Is Microfinance still a force for good?

kalyan3Microfinance refers to financial services for low-income individuals who are without access to banking services. It was developed by Muhammad Yunus, Nobel prize-winner and founder of the Grameen bank. It started when he launched a project in rural Bangladesh making small loans to low income families.

Examples of microfinance can be seen in loaning an individual enough money to buy a sewing machine, enabling them to produce clothing and sell it on, generating enough income to improve their living standards and repay the loan with interest. Microfinance now spans myriad other services including savings, insurance, remittances and non-financial services such as financial literacy training.

Microfinance spiked in popularity during the 2000s, hailed by leading development economists and world leaders alike, as a powerful tool that could help eliminate poverty. Expectations were high that the movement would enable individuals to lift themselves out of poverty, with programs often targeted towards poor women, providing the access to finance through them. Having women responsible for loan repayments improved their status and in some communities has even lead to declining levels of violence against women.

However since 2010 there has been growing criticism for micro finance institutions (MFI). Due to the high return rate, some new MFI’s now operate for profit and the market is becoming increasingly commercial. This trend has been condemned by Yunus who claimed that “poor people should not be considered an opportunity to make yourself rich.”

Daniel Ortega, the Nicaraguan President, supported people who weren’t repaying their loans as they had been trapped in debt, while Sheik Hasina Wazed, Bangladeshi Prime Minister, described the MFI’s as “sucking blood from the poor in the name of poverty alleviation.”

A study by Kinnan suggested that monthly consumption (an indicator of welfare) had not been increased in those who had received a loan. Potentially because families have invested in durable goods like a tin roof, providing long-term social benefits not increased income.

There are still “not for profit” microfinance organisations such as Kiva where individuals can make a loan of $25, collectively with other donors from around the world, providing a loan for someone in a dire situation to help themselves and their families.

Currently data is inconclusive, as only a small amount of information has been gathered on people who qualify for micro-loans but are not recipients. Without this comparison group it is difficult to draw conclusions on the effects of microfinance, but there are now larger scale studies being carried out using randomised controlled trial techniques. This method compares current income and assets of two groups – one of which opt to receive loans and one of which don’t – and these results will shape our future understanding.

Many people have said Microfinance is not the “silver bullet” to end poverty, and is open to abuse by western companies. Whether it will live up to its initial expectations is still open to debate.

One comment

  1. 22 Jun ’13 at 12:11 pm

    Hugh Sinclair

    A couple of corrections here. First of all, the RCTs, and academic literature more generally, have generally pointed to MF being far from a magic bullet. David Roodman concluded the overall impact of MF on poverty reduction to be “zero”, and he is not necessarily a critic of the sector. His book “Due Diligence” is a sobering read. Maren Duvendack performed perhaps the most rigorous study to date on the effeciveness of MF and concluded similarly. This is not to say MF is “evil”, nor that it is a “miracle”. The current evidence suggests it is largely useless – it has no widespread notable impact on poverty that any credible researcher has been able to find. This has not stopped the claims that this is the miracle cure for poverty reduction, but on closer inspection one generally finds those making such claims are those who stand to benefit most from maintaining the hype surrounding MF.

    Secondly, Kiva may be not-for-profit, and does not charge MFIs for the capital it provides, and Kiva users earn no return. However, the MFIs themselves are often for-profit, and in some cases charge interest rates worryingly close to 100% APR. So, there is substantial profit within the supply chain, it just doesn’t happen to accrue in Kiva’s pockets or those of the (naive) users of Kiva. Beware, and read the small print. Kiva does publish the so-called portfolio yield of the MFI partners, but this is a gross under-estimate of the actual cost paid by the poor for the loans. Cross referencing Kiva’s stated portfolio yield with the actual interest rates charged, as published by websites such as http://www.mftransparency.org, demonstrates this point very clearly.

    If we want to see genuine development take place as a result of MF, two key ingredients are required: improved transparency, and increased regulation, both of MFIs and of those that channel funds to MFIs (often based in “developed” countries). The former is discussed, but rarely implemented. The latter is vehemently resisted by the microfinance community, who fear regulators will clamp down on their more profitable activities and oblige transparency. This is where the real battle for the effectiveness of MF is being fought, in my opinion. We have the technology and know-how, now we need to actually do decent MF rather than pretend we do it while hiding under an opaque, but profitable, veneer of PR, nice photos and heart-warming anecdotal stories. Only then will we possibly see the improvements promised since the 1970s, and take a small step towards Yunus’s dream of poverty being relegated to museums. Right now that remains a distant fantasy.

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