuck in a cycle of low-profit, subsistence work (Karnani 2007) ^[9].

Economic conditions also impact the success of microfinance. During periods of economic downturns, these microenterprises face a fall in income as aggregate demand in an economy decreases. Therefore, loan recipients encounter greater financial burdens of loan repayments, making them more vulnerable to default on their loans. 

Ethical Microcredit Approaches to Reduce Financial Exclusion 

As a result, ethical microcredit models like Grameen Bank and Akhuwat Islamic Microfinance have been developed. These banking plans are characterised by low or zero interest rates. 

Grameen Bank was a microfinance project started by Dr Muhammad Yunus which had an objective of providing comprehensive financial services to empower the poor to realize their potential and to break out of the cycle of poverty (Grameen Bank 2025) ^[10]. The lending scheme requires borrowers to form groups of five, which is responsible for repayment of loans. If one person defaults on the loan, the entire group becomes ineligible to borrow. This microcredit model also ensures that the borrower does not face over-indebtedness as the loans have low interest rates, enabling poor borrowers to take out loans easily.

Similarly, Akhuwat Islamic Microfinance, a Pakistani NGO that aims to provide individuals with the opportunity to become financially included in society via interest-free loans (Akhuwat 2025) ^[11]. Akhuwat has disbursed 355 billion PKR in interest-free loans (Akhuwat 2025) ^[12]. These microloans have reduced poverty in at least 40 percent of client households in Pakistan, while 90 percent of women reported increased business income (World Bank Group 2025) ^[13].

Conclusion

Microcredit is a vital tool for developing countries, especially for promoting financial inclusion and economic development. Microloans can be highly effective at reducing poverty and unemployment in less economically developed countries (LEDCs). However, the success of microcredit is dependent on its design. Ethical models like Grameen Bank and Akhuwat Islamic Microfinance are great examples at demonstrating how access to financial services can be provided to every citizen, without leading to over-indebtedness. Low-interest microfinance institutions are one of the most effective means to tackle poverty and insufficient growth. 

References

Klapper, Leora, Dorothe Singer, Laura Starita, and Alexandra Norris. 2025. The Global Findex Database 2025: Connectivity and Financial Inclusion in the Digital Economy. Washington, DC: World Bank. doi:10.1596/978-1-4648-2204-9.

World Bank; International Finance Corporation. 2022. Fintech and SME Finance: Expanding Responsible Access. Washington, DC: World Bank. https://doi.org/10.1596/37355.

United Nations Development Programme. 2022. “Microcredit for Business Purposes.” SDG Private Finance UNDP. https://sdgprivatefinance.undp.org/leveraging-capital/sdg-investor-platform/microcredit-business-purposes#references.

Wei, Wei, Tanwe Sarker, Wioletta Zukiewicz-Sobczak, Rana Roy, G. M. Monirul Alamam, Md Ghulam Rabbany, Mohammad S. Hossain, and Noshaba Aziz. 2021. “The Influence of Women’s Empowerment on Poverty Reduction in the Rural Areas of Bangladesh: Focus on Health, Education and Living Standard.” Int J Environ Res Public Health 18, no. 13 (June). doi: 10.3390/ijerph18136909.

Oxfam International. 2025. “Why the majority of the world’s poor are women.” Oxfam. https://www.oxfam.org/en/why-majority-worlds-poor-are-women#:~:text=Increasing%20women's%20economic%20equality%20would,not%20just%20a%20fortunate%20few.

Sustainability Directory. 2025. “How Do Micro-Loans Specifically Support the “Decent Work” Aspect of SDG 8?” Sustainability Directory. https://lifestyle.sustainability-directory.com/learn/how-do-micro-loans-specifically-support-the-decent-work-aspect-of-sdg-8/.

International Labour Organisation. 2015. Microfinance for Decent Work: Enhancing the Impact of Microfinance : Evidence from an Action Research Programme. Geneva: ILO.

Schuster, Caroline. 2015. “Your Family and Friends are Collateral: Microfinance and the Social.” Culanth. https://www.culanth.org/fieldsights/your-family-and-friends-are-collateral-microfinance-and-the-social.

Karnani, Aneel. 2007. “Employment, not microcredit, is the solution.” Findevgateway. https://www.findevgateway.org/sites/default/files/publications/files/mfg-en-paper-employment-not-microcredit-is-the-solution-jan-2007.pdf.

Grameen Bank. 2025. “Grameen Bank Mission.” Grameen Bank. https://grameenbank.org.bd/.

Akhuwat. 2025. “Akhuwat's Impact in Numbers.” Akhuwat: Home. https://akhuwat.org.pk/.

World Bank Group. 2025. “Microfinancing Pakistan’s Women Entrepreneurs: A Chance for Jobs and a Better Life.” World Bank. https://www.worldbank.org/en/news/feature/2025/06/30/microfinancing-pakistan-s-women-entrepreneurs-a-chance-for-a-better-life#:~:text=Microfinance%20as%20an%20Agent%20of,women%20reported%20increased%20business%20income.