Sunny Days for Microfinance

Many, including SSIR editor Tamara Straus, have characterized recent news from the microfinance industry as “largely depressing.” Straus used those words to describe the findings of microfinance impact studies. Others are depressed by the debacle underway in Andhra Pradesh, India—one of the epicenters of modern microfinance—where the government temporarily prevented MFIs from conducting business in part because of reports of overly aggressive repayment collection.

I couldn’t disagree more with that perspective on the state of microfinance. I think the current moment is the beginning of the golden years for microfinance. 

First let’s turn to the impact studies. At the 2010 Microfinance Impact and Innovation Conference a few weeks ago results from the three rigorous assessments of microcredit impact completed so far were presented (I’ve created a list of posts about the research presented at the conference here) . While these studies were conducted in very different contexts that found remarkably similar things: on average there is not much impact, positive or negative, on borrowers. Despite the many inspiring anecdotes that fueled the popularity of microfinance in the public mind, researchers found little evidence that borrowers significantly increase their incomes, invest heavily in their businesses, or that children attend more school or women become empowered.

The disappointment in the findings of the impact studies is driven by unrealistic expectations. The studies have thoroughly exploded the myth that microcredit is a silver bullet for eliminating poverty. But believing that microcredit—or anything—is a silver bullet for poverty was silly in the first place.

Far from being depressing, the impact studies are full of good news for microfinance. Each of the studies found that some types of clients benefited substantially from access to credit. It’s as true to say that the studies found that microfinance “works” as it is to say that they found that it “doesn’t work.”

Even better, several other studies presented at the conference suggested that small tweaks to the products offered by MFIs—such as delaying the beginning of repayment by a few weeks, offering loans in-kind rather than in cash, or providing very basic financial training—can dramatically improve outcomes for borrowers.

Taken together, the studies presented showed that there is tremendous promise ahead for microfinance: the right products, targeted at the right clients, can have major positive impact. That’s a conclusion to celebrate, not to be depressed by.

It’s a bit harder to see the silver lining in the microfinance crisis in Andhra Pradesh (AP) (For a good backgrounder see this post from David Roodman and his follow-ups). There reports of over-indebtedness and aggressive collection tactics (as well as other very complex political dynamics) led the government to shut down microfinance operations temporarily and attempt to impose strict new regulations on MFIs. It’s not clear how the crisis in AP will ultimately be resolved, but the industry as a whole is very lucky that this crisis happened where it did. 

Many of the underlying problems in AP are shared with other regions—over-indebtedness, reckless growth of MFIs and credit, aggressive collection tactics. AP’s crisis is a needed warning to the rest of the industry to take these problems seriously. But AP is also better positioned to weather this crisis than any other region of the world. The major MFIs operating in AP are among the best run in the world. If the crisis puts them in financial jeopardy, these large, well-respected MFIs will find it easier than most to recapitalize. Even if some of them can’t recover and go bankrupt, there are many MFIs in India that could step in to fill the gaps, and clients have generally better access to alternative sources of credit than in many places in the world. In other words, the warning has been delivered in the locale most likely to survive a crisis.

I think the proper analogy to understand the current state of microfinance, then, is the Enlightenment. We would hardly call the discoveries of gravity, heliocentrism or germs “disappointing” today. They did dramatically change worldviews and require abandoning some cherished beliefs about how the world worked, but they also laid the groundwork for major advances into a brighter and better future.

I think that’s the state of microfinance today. If the industry decides to learn from quality research and heeds the warnings of the AP crisis, sunny days are ahead.

Read more stories by Timothy Ogden.