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.

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.