Microfinance in Bangladesh: A Solution for Poverty Alleviation or a Path to the Debt Trap?
Woo Yi Ting, Research Executive
Overview of Microfinance in Bangladesh
Microfinance has emerged as a pivotal strategy for poverty alleviation, particularly in developing countries. Microfinance Institutions (MFIs) offer several financial products and services tailored for the poor and disadvantaged, who often lack access to traditional financial resources. The offerings include microloans without collateral, investment management, deposit insurance, and others. By providing these financial services, MFIs empower low-income individuals to participate in the economic market and exploit entrepreneurial opportunities. This can foster sustainable growth by enabling communities to build resilience, create jobs, and enhance local economies through increased productivity and self-sufficiency. In Bangladesh, where microfinance has taken root, its impact on rural households has been significant. As one of the most densely populated and poverty-stricken countries in the world, Bangladesh has a large informal sector and limited access to traditional banking, making microfinance a popular and practical solution for economic inclusion. However, despite its successes, the microfinance sector also faces challenges that can undermine its potential.
In Bangladesh, approximately 18.55% of the country’s population, of which 40.86 million members, including 31.53 million borrowers, have benefited from 731 MFIs (Microcredit Regulatory Authority, 2023). This substantial engagement underscores the critical role of microfinance in rural populations' economic lives.
One prominent example of microfinance in Bangladesh is the Grameen Bank, founded by Dr. Muhammad Yunus in 1983 (Grameen Bank, 2024). A distinctive feature of Grameen Bank is its requirement that there be no collateral for loans. Unlike traditional banks that may intimidate poor clients with their formal settings, Grameen Bank brings services directly to borrowers in their communities. Most banking transactions, except for loan disbursement, occur during village meetings organized by center managers, fostering a supportive environment for borrowers.
Besides, Grameen Bank revolutionized the provision of microloans by focusing on women, who often face significant barriers to accessing credit. The bank prioritizes empowering women, with 98% of its clients being female, and over two-thirds of these women have improved their living conditions. Another notable initiative is the Struggle (Beggar) Members Program, which provides interest-free loans to help beggars achieve financial independence. As of today, 21,383 individuals have given up begging and become self-sufficient through this program. Grameen Bank is committed not only to alleviating the poverty of its borrowers but also to ensuring that future generations are supported. To this end, the bank provides education loans, new entrepreneurship loans, and scholarships for the children of its members (Grameen Bank, 2024).
As of December 2024, Grameen Bank operates through 40 zonal and audit offices, 240 area offices, and 2,568 branches, serving nearly 45 million people across 81,678 villages. With a high recovery rate of 96.17% and a cumulative loan disbursement of nearly $39.5 billion, Grameen Bank has significantly contributed to Bangladesh's development under strong leadership (Grameen Bank, 2024).
Mechanisms of Economic Stimulation
Research estimates that microfinance has contributed between 8.9% and 11.9% to Bangladesh's GDP, with an even greater impact on rural GDP, estimated at between 12.6% and 16% (Raihan et al., 2017). This demonstrates that microfinance not only supports individual borrowers but also stimulates local economies by enhancing overall economic activity. The resulting multiplier effect, where increased access to finance leads to higher household incomes, greater consumption, and further investment in local goods and services. This, in turn, fosters inclusive growth by ensuring that the benefits of economic development extend to traditionally underserved rural communities, helping to reduce inequality and promote broader economic participation.
According to the study (Raihan et al., 2017), microfinance has a direct effect on production. Borrowers often use microloans to invest in small businesses, agricultural activities, or other income-generating ventures, which leads to increased production and, consequently, higher economic activity. For instance, a farmer might take out a microloan to purchase seeds and fertilizers, leading to improved crop yields and increased income. This direct infusion of capital enables individuals and communities to enhance their livelihoods and contribute to overall economic growth. As capital accumulates, the marginal productivity of capital rises, especially in undercapitalized rural areas, leading to greater output per unit of investment. Consequently, microfinance not only improves individual livelihoods but also drives broader economic growth by increasing both income levels and national output.
Additionally, microfinance enhances business competitiveness by enabling them to expand their operations, hire more workers, invest in necessary tools, technologies, and training that improve productivity and efficiency. As these small enterprises grow, they create new employment opportunities for individuals within their communities. Muneer and Khalily (2015) found that microenterprises achieved average economic returns of 64%, created approximately two full-time jobs per microenterprise, and accounted for an estimated 10 million new jobs in Bangladesh. Notably, total factor productivity (TFP) in income-generating activities was also 3.53% higher for microenterprises with access to microfinance compared to those without such access. In the context of growth models like the Solow Growth Model, improvements in TFP are key drivers of long-term economic growth, as they reflect more efficient use of capital and labor. Thus, microfinance not only fuels immediate gains in output and employment but also supports sustained increases in income and GDP over time.
Challenges: Over-Indebtedness and Financial Distress
Despite the positive impacts of microfinance, the sector also faces significant challenges. The surge of microfinance has raised concerns about the sustainability of borrowing practices, particularly if borrowers do not achieve sufficient returns from these loans.
Over-indebtedness is currently one of the most serious risks associated with microfinance, threatening both social impact and the stability of the industry (Jessica, 2010). A household can be classified as over-indebted if its debt obligations exceed 40% of its income or assets. In Bangladesh, studies indicate that approximately 26% of microcredit borrowers experience over-indebtedness (Khandker et al., 2013), placing them at risk of deepened poverty and various material and psychological consequences. A key driver of overindebtedness is the high interest rates charged by microfinance institutions (MFIs), which are estimated to be around 36.6% globally (Rauf et al. 2022) —significantly higher than the 9% to 15% interest rates offered by traditional banks in Bangladesh. The elevated rates often stem from the financial and operational costs associated with running MFIs. As a result, borrowers may find themselves in a precarious situation of over-indebtedness, struggling to meet repayment obligations while attempting to maintain their livelihoods.
Over-indebtedness can lead to financial distress and worsen the poverty situation of borrowers. Eurofound (2013) indicated that borrowers in financial distress may reduce essential expenses, leading to deteriorating living conditions and health outcomes. Families may prioritize loan repayment over basic needs, resulting in malnutrition and untreated health issues, which reduce their ability to work and earn. This situation affects not only individual borrowers but also has lasting impacts on their families and communities, perpetuating the cycle of poverty. Moreover, as borrowers struggle financially, their reduced spending weakens the overall economic health of their communities. Lower demand for goods and services negatively affects local businesses and employment opportunities. As sales decline, businesses may reduce staff or operations, deepening unemployment and hindering community development. This creates a feedback loop of financial and economic decline. Ultimately, such cycles of debt and distress undermine the core goals of microfinance, which aim to promote empowerment and sustainable economic growth.
When a significant portion of borrowers fail to meet their repayment obligations, MFIs face heightened credit risk, which leads to a surge in non-performing loans (NPLs). For example, during FY22, NPLs in the MFI sector soared by 85% year-on-year, increasing from Tk 4,528 crore in FY2020–21 to Tk 8,370 crore. As a result, the NPL ratio increased from 4.77% to 6.74%, reflecting mounting repayment difficulties among borrowers due to the COVID-19 pandemic and economic disruptions caused by the Russia-Ukraine war (Bangladesh Bank, 2022). Inflation also intensified the problem, as the Consumer Price Index rose to 6.15% in FY22 and further to 9.02% in FY23, reducing borrowers’ ability to meet loan obligations (Bangladesh Bank, 2022).
Source: Microcredit Regulatory Authority
The rising volume of undermines the financial health and operational sustainability of MFIs, many of which rely heavily on high repayment rates to remain solvent. As defaults rise, MFIs may experience liquidity shortages, reduced investor confidence, and potential withdrawal of funding from donors or financial backers.
Conclusion
Microfinance has the potential to be a powerful tool for poverty alleviation, providing access to capital and empowering individuals to improve their economic circumstances. However, the challenges of over-indebtedness must be addressed to ensure that microfinance fulfills its promise. By enhancing financial literacy, implementing fair lending practices, and supporting borrowers in managing their debts, the microfinance sector can continue to play a vital role in stimulating economic activity and improving the lives of the poor. Ultimately, the goal should be to create a sustainable microfinance system that empowers individuals without leading them into cycles of debt and financial distress.
References
Bangladesh Bank (2022). Bangladesh Financial Stability Report 2022. https://www.bb.org.bd//pub/annual/fsr/financial_stability_report_2022_en.pdf
Eurofound (2013), Household over-indebtedness in the EU: The role of informal debts, Publications Office of the European Union, Luxembourg. https://www.eurofound.europa.eu/system/files/2014-11/ef1373en.pdf
Jessica S. (2010). Microfinance Over-Indebtedness: Understanding its drivers and challenging the common myths. Centre for European Research in Microfinance. https://www.findevgateway.org/sites/default/files/publications/files/mfg-en-paper-microfinance-over-indebtedness-understanding-its-drivers-and-challenging-the-common-myths-2010.pdf
Khandker, S. R., Faruqee, R., & Samad, H. A. (2013). Are microcredit borrowers in Bangladesh Over-Indebted? In World Bank policy research working paper. https://doi.org/10.1596/1813-9450-6574
Microcredit Regulatory Authority (2023). Microfinance in Bangladesh (Annual Report) https://mra.portal.gov.bd/sites/default/files/files/mra.portal.gov.bd/page/65ce1539_6986_43b1_b4c7_dde44450eac5/2024-02-14-05-59-54ac09fa8647ffc657158c9c24d7dc4d.pdf
Muneer, F., & Khalily, B. (2015). Access to credit and economic returns and productivity of micro enterprises in Bangladesh. Institute of Microfinance.
Raihan, S., Osmani, S., & Khalily, M. B. (2017). The macro impact of microfinance in Bangladesh: A CGE analysis. Economic Modelling, 62, 1–15. https://doi.org/10.1016/j.econmod.2017.01.002
Rauf, F., Wanqiu, W., Jing, L., Qadri, S. U., Naveed, K., & Rahman, S. U. (2022). Dynamic analysis of the determinants of long-term microfinance interest rates: Macro and micro factors. Frontiers in Psychology, 13. https://doi.org/10.3389/fpsyg.2022.1008002