Economic Development

A Sobering Assessment of Microfinance’s Impact

At a conference last week of leaders in microfinance, attendees focused on the nitty-gritty of the social impact of microlending, and the results of the discussions were both sobering and startling.

At a conference last week of leaders in microfinance, attendees focused on the nitty-gritty of the social impact of microlending, and the results of the discussions were both sobering and startling.

Basically, none of the 250-plus academic researchers, practitioners, and investors at the Microfinance Impact & Innovation Conference in New York City seemed to know whether microfinance generally works—whether the 30-year experiment in giving small loans to the poor has a positive impact on their livelihood. In fact, there is increasing evidence that microloans—often given at high interest rates and with strict repayment terms—can further impoverish and indebt poor people. This is frightening, given the growing size of the microfinance sector. MicroBanking Bulletin reported that at the end of 2009 there were 1,084 MFIs serving 74 million borrowers receiving $38 billion in loans.

Abhijit Banerjee, the Ford Foundation International Professor of Economics at MIT, presented largely depressing findings from his study of Spandana Microfinance. Banerjee looked at 7,200 households in 104 neighborhoods in Hyderabad, India over the past year and a half, where loans of $250 were given to groups of women at an annual interest rate of 28 percent. What Banerjee found is that only 5 percent of Spandana’s loan recipients started new businesses and, in general, there was no impact on spending. “We saw no effect on family expenditures or education, no long-term effects,” said Banerjee. “We found no evidence of women’s empowerment either,” possibly because the money goes directly to women who are often too overburdened with domestic and childcare duties to become successful small-time entrepreneurs. However, Banerjee said his research team did see evidence that the loans were being used to alleviate health crises.

Esther Dufflo, the Abdul Latif Jameel Professor of Poverty Alleviation and Development Economics at MIT, had similarly bad news about microfinance’s social impact. She presented findings from the first-ever impact evaluation of a rural area that previously had no access to microcredit. Analyzing about 5,000 households in rural Morocco who received loans of $125 to $1,850 from Al Amana Microfinance over a two-year period, Dufflo said the first thing to note was that demand for microfinance loans was low. But, more importantly, “the effect on consumption for the entire sample was negative and insignificant,” she said. “There was no huge improvement in welfare, no effect on [loan recipients’] starting new activities. … No impact on education, no impact on women empowerment.” What did change as a result of the loans, said Dufflo, was diversification of livestock. Forty three percent of loan recipients bought and raised a new type of animal; those who raised sheep, bought chickens; those who raise chicken, bought goats. Also, those with paid jobs often quit them to focus on family farming.

Carlos Danel, co-founder of the highly controversial and much lambasted Compartamos Banco, also spoke at the conference. Over the past 20 years, Compartamos in Mexico has become the largest for-profit microfinance institution in Latin America, serving more than 1.3 million clients. The company went public in 2007 in a transaction worth $467 million, and as of 2009 has a total loan portfolio of $591 million. Compartamos is now opening its troves of data to an academic research team led by Yale University Economics Professor Dean Karlan, a move Danel said has led “people to assume we’re investing in research to defend our work.” But Danel is adamant that is not the case. The reason? “There are more assumptions than evidence in the MFI industry,” Danel said, continuing, “This was an industry born out of supply, not demand. [The loans] reflect what we can do, rather than what the client wants.” Karlan’s impact study of Compartamos started in 2008 and will end in 2012 with a baseline of 19,000 people, likely making it the most comprehensive microfinance impact study ever conducted.

But will academic studies affect microfinance banks’ practices? Danel indicated yes, pointing out that due to the lack of comprehensive MFI studies, “We don’t know how we can improve things for the client.”

Already, there are examples of research affecting and improving practice. Erica Field, an associate professor of economics at Harvard University, presented research about what happens when flexibility is introduced in microloans, specifically a two-month grace period for repayment. Working with Jolly Zachariah, a Citibank executive turned microfinancier at Ujjivan, an urban MFI in India, Field studied 169 groups of 845 female borrowers in Kolkata, who were given loans of between $100 and $250 at an annual interest rate of 22 percent. What Field found was that the women who were offered grace periods had higher profits and more inventory. In other words, there was clear business expansion, although the grace periods brought up the default rate by 12 percent. Field concluded that “microfinance products need to be designed to optimize risk and better outcomes”—an argument Ujjivan has heeded by instituting grace periods for some loan takers. “We are implementing ideas that work for clients,” said Zachariah. Yet Zachariah admitted he is “a totally confused [microcredit] practitioner.” The industry’s greatest problem, he said, is the low skill set and education of microfinance clients, something that was not the case when he helped open up India to retail banking for Citibank in 1986.

The researchers, practitioners, and investors of microfinance did agree on one thing. There is much that we don’t understand about microfinance and much research and work to do. Among the items high on the agenda are studying: the psychology of decision-making by microfinance clients; the quality and flexibility of the loans; the need to provide financial assistance and coaching to loan recipients; and the degree to which easy access to loans are creating over-indebtedness—a phenomenon that needs no explanation to Americans. “Basically, we’re flying blind,” said Richard Rosenberg, a senior advisor at the Consultative Group to Assist the Poor. “Research help with over-indebtedness is urgently needed."

Read more stories by Tamara Straus.

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  • BY Sylvia Ventura

    ON October 28, 2010 01:13 PM

    Interesting post, thank you Tamara! I agree with the need for redesign of MF products.  Maybe part of the solution is simpler. The Grameen Foundation show us some interesting aspects, allowing for group aggregation on the demand side and letting the ‘group’ dynamic provide/share the individual support needed, financial litteracy, vetting and peer pressure/support to go through with the project for which they borrowed and the payment of the loan. The unsettling aspect here is the evidence that loans are being used to alleviate health crisis. If confirmed with future studies maybe health should become a part of the MF product or deploy a campaign that pairs up lending and individual wealthfare goals.

  • Blake Nichols's avatar

    BY Blake Nichols

    ON October 28, 2010 07:41 PM

    Good post!  I find it interesting that when the idea for micro-finance was developed, people jumped in seemingly without studying if the solution fit the actual problem.  It seems that we’ve found that the financing actually contributed to problems, often through unproductive priority shifts.

    I however, my gut feeling won’t allow me to believe that micro-finance is as bad as those who presented at the Micro-finance Impact & Innovation Conference make it out to be.  I think two questions have to be asked:
    1) Are the correct social impact metrics in place?
    2) Should financers have more strict control over the cause’s operations?

    I don’t know the answers, however the questions must be asked.

  • BY Richard Kennair

    ON October 28, 2010 10:41 PM

    There have been anecdotal incidences in Uganda of MF gone awry and poorly thought out - but I thought it was situational in context. I really think that more research is required as to efficacy - not to poo-poo the concept, but to improve MF and make it effective, or more effective.

    I totally agree with Blake’s comment of “people jumped in ...” - and that seems to happen a LOT—funders have historically liked the idea of replicating programs that seem effective.

  • BY Jose Luis Montes

    ON October 29, 2010 02:50 AM

    Very interesting, but not new: that’s part of the debate in MF cercles since some time ago. Nearly nothing is 100% good or bad, and is obvious that any new (and MF is new, even thought it’s been on for years) thing needs further adjustments. And environment changes and will lead to more need of adjust., so be prepared for that. And there’s not just one model. Not even just slight diferences: Grameen model vary a lot from NGOs models, for example. What’s the impact in results if, instead of a microfinancial agency receives demands and deliver mcredits, a NGO trains in concrete job/business some women and then after funds their startups? Maybe a lot difference ... research is needed to understand, fine tune or big change adopting. And we are just at the begining. Don’t like this kind of “cool hype/shit fall” movements to which human being is so liking ... MF wasn’t god’s creation nor now is devil’s invention, let’s be consistent in the long term.

  • BY Richard Kennair

    ON October 29, 2010 09:10 PM

    Jose - your statement of:

    “a NGO trains in concrete job/business some women and then after funds their startups”

    is what one of our project partners in Uganda does. We fund the training of rural individuals in skills that can be developed into viable businesses, in how to set up a community based cooperative, and how to market their product—and after completion the groups are given loans - but not cash, rather the equipment and initial supplies needed to start up. We raise the funds by selling a portion of their product in North America (which we have bought from them at fair market value) - but we emphasize that this is to be supplementary income - and that they must develop products for the local market. We also accept, as payment, product in lieu of cash payment.

    We are relatively new at this, and it will be a few years before we know if it’s truly successful - but we are trying to put as many safe-guards in place so that it won’t be detrimental.

  • It is a little alarming that the industry and some of its leaders would feel so uncertain about microfinance. It is even more alarming that some microfinance clients are ending up with nothing but the burden of increased debt. I have to wonder why the microfinance industry is growing when there is so much uncertainty around its effectiveness?

    The situation suggests that microfinance alone is not enough to change client’s lives. Just like a traditional lender, a microloan provider must evaluate the borrower and their use of the money (business plan?). Further, in the case of microloans to low-income borrowers, lenders should consider what other factors contribute to abitility to repay. Lenders may find it useful to add financial literacy or business training requirements to their microloan agreements.

    It’s good to know research and innovation are continuing in this field. The industry should aggressively pursue evidence that demonstrates the effectiveness of microfinance before philanthropists and investors give up on this method of social enterprise.

  • I think microfinance is like anything…it cant work done in isolation. Rather, it needs to be part of an integrated network of support services.  Women cant do anything with a mere loan when issues like child care, education, health, security etc etc are unaddressed. Providing some coaching and a system of peer support is a step in the right direction, but more needs to be done.

  • Ajay Joy's avatar

    BY Ajay Joy

    ON November 3, 2010 07:53 AM

    an article written so precise!
    The euphoria with Microfinance as the salvation mantra for poor is turning sour in India. Many reports came from Andhra Pradesh about the harassments by collection agents. Many people commited suicide and the Govt had to step in to regulate their functioning. An IPO issued MFI SKS Finance is facing dire time in market. Simply put, when the capital markets need more and more from MFI stocks, MFI has to transfer that burden to end customers- the poor. Such an irony to see sophisticated modern era leeches. When interest rate climbs up 28% an year, what kind of rural enterprise can be expected to perform better than that. No surprise from the studies to see that only beneift from MFI is in health emergencies.

    An article from INdia worth serious reading although leftist in the framework

  • BY Chris Dunford

    ON November 3, 2010 06:22 PM

    The great thing about this conference (I was there the whole three days) was that the presentations and conversations really stuck to what the evidence from good studies tells us.  What I didn’t hear was support for Tamara Straus’s alarm that “there is increasing evidence that microloans—often given at high interest rates and with strict repayment terms—can further impoverish and indebt poor people.”  The operative and disputable word is “further.”  Of course, we know that some microfinance clients don’t do well, and even may be harmed by ill-advised participation in microfinance, but they tend to drop out very quickly.  Other than drop-out rates (which have many non-malevalent causes), the evidence doesn’t show us yet that further impoverishment or indebtedness is the norm or even common.  To maintain that this observation is “frightening” goes beyond the evidence into the realm of jumping to conclusions from isolated accounts coming from places like India, where the bias against microfinance has many drivers that have little to do with the actual experience of the vast majority of microfinance clients (see Intellecap’s October white paper “Indian Microfinance Crisis of 2010: Turf War or a Battle of Intentions”).  One of the most important conclusions of the conference was that microfinance works better for some people than others, and research best focuses on determining what works where and for whom, so that microfinance practitioners can adapt accordingly.  It is also clear that microfinance by itself (as starkly illustrated by Esther Duflos’ initial findings in Morocco) may not be helpful at all without combination with other services (as other commentators here have written).  Nothing counter-intuitive about that finding!  Just because some prominent enthusiasts for microfinance have gone way beyond the evidence in proclaiming a “miracle,” we shouldn’t ignore the evidence that microfinance does some real good for large numbers (but not all) of the clients.  Does it cause more harm than other development interventions?  So far the evidence doesn’t support that conclusion.

  • BY Phil Smith

    ON November 18, 2010 06:51 PM

    Interesting read,  I have done some research lately on a group called Opportunity International, and they seem to be finding much stronger results than those provided by the masses. I would think it is due to their community/team approach to lending, and the effort they continually make to mentor those getting the finances in strong business practice and management.

  • Tamara G.'s avatar

    BY Tamara G.

    ON October 6, 2011 05:27 PM

    In my view, the problem with microfinancing in the areas of extreme poverty is more fundamental than most people in the comments have admitted. It cannot be fixed by tightening one bolt or another. it needs complete change of machinery -  replacement of Eastern societies and values by Western societies and value system.

    Microlending or microfinance is an inherently Western capitalist idea. It is based on competition and individual success. Capitalism has created a wholesome value system, which drives individual and group behaviors in capitalist countries.

    The East is different in its value system and traditions. It is overwhelmingly different culturally. Most Eastern societies deeply value community and cooperation as opposed to competition and individualism, which they see as destructive of their community and family life style.

    Even if the loan recipients in the East want to act as capitalists, most of them can’t because their behavior is seen as antagonistic to local tradition, and they may get expelled from their original communities. Therefore, poor take the loans, but do not use them as Westerners would. They do not want to be ostracized by the community. To make microfinance successful, the community and tradition need to be abolished.  Is it the goal of microfinancing?

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