Microcredit was initially promoted as a means of nurturing the entrepreneurial spirit of the poor to increase income generation opportunities. It turns out the poor utilize microloans in many other ways and here are some common uses of microcredit:

Microcredit for Business Activity and Investment

Micro-entrepreneurs could microloans to start new businesses (repair shop, vending stall, restaurant, corner shop, etc.) or use microloans to expand a current business by investing in working capital (perhaps for purchasing a greater quantity of inventory to meet high market demand). The loan’s impact would be considerably greater in the first case.

Microcredit for Consumption Purposes

The poor often need to repair their homes (which are easily damaged by strong winds or rains) and purchase items to facilitate the running of their households (such as purchase of clothes or food). Microfinance institutions often tailor microloans to meet specific demands; Grameen Bank (Bangladesh) and Maxima (Cambodia) both offer home improvement or home construction loans to clients.

At other times, microfinance institutions are unaware that their microloan is being used to buy consumer goods instead of for purchasing capital.

Microcredit for Repayment of Other Loans

Since multiple borrowing is common in many markets, clients find themselves unable to pay their debts. They often approach other microfinance institutions to take out loans for the purposes of repaying ‘other’ loans. This practice is not as rare as loan officers may like to think, as Barbara Kiviat recently posted at the Reuters blog:

“Thursday I was at this conference, where Dean Karlan of Yale talked about research he’s been doing with Jonathan Zinman of Dartmouth. In interviews with microfinance recipients in the Philippines, the pair discovered that some 46% of borrowers used a decent chunk of their business loan to pay down other debt”.

Theoretically, this behavior would result in a repayment crisis, as consumers continue to take on new debt to pay off their old burdens. Microfinance institutions in the beginning of the ‘repayment series’ may recover their funds but there will be plenty of MFIs who will have to write-off their outstanding loans.

Of course, there may be other ways to utilize microcredit, but these are three basic categories most types of uses fall into.