Reading Time: 4 minutes
This blog was originally posted on 59 minutes of development and Next Billion. Since January, when six randomised control trials were published ‘definitively’ stating that microcredit is not a viable poverty alleviation tool, microfinance has been taking a lot of heat in the media. One recent article went so far as to compare it to “a zombie that refuses to die.” What’s kind of funny is that the researchers themselves weren’t quite so negative, not that anyone will take the time to read a massive research document. Here’s a line I liked.
Since January, when six randomised control trials were published ‘definitively’ stating that microcredit is not a viable poverty alleviation tool, microfinance has been taking a lot of heat in the media. One recent article went so far as to compare it to “a zombie that refuses to die.”
What’s kind of funny is that the researchers themselves weren’t quite so negative, not that anyone will take the time to read a massive research document. Here’s a line I liked.
“These results suggest that although microcredit may not be transformative in the sense of lifting people or communities out of poverty, it does afford people more freedom in their choices (eg, of occupation) and the possibility of being more self-reliant.”
So why the backlash? It’s partially the sector’s own fault. Because microfinance was billed as the ‘silver bullet’ to eliminate poverty, long-time critics are gleefully pointing to the research as proof that it’s only the industry’s greed that keeps it going.
To paraphrase Taylor Swift, microfinance’s haters are gonna hate, regardless of the research. But here are six (sometimes obvious) questions they should ask themselves before using the recent studies to make sweeping statements about its value as a development tool.
1. The studies only looked at microcredit. Are microcredit and microfinance the same thing?
No, they aren’t. Credit is just one type of service. Microfinance encompasses all financial services, usually credit, savings and sometimes insurance, pensions, etc, that are offered to the poor. Most microfinance providers will opt to provide a mixed basket of services, in regulatory environments that allow them to do so without a banking license.
2. Have there been any other studies on microcredit that found positive results?
Plenty of them! One of my favorites is the one that looks at microcredit as an income smoothing tool. That is, when other cash flows are lower, or big expenses are looming, microcredit enables families to avoid selling off assets or going hungry.
Case in point: I met a woman a few weeks ago who lives in a remote area and has a small farm. While her crops are growing, her husband travels to other areas to help with harvesting there, and/or to take other odd jobs. Before microfinance was available in her area, she essentially had to wait for him to come home with money, and just survive on whatever meager savings they had. Now, she takes a loan to fund her basic consumption while he’s gone, and uses the money he sends home to pay it off. Her stress level has been reduced a lot and her consumption is much more stable. Significant? I think so.
Another obvious example of this is in financing people to seek employment abroad. It’s definitely better for families than selling off their land and/or taking loans from informal lenders (who can charge rates that make Banco Compartamos look charitable). And soon we’ll have research to support that.
Also, the recent randomised control trials on microcredit did not explore whether it had a range of effects. It’s possible that for certain borrower profiles, the impact of microcredit is much bigger than for others. It would be really interesting to know more about whether there are sub-groups that did experience significant improvement, as that could help microcredit institutions refine their lending criteria and loan appraisal processes.
3. It must be risky to provide credit to poor clients, without any collateral or guarantee. Does that explain why microfinance interest rates are higher than commercial banks’?
Yes, it does! Remember that microfinance clients are usually people that no other banks will give credit to. On top of that, many low-income countries are at risk of floods, cyclones or droughts, during which they often will defer or write off client loans. Not to mention the fact that many microfinance institutions write off loans when a client or her spouse dies. So they have to plan for certain potential losses when calculating their interest rate.
Further, in part because many MFIs are restricted from taking deposits, they often take loans from banks for their own capital. This means that they incur a cost of funds that’s reflected in their interest rates.
While microfinance haters love to cite the 200 per cent interest rate that’s sometimes charged by Compartamos in Mexico, the global average is closer to 35 per cent. And in some markets, interest rates are capped; in Bangladesh, 27 per cent (with a declining balance) is the limit.
4. Unlike income grants and many other development interventions that critics cite as better options, most microfinance institutions are financially sustainable. So why are we comparing them?
Last month, six more randomised control studies concluded that BRAC’s model of helping households move out of ultra poverty was ‘definitively’ effective across a range of contexts. Very exciting! But a key piece of that programme is targeting; that is, finding ultra poor households that will experience transformational improvements in quality of life after two years of comprehensive support. Guess what? Doing this is expensive, ranging from about USD 1,538 per household in India to USD 5,732 in Peru.
Should we be comparing that with microcredit (or microfinance), which targets slightly better-off clients and serves them sustainably? Should we be surprised that the outcomes aren’t the same?
5. Should we be hating on the players or the game? Who makes the rules here?
To my mind, it’s regulators who should really be consuming the research findings and asking questions. Do these studies have implications for consumer protection? For policies regarding interest rates and deposit taking? Again, they’d probably need a much better breakdown of the results than what’s currently available. But since microfinance institutions have to abide by the policies set out by regulatory bodies, influencing the policy environment seems like a much better use of time than harping on providers themselves (unless you’re a hater and just want to hate).
6. Is anyone actually suggesting that we should abolish microfinance and give up on financial inclusion?
In spite of their findings, none of the researchers behind the recent studies are suggesting this. Rather, their general consensus is that the development community should focus on improving microfinance’s social impact, while considering when it can be an appropriate tool. Perhaps the sector’s critics should follow their lead, stop demonising microfinance, and instead support efforts to improve it.
Or they could just have a dance party and move on.
Maria M May is a senior programme manager for BRAC’s social innovation lab and the microfinance research and development unit. Her team is dedicated to understanding clients’ needs, and designing new microfinance products, or improving existing ones accordingly.