Attracting support from the likes of Bono, Natalie Portman and Bill Clinton, microfinance (a.k.a. microcredit) was once seen as a near magical potion to lift people out of extreme poverty. Extending small loans to previously “unbanked” poor people theoretically allows them to start or grow tiny enterprises - which then leads to income growth, improved nutrition and women’s empowerment. Based on these types of outcomes, a United Nations year was dedicated to microcredit in 2005 and, in 2006, a Nobel Peace Prize was awarded to Muhammad Yunus and the Grameen Bank.
Then, a few short years later, a flurry of negative headlines struck.
Two years ago, reports came that the first rigorous studies showed microfinance efforts fell short of achieving the goals once thought. Earlier this year, rumors of suicides due to excessive debt in India, the increasing influence of for-profit interests (including India microfinance bank SKS’s IPO) and sky-high interest rates (averages of 25 to 30% and up to 100%) were reported.
Christian organizations (NGOs and churches) have been heavily involved in microfinance. Many globally minded Christians have directed money toward microfinancing, whether through donations to organizations like World Vision, small “peer to peer loans” through Kiva or through private investment funds. Given recent events, are we unintentionally further oppressing some of our most vulnerable global neighbors by supporting these endeavors?
Digging deeper than the headlines, microfinance does seem to be worthy of our continued (though more careful) support. A billion or more people still lack access to formal financial services. Instead, they rely on means of managing money which are usually more expensive, while offering less reliability and security. For example, to buy items to stock a tiny grocery store, an entrepreneur might have to borrow from local money lenders who charge 20% interest - per day! Or, to save money for an emergency or a child’s school fees, she might have to pay someone (a “money collector”) at a 30% rate of interest to hold her funds. When done right, microfinance fills these critical gaps.
As for the random control studies, they did show some positive results (as noted by the authors themselves) despite what the popular press reported. And they were each conducted in very specific contexts under relatively short time frames. Microfinance takes place in many contexts and is delivered by many organizations using varying methodologies. Thus, the researchers caution against generalizing from these studies.
Interest rates are tricky. Making tiny loans is an expensive endeavor. Just to cover costs and break even (and maintain the viability of the organization) requires rates that may shock our sensibilities. Some studies also indicate that price may not be the most important issue for borrowers. Access and reliability may matter more. And there are some examples in which competition has served to lower rates.
The increasing involvement of for-profit delivery institutions and funders presents a difficult tension. If financial services are to be expanded to the billions of people who could potentially benefit, funding must come from global markets. Government grants and philanthropic dollars are not nearly sufficient. Yet, it would not be hard to imagine that profit-seeking institutions can become beholden to the interests of investors. For those who may be concerned about profiteering, however, a recent industry study indicates that on average non-profits and for-profits are indistinguishable in terms of return (on assets) and interest rates charged. Moreover, the overall percentage of clients served by profit-seeking institutions is still relatively small.
The jury is still out on the extent of client over-indebtedness. Since many places lack credit bureaus, borrowers can take loans from several institutions simultaneously and become trapped in cyclical debt, especially in contexts in which many providers are vying for the same clients. However, movements are underway to establish responsible client protection practices (i.e., the Smart campaign). Furthermore, there are still places in the world where microfinance is more of a fledgling effort led by small NGOs and is far from a competitive jungle with multiple lenders.
These controversies have raised important questions and prompted greater efforts to protect clients, improve delivery and measure actual social impact. Still, I believe that microfinance, especially when seen as more than credit (including small savings accounts and insurance) and carefully delivered by organizations that define “development” as more than economic gain alone, is still worthy of our judicious support. Poor people around the globe who can benefit from them will be much worse off without the ready availability of inclusive financial tools.
(Photo of South African participants in a Small Enterprise Foundation program courtesy of GiveWell/Wikimedia Commons.)