Critique of microfinance raises questions about efficacy, donor support of the industry

The microfinance industry is once again coming under fire for failing to deliver on poverty alleviation, income generation, education and women’s empowerment impacts — this time as the result of a broad survey of microfinance programs.

The survey, released recently by the Abdul Latif Jameel Poverty Action Lab and Innovations for Poverty Action, looked at the impacts of microfinance using seven randomized control trials in different regions of the world during the course of nine years. The study examined a wide range of contexts and borrower types and found that while microfinance does not have harmful effects on borrowers, it doesn’t help their livelihoods, either.

While it strongly challenged microfinance’s poverty-alleviating potential, the study also said that the industry remains a useful financial tool because it can provide low-income households with more freedom over how they manage their money.

The report has been described as “provocative” and “sobering”and has raised questions about if and how donors should continue to invest in the $68 billion industry that serves approximately 300 million people. Though others, including Alex Counts, Grameen’s president and CEO, encouraged addressing how to make microfinance work better rather than leaving the industry behind.

The notion that microcredit lifts people out of poverty is, “putting the bar unrealistically high,” said Dirk Elsen, director of emerging markets at Triodos Investment Management, adding that while microfinance may not increase income on its own, it can give people choice in how they manage their daily lives. Microfinance can also help develop financial sectors in lower-income countries, he said.

“The promise of microcredit should never have been that it was the best way to bring people out of poverty,” Justin Oliver, director of global outreach at Innovations for Poverty Action, told Devex.

Microcredit supporters hoped it might have some effect on poverty but it was particularly attractive because it offers a viable business model, he said.

Grameen President Alex Counts said he thought the survey was “unfair” because no one said that microcredit would transform average clients’ lives, and urged industry leaders to focus on how to make microfinance work better instead of asking whether it works.

“Microcredit didn't cure cancer, cure the common cold or find Bigfoot. There's many things that it failed to do but why not talk about what it succeeded in doing and then [the] top line message would be more constructive,” Counts said.

If you look at the research, he said it consistently shows microfinance brings significant though modest benefits. “But modest benefits times 200 million families — that’s not so modest. Five to 10 percent do experience transformative benefits, so shouldn’t we be looking at how to expand this with applied research for better financial products?”

Moving forward: Continue model or invest in new innovations?

With the latest evidence further challenging the notion that microfinance can help the poor, it begs the question of whether donors should change their strategies or redirect their funds.

Elsen said donors should still invest in the standard microfinance model even if it does not boost economic status because it helps the poor deal with income shocks that arise such as paying for a wedding or illness.

In addition, several people said that the sustainable business model and the size of the industry make it too effective to dismiss.

“We could start new investments in new things, but I don’t see other business models with promise to replicate the reach and sustainability microfinance has achieved,” said Paul DiLeo, president of Grassroots Capital Management. “Not to minimize the shortfalls, but we should be careful about tossing out something that exists instead of making it more effective.”

Others have advocated that it is time to abandon the old model and find innovative ways to use microfinance effectively for poverty alleviation, such as investing in digital transfers to increase credit access and lower transaction costs for the poor.

“We must think beyond the standard microcredit model,” said IPA Founder Dean Karlan. Modern microfinance- savings and insurance, and more flexible credit products have generated larger impacts than simple credit, he said.

J-PAL director Esther Duflo echoed the need to look beyond credit and shift a greater focus to new products like insurance, savings and mobile money that groups concerned with the link between credit and financial inclusion have explored.

But Esther Duflo emphasized the importance of testing these new microinsurance products to prove success from the start in a way that was lacking in the earlier, more optimistic days of microfinance.

“We need to be careful not to jump from one fad to the next: it will be important to evaluate those innovations and get evidence of impacts before we go through the cycle of enthusiasm, despair, and finally, evidence that has characterized microcredit,” Esther Duflo said.

But for some improving research and evidence is not enough. If poverty reduction is the main goal, aid donors should not finance microfinance lending, said IPA Executive Director Annie Duflo.

“Given that microcredit has not led to transformative impacts on poverty, donors and private investors interested in increasing the social impact of credit could use philanthropic money to encourage the design, piloting, and testing of more flexible credit products,” Annie Duflo said.

Donors and governments should also focus efforts on creating supportive regulatory frameworks for financially viable and responsible products for the under-banked and the unbanked, she said.

Counts, from Grameen, agreed that donors should not be investing in MFIs because MFIs can source money through impact investors and commercial sources.

The infrastructure that microfinance has helped build touches millions of people and can be tapped by new products including solar or healthcare innovations that are looking for a means of distribution, he said.

“There are some really exciting high impact opportunities to do that and it would be silly to say we shouldn’t put philanthropic dollars to use this infrastructure that’s been built up and users have paid for,” Counts said.

In international development “we go through fads,” he said, and should think carefully before turning and saying that something that has been worthy of development suddenly is not.

Should donors continue to invest in microfinance or leave it to the private sector and invest in new innovations for financial inclusion?

Read more international development news online, and subscribe to The Development Newswire to receive the latest from the world’s leading donors and decision-makers — emailed to you FREE every business day.