Hard questions for microfinance

    Through microfinance, widowed women from the Kabuga region in Kigali, Rwanda, were able to start a tailoring cooperative with 20 sewing machines. Photo by: configmanager / CC BY-NC-SA

    Note from editor: This feature on microfinance is produced and published by Devex Impact: a global initiative by Devex and USAID that focuses on the intersection of business and global development and connects companies, organizations and professionals to the practical information they need to make an impact.

    It is safe to say that few development practices in history have been elevated to the celebrity status enjoyed by microfinance.

    Generally, a small community of development practitioners and government officials debate the merits of methods such as conditional cash transfers, public-private partnerships and other practices for helping to improve the condition of the world’s poor.

    Not so for microfinance, and particularly microcredit.

    “Give a man a fish, he’ll eat for a day. Give a woman microcredit, she, her husband, her children and her extended family will eat for a lifetime,” said U2 lead singer and celebrity humanitarian Bono in 2005.

    Microfinance was promoted by Oprah Winfrey on her show and was featured in an episode of the hit animated comedy series The Simpsons. More importantly, it was embraced by world leaders, such as former U.S. President Bill Clinton and U.K. Prime Minister Tony Blair.

    “Microfinance is an idea whose time has come,” said United Nations Secretary-General Kofi Annan in 2005.

    The crowning glory for microfinance came a year later in 2006 when the Nobel Peace Prize was awarded to Muhammad Yunus and Grameen Bank. The Nobel laureate did not create the concept of microcredit – similar small credit cooperatives have operated since the mid-19th century – but he helped turn it into a global phenomenon.

    Part of the appeal of microfinance is the idea that it is a transformational type of assistance to the poor that is nearly limitless in its possibilities, said David Roodman, a senior fellow at the Center for Global Development in Washington D.C. who has written extensively on microfinance.

    “You can do anything with money,” said Roodman in a telephone interview. “If you build a well, it can only do one thing. With money you can imagine a million possibilities, a million story lines. I think it really fires the imagination. There is a real sense that you are not just helping people, you are transforming their lives. There is this notion that credit springs people out of the poverty trap.”

    Microfinance is also one of the few development practices with supporters on both the left and right side of the political spectrum, said Roodman, author of the book, Due Diligence: An Impertinent Inquiry into Microfinance.  

    “Microfinance is about entrepreneurship and lifting yourself up by your bootstraps, which appeals to the right,” said Roodman. “And it has been talked about as something that empowers women, which appeals to the left.”

    Selling our skin

    At about the time Muhammad Yunus and Grameen Bank were receiving the Nobel Peace Prize, a woman in Koppal, India, named Lakshmavva was looking for help. When she could not find farm work to support her family, she turned to microfinance.

    She joined a microfinance group and took out several loans, including one to buy a buffalo. Though the animal helped her family’s financial situation, one of her sons had to drop out of school to care for the animal. Another son took over the task later. In the end, both sons ended up as agricultural labors and Lakshmavva’s situation was little improved.

    The story, as recounted in the 2009 book The Meaning of Money: How Women See Microfinance, by Smita Premchander, was just one example of what researchers were finding as they looked closer at what was supposed to be the life-changing impact of microfinance.

    Other researchers found much more disturbing tales of microfinance gone wrong.

    “The NGOs said that their loans would bring happiness to our lives, as we would get money to start businesses. They lured us by telling us we would have chickens, a latrine, and many other things. We believed them,” a villager is reported as saying in the report The Limits of Microcredit—A Bangladesh Case, produced by the Goldin Institute.

    “They said that we would have to repay the installments every week but we would never feel burdened by the loan,” the villager stated. “But later we felt the burden. Then we understood that we could never get rid of the loans even after selling our skin.”

    The Goldin Institute report found serious problems with the assertion that women are automatically empowered by microfinance. “Women take microcredit as their husbands order them to do so,” the report stated. “When their husbands fail to pay the installment, then NGO workers abuse the women a lot. Women have to bear the pressure coming from both sides.”

    Such anecdotes were becoming more common in the mid-2000s as microfinance continued to boom. In 2009, a series of reports using randomized controlled trials changed the global conversation. 

    Economic professors Dean Karlan, of Yale University, and Jonathan Zinman of Dartmouth, studied microfinance clients in the Philippines over a two-year period using this scientific method and found little to justify the global fanfare.

    “Microcredit is not a transformational panacea that is going to lift people out of poverty,” Karlan told the organization Grantmakers Without Borders. “There might be little pockets here and there of people who are made better off, but the average effect is weak and diffuse, at best.”

    A study in India, by Massachusetts Institute of Technology economics professors Abhijit Banerjee, Rachel Glennerster, and Esther Duflo, produced similar findings. Using the randomized controlled trials method, the research was not able to find improvement in children’s health or women’s empowerment among microfinance recipients – as compared with the control group.

    Not long after these landmark studies were published, media reports began surfacing of microfinance recipients in the Indian state of Andhra Pradesh committing suicide due to high-pressure collection tactics and soaring interest rates.

    The idea that microfinance was the “silver bullet” – the long awaited solution to the problem of global poverty – died a noisy and ignominious death in 2009 and 2010.

    “While few would deny that equitable access to financial services can help improve the circumstances of poor people, what remains unclear for many is whether microfinance has and can reduce poverty in a meaningful way,” noted Grantmakers Without Borders in their report Microfinance: A Guide for Grantmakers. “Also unclear is whether microcredit, the leading tool of the microfinance industry, might not in fact leave some people worse off.”

    A resilient development practice

    Despite the problems, microfinance remains a popular and widely used form of development assistance. Data from large and small donors indicate that it has weathered the storm well.

    More than 120 million families are recipients of microloans, according to the organization Microfinance Information Exchange (MIX). In 2002, the organization tracked 124 microfinance institutions worldwide. In its latest annual report, that number rose to 2,000 institutions in 110 countries representing more than 92 million borrowers and 66 million depositors.

    The total global investment in microfinance reached $24 billion by December 2010, according the Consultative Group to Assist the Poor (CGAP), a research center dedicated to advancing financial access for the world’s poor. 

    In recent years, during the height of criticism about microfinance, the growth rates of global investment in microfinance dropped from an estimated 30% in 2008 to an estimated 13% in 2010.

    “The decline in the growth rate is due to a higher number of microfinance projects coming to an end in 2010 compared to previous years, rather than a slowdown in new commitments,” the CGAP noted in a report on the topic. “The amount of new commitments was higher in 2010 than in the years 2007 to 2009.”

    While CGAP is a barometer of large donor support, the microfinance website Kiva provides insights into public sentiment toward microfinance. It allows Internet users to lend as little as $25 to a group or individual.

    The website started in April 2005 with seven loans totaling $3,500 and grew quickly to more than $1 million in lending by November 2006. By February 2008, the site had 250,000 users and by November 2009 – the height of the microfinance crisis – it had reached $100 million in loans distributed. That has grown to $360 million today.

    A very dangerous game

    Though microfinance has retained its funding support, it now faces hard questions from donors and criticism from some of its high-profile supporters.

    “When microfinance spread across the world, some people abused it,” Muhammad Yunus told The Guardian newspaper. “Some went berserk. In my opinion, if there is any personal profit involved, it should not be called microfinance, which should be totally devoted to the benefit of poor people. People used the respect for microfinance.”

    Microfinance expert David Roodman noted that microfinance, at its best, efficiently delivers credit to millions of people who need it. This is evidenced by the fact that despite the problems, the number of people seeking microcredit is not diminishing. But, he said, it can also be a powerful tool for harm.

    “Credit is a very dangerous game,” said Roodman. “Credit is both useful and it also something that can hurt people, especially vulnerable people. I’m not prepared to say we shouldn’t offer it all because hundreds of millions of people are voluntarily using this service. It must be useful to them. We need to have healthy balances between taking care of the clients and wanting to expand in order to serve more clients.”

    Most experts agree that the solution to the problems of microfinance lies in a variety of remedies related to increased measures to protect recipients from abuses, as well as an expansion of non-credit financial services to the poor such as micro-savings and micro-insurance. A broader approach to the concept of poverty is also needed.

    “The problems of the poor go well beyond money or things,” noted Christopher Dunford, the former president of the organization Freedom from Hunger. “They suffer a broader syndrome of disadvantage. Access to financial services is powerful because it offers people opportunity – a greater range of options to change their lives.”

    “But credit, even combined with other financial services, addresses one factor constraining the poor – lack of liquidity – only one of many factors constraining the poor.”

    Though microfinance has lost much of its sheen in recent years, it continues to be popular among recipients. And during times of scarcity, it is particularly appealing.

    “When all is said and done, a year of microcredit probably doesn’t help poor people as much as a year of girls’ primary education,” wrote Richard Rosenberg with the Consultative Group to Assist the Poor.

    “The value proposition of microcredit, and microfinance more generally, is that each ‘dose’ costs far less,”Rosenbergwrote. “Education, health, and many other social services require large subsidies year after year. When microfinance is done right–and only when it’s done right–small one-time initial subsidies can generate service delivery to very large numbers of people year after year.”

    According Roodman, microfinance is not inherently good or evil. It is misunderstood.

    “Microfinance has promoted the impression that it is good at some things—reducing poverty and empowering women—but it is actually good at another: building dynamic industries that deliver inherently useful services to millions of poor people,” said Roodman. “That duplicity, however unwitting, came home to roost in the last few years.”

    “On current evidence, the best estimate of the average impact of microcredit on the poverty of clients is zero,” he continued. “So microcredit as a whole appears neither to live up to the hype nor deserve the harshest attacks against it as enslavement by debt. It isn’t a miracle cure for poverty, and it is not the financial equivalent of cigarettes. Instead, the commonsense idea that credit can help in moderation and harm in excess appears close to the truth.”

    About the author

    • Floyd Whaley

      Floyd is a Devex correspondent and journalist based in Manila. He covers the Philippines for the International Herald Tribune and the New York Times. Floyd also operates Asia Editorial Services, a consultancy that provides writing and editing services to development organizations.