IDEAS home Printed from
   My bibliography  Save this paper

How Does Microcredit Work? A Review of the Theories of Microcredit


  • S.R. Osmani
  • Wahiduddin Mahmud


The remarkable speed at which the reach of microcredit has expanded around the world in the last three decades has piqued the curiosity of practitioners and theorists alike. While assessing the impact of microcredit on the lives and livelihoods of the poor remains a contentious issue, there is no disputing the fact that there is something novel, something special, about microcredit that has allowed an altogether new mode of financial intermediation to emerge, providing credit to millions of hitherto ‘unbankable’ poor without breaking the lender’s back. That is an extraordinary achievement in itself. Theorists have been keen to unearth the secrets behind this remarkable achievement. In particular, they have tried to understand why is it that the special features of microcredit seem to work, at least in terms of embracing those who were previously excluded from the formal credit market, without compromising the financial viability of the lenders. This has led to an enormous outpouring of theoretical speculations, often drawing upon the latest theoretical advances in economics and finance. The ideas and tools developed in the economic theories of imperfect information, and in the related theories of screening, incentives and mechanism design _ which are themselves of fairly recently origin _ as well as the tools of game theory, have been enthusiastically applied by a new generation of economists to unearth the secrets of microcredit. The present paper tries to present the main contours of this theoretical journey in a relatively accessible manner. As a backdrop to microcredit theories, the paper begins by reviewing the old and new theories of the rural credit market. The major theories of microcredit are then reviewed under three different themes depending on the nature of market imperfection that a particular theory is concerned with - namely, ex ante moral hazard, adverse selection and strategic default or the enforcement problem.

Suggested Citation

  • S.R. Osmani & Wahiduddin Mahmud, "undated". "How Does Microcredit Work? A Review of the Theories of Microcredit," Working Papers 35, Institute of Microfinance (InM).
  • Handle: RePEc:imb:wpaper:35

    Download full text from publisher

    File URL:
    Download Restriction: no

    More about this item


    Access and download statistics


    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:imb:wpaper:35. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Jabeer Al Sherazy). General contact details of provider: .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.