firmly in place has been confirmed through an abundance of historical evidence.
Microcredit system: conditions for its success
Microcredit system has recently launched in South Korea. The financing scheme for low creditors called Miso Credit –called "miso" meaning smile in Korean- is nothing new in other countries. The state-led microcredit lending program is aimed at giving access to cheap loans for low-credit poor people denied from the established financing system.
The program was first launched by the Grammen Bank in Bangladesh with the proposal of Nobel Prize winner Muhammad Yanus. The Asian country currently offers the financial aid to 7.94 million people -97 percent of them are women- at 2,560 branches, The system has quickly spread to Central and South American nations and India. The United Nations declared 2005 the International Year of Microcredit in an effort to promote the scheme.
Difference between our "smile" microcredit banks and a "Grameen Bank" in less developed economies
The government of President Lee Myung-bak has taken the initiative as part of its "for-the-poor" pragmatic policy and urged the private sector to participate in the program. The history of microcredit lending in Korea traces back to 2000. Korea Microcredit Joyful Union and Social Solidarity Bank started the business with private-sector contributions, followed by about 30 financial entities. The lending program gained momentum in March 2008 when a microcredit foundation was established with dormant deposit as the seed money. As of 2008, about 6,800 people borrowed 47 billion won under the scheme.
Potential beneficiaries are individuals with credit ratings of seven to ten, the worst rating on the scale, who can hardly tap the funds at the existing financial companies. Those belonging to the category rose to 8.161 million at the end of 2008 from 7.666 million a year ago.
The Miso financing program started as companies' voluntary movement to return part of their profits to the society. It will likely expand the fund to about 2 trillion won over the next decade, with about 200 to 300 organizations providing the service. Major customers are self-owned enterprisers, small merchants and franchise start-ups. The loan will carry an annual interest rate of 4.5 percent, with the ceiling varying over different categories: non-registered business, registered enterprisers and ventures. The loan lending criteria is highly strict. Those who have credit ratings of 7th or lower grades and assets less than 85 million won can apply for it while credit delinquents are not eligible. Start-ups can tap the fund only when they can raise half of what is needed on their own.
The scheme has started in less developed countries for its own reason. With the financial system yet to be fully developed, many people in those nations, even with a potential capacity to repay loans, could not get any access to the funding channels. Small but timely financial aid could serve as a pump-priming.
Moreover, developing countries may have abundant business opportunities and cheap prices mean that a small amount of money could have purchasing power strong enough to start a small business.
The fact that the front-runner Bangladesh is offering the aid mostly for women has a great implication. In a developing country, since married women has strong sense of obligation and integrity to raise children, the microcredit scheme has much room to magnify its merits.
The Miso program needs careful approach
South Korea, however, needs a careful approach. We are no longer a poor country but on the verge of joining the league of advanced economies. When the economy develops to such an extent, the market gets more saturated, leaving fewer opportunities for new businesses.
The sustainability of the program as a business is another matter. One of its businesses is to lend up to 5 million won to those without business license. The problem is what kind of ventures you can start with 5 million won. Street shops or cart bars are at the most but they are already overcrowded. Furthermore, since they don't pay taxes, policymakers should ask themselves whether the government needs to increase the number of the self-employed people even with state support.
When a franchise start-up applies for the microcredit scheme with a maximum of 50 million won, he needs to get a business license and half of the fund ready. For example, he has to prove that he can raise 25 million won on his own if the start-up cost is 50 million won. The "50-percent rule" is a major obstacle as about 60 percent of the applicants for the microcredit program plan to use the loan to open up a franchise business.
This program is apparently far from a charity giving out cash to the poor but an aid aimed at self-rehabilitation. To sustain the scheme, the borrowers should repay the debt. Otherwise, the lending rates should be tightened. In order to deter free-riders from squandering the money, they need to build a number of barriers. Those capable of servicing the debt may be able to tap the existing financing channels. Those unable to stand alone are highly likely to be denied an access to the microcredit system. It's a great dilemma to decide which group should be the focus of the program.
The chances are high that those who can open up a small business and sustain it have already made a success. It's doubtful how much the microcredit system can help those who have already experienced failure or have lower chances of success. Small loan granted under the program may prove to be of no use when a business fails not because of lack of money but due to lack of capability or poor environment. From this perspective, it's pretty clear that the microcredit system should be operated in a very prudent and careful manner for our economy.
Lessons from others' success stories
Examples of other advanced economies show that a key of success is to provide education and consulting services as long as the loan. Unlike developing countries where a small amount of money has high purchasing power due to abundant business opportunities and low inflation, you need a number of pre-conditions on top of fund to achieve a success in developed markets.
We should learn the lessons and provide various additional services for the beneficiaries of the microcredit program in cooperation with civil groups or non-profit organizations. Furthermore, the government needs to continue to seek the ways to offer more pragmatic and effective supports, rather than falling short of cursory and routine trainings. The program should be aimed at helping the poor earn their living and thus become or return to a key member of the society. The chance of its success increases if it is closely linked with regional civil groups.
Leading U.S. banks such as Citibank and Bank of America have led successful microcredit business. They have entered the emerging markets, like Mexico, for profit and brand image. Their cases can become a good guidance for South Korean banks planning to tap the Southeast Asian countries in the near future.
A number of microcredit programs around the world are mainly aimed at female customers. A Microfinance Institution Exchange data shows that 67 percent of the microcredit recipients are women. This has significant implication in many areas. Among the small-sized businesses with sustainable profitability, restaurants are the most popular and representative one. This business is attractive for many married women as they can run it with great responsibility and integrity while raising kids.
South Korea also plans to offer management consulting services along with the loan under the microcredit program, which requires a number of preparations. When a system takes a root successfully, a lot of elements should be in place. The microcredit scheme has launched after a long period of preparations. I hope it can quench the disadvantaged people's thirst for better access to established financing channels.
By Yoon Chang-hyun / Professor of Business Administration at University of Seoul, Secretary of the Citizens United for Better Society