The United States alone has spent $2 billion on microfinance programs around the world
in just the past five years, so it seems reasonable to raise this question, but in fact
it is a topic rarely discussed. The industry itself does a poor job of addressing this
Studies have shown that during an eight year period, among the poorest in Bangladesh
with no credit service of any type, only 4 percent pulled themselves above the poverty
line. But with individuals and families with credit from Grameen Bank, more than 48%
rose above the poverty line.
Considering that the Grameen Bank has made loans to over three million people, that
would mean that nearly a million and a half Bangladeshis have risen out of poverty
thanks to these small loans. That sounds very positive, but unfortunately this
eye-catching claim is only an unattributed and unsupported statement shown on a
website that promotes broader use of microcredit (The Virtual Library on Microcredit,
www.gdrc.org). On Grameen's own website, there is no such claim nor any other information
even related to this issue. Nothing on either site evaluates microfinance
in this way.
From a more impartial source, the New York Times, comes this troubling passage:
But there are still no stringent evaluations of microcredit programs generally viewed
as credible by experts. "Energetic, entrepreneurial people do well with microcredit,"
said Jonathan Morduch, an associate professor of public policy and economics at New
York University. "But others who are less skilled and trained, how do they do? Can
very poor households get decent returns or not? That's the big question policy-wise."
There are several more serious questions about microfinance, and some will be brought
(Yet) today there is a growing push for the nonprofit groups and banks that run such
programs to reach deeper into the ranks of the poor, though there is little rigorous
evidence judging whether the very poor benefit from microcredit, economists say.
(Debate Stirs Over Tiny Loans for World's Poorest, NYT, April 29, 2004)
In raising these issues, it is not my intention to deride microfinance, nor do I wish
to delay action to reduce poverty, to decrease opportunities for the poor and disadvantaged,
or to slow the flow of development resources directly to the people who need it the most.
Yet, it appears that there is a rush toward a much talked
about scheme without an adequate understanding of what that scheme can and cannot do,
and about what our development objectives are or should be.
The objective of development work is to deliver relevant, effective, and efficient
service to beneficiaries toward an understood goal which is, in the case of finance
programs, economic growth. At first glance, microfinance is this, but microcredit is
not microfinance, credit is only a tool, and, in any case, no one knows if microfinance
is actually successful in socio-economic and microeconomic terms.
Let us first understand what actually happens in microcredit.
On the corner outside my Tashkent office is an older man. He is there every day behind a table
from which he sells a bit of this and a bit of that. He joins a microcredit program
and borrows $50 at 50% a.p.r. for three months; he will pay back $56.25.
With the fifty dollars he borrowed, he goes to the market and buys some items for resale.
He sells it at his table at a 60% mark-up to yield $80 in revenue. That 80 minus the 56.25
repayment leaves him $23.75. Over the three months, that is $7.91 a month.
That is not bad. A pension in this country is between $6 and $14 a month, so the marginal
income made possible by the microloan is very important to him.
But, how does that, as one typical program report put it, "give microentrepreneurs greater
opportunity to grow their businesses"? Is selling cigarettes one at a time a business?
And how is eight bucks a month going to start a business with sustainable employment?
That question about sustainable employment might sound ridiculous, but the program
description goes on. Under program objectives and goals it says that "a major focus
is to achieve financial sustainability (of the microlending institutions... and) to
give micro-entrepreneurs greater opportunity to grow their businesses".
But only one
paragraph later, it is changed; the goal is to "...reach not less than 1,600 people
by the end of the second year, 2,400 by the end of the third year, and 3,200 people by
the end of the performance period."
In the span of one paragraph, job creation and income generation are gone, and success
is quantified only by sustainability of the micro-finance institutions the project will
create. Microfinance itself is too often the objective of a development program, and
that should not be.
Far more rigor is needed in defining and sticking to the true goals of development finance
so that programs like this can be avoided, but it is simply and broadly accepted that microfinance
contributes to economic development, so the success indicator becomes microfinance instead of
economic development, and the existence of thousands of clients is considered an indicator of
economic improvement. This is a classic example of petitio principii, begging the question,
using the matter to be proved as part of the argument.
Throughout the microfinance industry, very little effort has been made to verify or
measure the economic impact. Indeed, as observed with a surprising nonchalance in a
World Bank report on Latin America, "The impact of microfinance on the poor remains
In fact, it is likely that the macroeconomic effect of a successful
microcredit program can be quite bad.
In the absence of a local bank, the accumulating interest earnings of a growing microcredit
organization must be placed in a bank outside the area. As a result, already scarce financial
resources leave the target area. The more the organization grows, the more money it
accumulates. The more money it accumulates, the more money leaves the poor area and goes to a
bank in another, probably more prosperous place.
And in underdeveloped countries, funds in a bank are often lent only to one of the bank
manager's cronies. When those funds are MFI deposits, the poor people in a successful
microcredit program are providing loan capital for the country's well-connected elite.
Microcredit is not microfinance, and savings, it seems, is always considered as an
'add-on', something for the project to try
later, after the MFI is established. Why is that? Why is savings promotion conditional?
Perhaps if we were to plan for success, we could properly appreciate the value of saving
and help the poor build assets from the start.
As it is now, it is very rare to see a project with a plan to promote savings, but saving
is more important than borrowing in poverty reduction. The Corporation for Enterprise
Development promotes savings programs in the US, and points out that "without assets,
poor families are likely to remain poor. Michael Sherraden, author of 'Assets and the
Poor', observes that, 'Few people have ever spent their way out of poverty. Those who
escape do so through saving and investing for long-term goals.' And without asset development
policies, only a very few poor families will have the opportunity, incentive, and institutional
supports necessary to save for and acquire productive assets."
And 40-60% interest rates on loans are not conducive to wealth accumulation, but
discussions of interest rates will come later.
At this point, though, another macro-economic factor should be noted: savings are a
key factor in establishing a proper money supply for a country. Savings leads to the
sort of money supply an economy needs by adding short term savings to cash (M2 and M1).
In undeveloped economies M1 is usually far too large compared to M2. Without savings,
the economic actors are dependent on cash and barter, and economic growth is virtually impossible.
This is the case in the former soviet states of Central Asia, for example, and from a
development standpoint, this is a very important issue. Before the collapse of the USSR and
subsequent currency crises, people in this region had a rather high propensity to save.
With proper incentives and confidence building measures, they might gradually return to
retail banks, and their savings would make a significant contribution to long-term economic growth.
Instead, throughout the FSU and in most other places, microfinance is used as a substitute
for banks. Initially, this was perfectly sensible; the poor needed access to financial
intermediation services because banks do not want to bother with such small amounts.
However, as the role and goal of microfinance became obscured, microfinace came to be seen
by development planners as wholly independent from the banking system, a replacement for banks.
This loss of focus is a problem. If we assume that increasing participation and sustainable
MFIs are only the first stage towards our goal of a normal banking function, then it is
reasonable to expect an implementation plan for a later stage of microfinance, the entry
into mainstream banking. Sadly, there is little evidence of such advance planning.
Instead, in this writer's experience, plans focus on building groups and numbers of borrowers,
on simple expansion of the basic model without foreward thinking about the needs of the borrowers.
Possibly, this is because graduating borrowers to larger loans is actually a marketing program.
Everyone realizes that in poor societies there is a need for loans of a few thousand dollars,
but this alone does not justify grafting on a program to graduate microborrowers to larger loans.
What would justify a program of larger loans is an adequate number of qualified potential borrowers,
a market for the financial product.
To learn if adding larger loans to a microlending program is workable, there must be an analysis
of the program's existing
membership to quantify the demand for larger loans. Given the predominance of traders in these
programs, this demand will always be very small because few traders can manage dramatically larger
sums and because few traders can make the transition to creating and managing productive enterprises.
Moreover, as most implementers understand, managing a $100 group loan is completely different from
a $2,000 individual loan. Due diligence, loan service, and more are required for the larger loans
to succeed. In program design, this means that little of the structure of MFIs is transferable to
the larger loan program.
Consequently, it is highly unlikely that graduation beyond a few hundred dollars will occur in any
great number in even the best microfinance programs. So once again, we return to the simple measures
of membership rolls which are short-term indicators at best.
From time to time, however, reports of jobs created are cited as a measure of progress, though these
are not as frequently cited as they once were.
It is both ironic and fortunate that job creation claims from microfinance programs have faded
from prominence in recent years. It is ironic that they are not often mentioned because job
creation and income generation are the real goal of all economic development programs, but it is
fortunate that they are rarely publicized because so many of the numbers reported in the past
were simply unbelievable and easily challenged.
Some of the more egregious claims were discredited by comparing the new job claims to the area's
unemployment statistics, when it became immediately evident that such economic growth as
would be required to create such a quantity of jobs never happened.
In those rare instances where the figures are plausible, it is still rare to find any
differentiation between commercial and productive work. Every microfinance project
acknowledges the predominance of traders in the membership, but little sustainable employment
can be reliably identified.
The issues in the foregoing discussion arose out of a preliminary look at only the objectives
of microfinance programs. When examined further, when we look at the practice and implementation
of microcredit and microfinance programs, still more questions reveal themselves. A few of these
with brief comments:
A) Women are disproportionately represented in microprograms. Perhaps that is good; inferentially at least
many believe women in developing economies are more responsible with money than men are.
On the other hand, since microcredit is primarily used by traders, what happens when a woman
takes on this added activity?
In an assessment report by Facet BV, a Dutch development firm, a problem common to most microcredit
programs was observed: many microloans are used for household needs. This possibility
might even be an attraction to women borrowers. In any case, not all of the borrowed
money is available for income generating activities.
No news there, but since women almost
always retain responsibility for maintaining the household, the study showed, this means that
the woman is forced to work harder in the household to generate the time needed to be able
to work to generate the revenue to repay the loan.
B) NGOs are, in the view of most implementers, the best vehicle for delivering microfinance
services. That view is taken as the starting point as often as not, and the only question is
whether the program should be run
through existing organizations and associations or whether new NGOs need to be formed.
A search for options, it seems, rarely occurs.
As noted earlier, a main reason for this is that microfinance is usually seen and used as a
substitute for banks. There is good reason for this-- if banks worked, microfinance
might not even be needed-- but it would seem wise at least to try a program to
resurrect retail banking through smaller, more progressive banks and credit unions.
Mainstream banking is more beneficial for development and for savers, and it should be an
objective of development agencies to promote a banking culture.
C) It is widely assumed that poor people do not save, but this is not true at all.
Even in the FSU, where banks and currencies collapsed quite recently and
thoroughly destroyed any confidence people have in local banks and their countries' currencies,
people save regularly. Instead of putting money into banks, they hold dollars, buy
and hold assets like carpets and livestock, or pool their funds with family members for
a business venture.
Even in much poorer societies, in India and Bangladesh, home-grown savings schemes abound.
An excellent review of these programs is in the book The Poor and Their Money by
Stuart Rutherford. (Now out of print but available online in PDF.)
Putting aside terms like microcredit and microfinance institution, Rutherford looks
at the financial issues involved from
the perspective of the poor and sees that all of the various programs intended to serve
their financial needs are actually variations on savings activity. He describes the
variety of approaches as roads to a "usefully large lump
sum". It is a brilliantly simple perspective, and it shows that from a
starting point different than that of most
foreign-funded programs, serving the poor versus building an institution, sustainability
is achieved because the programs deliver
what the poor people really need.
And it is productive assets that poor people need.
D) Debt and debt service among borrowers of small loans is worth a further look as well.
A World Bank study of microfinance programs in Latin America and Africa showed that borrowers would
draw funds from any source they could to repay because they knew that successfully repaying
a small loan would qualify them for the larger loans in the microcredit program's lending cycle.
At best, this means the smaller loans are not what the borrowers needed. They were using
the smaller initial loans as stepping stones to gain access to the larger sums that are actually
useful to them. At worst, it raises the issue of potential future fraud and increasing default.
If the participation in the microcredit program was insincere, risk will only increase with
larger sums at stake.
In either case, this is bad news for the microfinance programs.
E) Every decent microcredit program manager can recite the program's most current
default and delinquency rates, but few truly know how much default and delinquency
actually exist because they are hidden in the groups. Default rates are difficult
to know in group lending.
Of course, program managers are aware of this problem. Understanding it is
the main reason why most microcredit programs organize groups in the first place, and the
low level of final defaults becomes a strength of solidarity programs. Even so, the
group approach conceals critical information from lenders, and information management is
a cornerstone of MFI development.
Moreover, the most recognized flaw in group lending is how the stronger members, the ones
who might have the chance to build small enterprises, are called upon to cover the
delinquencies of the weaker members. This is understood, but the consequence is rarely
faced: this directly reduces the likelihood of larger, sustainable businesses growing
out of group microlending programs because the best candidates for growth are held back
by the added costs of group member failures.
F) Interest rates are one of the most discussed topics in microfinance, and there is no
need to repeat the discussion, but no essay on micro-finance would be complete without a
section on interest, so here are two observations.
First, you are undoubtedly aware that the case for lower interest rates to make
borrowing more affordable and leave more revenue with the borrower is routinely set
aside in favor of sustainability. This question has been conclusively won by the MFI,
and so-called "subsidized" loan programs are rarely seen.
But the fact is microcredit is enormously subsidized by foreign donors. True, this subsidy is
scheduled to end after some years, but if the aim is to stimulate employment and income generation,
it can be argued that the foreign subsidy should go more directly to the businesses to more
immediately and reliably increase employment. The interest rate debate should not be ended.
Second, and of increasing importance, Islamic areas are seeing more foreign assistance,
they are very poor, and microfinance will be in the development mix.
Of course, you've heard that interest is forbidden in Islam, but do you know why?
There is a line of reasoning in hadiths about how money is
only a store of value and not a productive asset so it is morally wrong to make a gain
from nothing of value, but this is a tortured argument that has been built over centuries
to explain Mohammed's order to his followers to stop borrowing from usurious moneylenders
whose interest rates where keeping so many poor. Mohammed was a political leader, and his
orders were practical; to assure they would be obeyed, he told the people that god wanted
it that way.
Today, as fanatics try to drum up support, foreign programs which demand 50% interest will
be an obvious example of infidel subversion.
As this essay has posed far more challenges and questions than it has praised or answered,
the author feels compelled to repeat a line from the introduction: It is not the intention
to deride microfinance to delay action to reduce poverty or to stall development activities
that help people in need. Quite the contrary is in fact true. It is hoped that due consideration
to all aspects of micro-finance programs, from design through implementation and on to their
externalities, will make the programs more effective.
The main argument in this paper is that while microcredit contributes to mitigate a number
of factors that contribute to vulnerability, as it is practiced it is not likely to help
people rise out of poverty.
Access to credit is certainly a problem in most poor countries, and programs which provide
credit beyond a certain loan threshold will be useful, but to a large extent the value of
a loan, indeed its basic purpose, is contingent on how poor the household is to
start with. The poor need assets, not credit.
Comments are encouraged.