Forty years ago, before microfinance was called microcredit, before it even had a name, I made $50 loans to 800 Guatemalan farmers in the form of six bags of 12-24-12 fertilizer, which dramatically increased their yields on the plots of maize and beans they cultivated.
Of the 800 farmers, 799 of them repaid the loans in full, plus 12 percent interest.
Over the two years I lived in San Martin, I came to witness dramatic changes in the incomes and overall standard of living of these farmers. When it came time for me to leave, many of them wept, begging me not to leave. It was a powerful experience that set me on the path I follow to this day.
Sadly, I never conducted randomized control trials against the farmers who didn’t participate in this program, so I don’t have hard evidence of “causation.” Maybe the 800 farmers got ahead of their neighbors due to some other factors, like they were smarter, had better land or were better farmers. For me, it was enough to trust my ears and eyes: When I first started working with these farmers, most were in rags and their families on the verge of starvation. By the time I left, only two years later, their children were eating better, they dressed better, and they viewed the future with optimism rather than despair.
Years later, John Hatch — my partner in our consulting firm — and I startedFINCA International, a nonprofit dedicated to spreading the power of microfinance to poor communities worldwide. Today, we have close to 2 million clients and a billion-dollar loan portfolio in 23 countries in Latin America, Africa, Eurasia and the Middle East.
But when we first started, we had to combat a number of myths about poor people and money. The first was that poor people can’t take loans because they won’t be able to repay. The idea was that the poor were starving to death, so they would immediately channel anything you gave them into consumption and not pay you back.
This thinking overlooked the ingenuity of the poor, like the group of women potters in Siguatepeque, Honduras, who, when I asked them how they invested their loans told me: “We bought groceries.” I was stunned. “But how are you able to pay us back?” The answer was, the groceries enabled them to break the cycle where they had to sell their ceramics as soon as they produced them, and at a very low price, just to put food on the table. Now, they could afford to wait as the middlemen grew more and more desperate for product, and were forced to pay more.
A second myth we had to combat was that poor people cannot save. I remember when I visited a FINCA village bank on the slopes of the Volcan de Agua overlooking the town of Antigua, Guatemala, and asked the women if they had been able to save some of the profits they had earned with the help our FINCA loans. Si, they told me. “Can I see it?” I asked. A discussion ensued. They didn’t realize I spoke the indigenous language, Cachikel. “Can we trust him?” one woman asked. They pulled up a straw mat on the floor of the house, and dug up a metal lard can. When they pried off the top, a huge wad of quetzales popped out, like a jack-in-the-box.
This was what economists call “capital formation.” Having no capital of their own, these women had borrowed money from FINCA to run their businesses, creating their money of their own, some of which they had saved.
Forty years later, an article in the American Economic Journal summarizing six RCT-based studies has found that microfinance does not increase incomes, does not empower people — especially women — and is not “transformative,” that is, it does not get people out of poverty. The best the authors can say about microfinance is “we note a consistent pattern of modestly positive, but not transformative, effects.”
On the face of it, studies such as those reviewed in the AEJ repudiate 40 years of the work and experience of people like me who have devoted our lives to microfinance, and still believe it is one of the most powerful tools ever employed in the battle to end world poverty. How does one reconcile these diametric positions? Are we practitioners all liars, having grossly exaggerated the impact of microfinance on poverty as a way to dupe donors and investors out of their money? Or are the social scientists who conducted these studies using a methodology better suited to testing pharmaceuticals but unable to capture what is really going on in the lives of the poor people it surveyed?
There is a disarmingly simple explanation, and one that takes into account the fact that the microfinance revolution is an evolving one that has yet to run its full course. When microfinance was young, the formal financial system in most developing countries reached only a small percentage of the population. When organizations like FINCA began to make loans to poor people, the clients who came forward already had viable microbusinesses that were being financed by money lenders in the informal sector, which charged rates of up to 10 percent per day. FINCA, when we started operations in Latin America, lent at 3 percent per month. Imagine the windfalls realized by our clients when, having grown accustomed to paying $150 per month on a $50 loan, they could get it for $1.50!
Fast forward to today. Microfinance providers number in the thousands, and customers in the hundreds of millions. The revolution succeeded: The poor have access to financial services.
But something, at some point, changed. I remember our clients in Malawi telling me, several years back: “We feel like we are only working for FINCA.” They meant that after they repaid the loan they had little left over for their own needs. In Nicaragua, around the same time, I remember my eldest daughter, who as an intern had participated in a social impact survey, reporting back to me: “Dad, a lot of women don’t have businesses! When I asked them what they spend the money on, they said things like clothes or fixing up their house.”
Clearly, the effectiveness of capital by itself no longer had the same transformative power it had in the “golden age” of microfinance, when it was still a scarce resource. We now had not only “first movers” as clients, we had millions of others who had come into the space and were competing against each other, all selling the same things, putting pressure on their margins and shrinking their net income.
But does this tell whole story? Despite the changes in the sector described above, the microfinance industry continues to grow. In India, where a major crisis in late 2010 destroyed much of the sector, the industry has grown by 50 percent over pre-crisis levels. At the global level, a leading investor in microfinance, ResponsAbility, predicted that the microfinance portfolio would grow 15- 20 percent during 2014. My own interviews with FINCA clients over the years suggest to me that microfinance still has a lot of juice left, even in a context of growing client versus client and MFI versus MFI competition.
Why would this be the case if, as the research suggests, there is no impact on income? The value proposition the researchers propose of “financial freedom” and “income smoothing” seems too anemic to justify a poor person going to the trouble of taking out a loan, much less putting it into a microbusiness that generates zero profits.
I would be foolish to take on the randomistas on their own ground. I used to know how to do multiple regression analysis, but those tools in my box have rusted through disuse. So, at the risk of appearing foolish, let me do exactly that. Call it my “impertinent” look at RCTs as the right way to explain what is going on in microfinance these days.
My biggest problem with the RCT methodology, acknowledged by the researchers, is the near impossibility of finding a control group, especially in saturated markets like four of the six in this study: Mexico, Bosnia, India and Morocco. Informal lenders and MFIs kept seeping in and contaminating the control groups. Confronted with this obstacle, researchers designed a “work around” in which the control groups had fewer subjects with microloans, but in some cases with only single-digit disparities. But they beat a strategic retreat even further. When confronted with the weak statistical power of the “treatment-on-the treated” results, they fell back on “intent-to-treat” effects where they could concentrate on averages and report with more confidence.
Economics, the “dismal science,” is supposed to explain people’s behavior around money, labor and other factors of production. For these findings to be accurate, you would expect a mass exodus from microfinance, not only among donors, investors and practitioners, but first and foremost among customers. This is not happening. The global loan portfolio of institutions that identified themselves as microfinance in 2011 was just south of $80 billion. Today, with so many new entrants to microfinance — telecommunications and remittance companies, among others — this number is probably edging toward $100 billion.
The truth about microfinance is still out there. We need more research that employs different methodologies, not just RCTs.
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An agricultural economist with 40 years of experience in developing countries, Rupert Scofield co-founded FINCA in 1984 with John Hatch, and has served as its president and CEO since 1994. He is president and CEO of FINCA Microfinance Holding Company LLC, an investment partnership for microfinance. He is the author of "The Social Entrepreneur’s Handbook: How to Start, Build and Run a Business that Improves the World."
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