When Is Microcredit NOT an Appropriate Poverty Intervention Tool?

In the last two decades, substantial progress has been made in developing techniques to deliver financial services to the poor on a sustainable basis.  Most donor interventions have concentrated on one of these services, microcredit.  For microcredit to be appropriate however, the clients must have the capacity to repay the loan under the terms by which it is provided.  Otherwise, clients may not be able to benefit from credit and risk being pushed into debt problems. This sounds obvious, but microcredit is viewed by some as "one size fits all."  Instead, microcredit should be carefully evaluated against the alternatives when choosing the most appropriate intervention tool for a specific situation.

Microcredit may be inappropriate where conditions pose severe challenges to standard microcredit methodologies. Populations that are geographically dispersed or nomadic may not be suitable microfinance candidates. Microfinance may not be appropriate for opulations with a high incidence of debilitating illnesses (e.g., HIV/AIDS). Dependence on a single economic activity or single agricultural crop, or reliance on barter rather than cash transactions may pose problems. The presence of hyperinflation, or absence of law and order may stress the ability of microfinance to operate.  Microcredit is also much more difficult when laws and regulations create significant barriers to the sustainability of microfinance providers (for example, by mandating interest-rate caps).

However, strong and innovative microfinance providers are able to operate even in extremely challenging circumstances. These providers uphold two prerequisites of successful microcredit: discipline˜both for clients (timely repayment) and institutions (business practices that lead to sustainability); and no subsidization of interest rates.

Examples of Alternative Strategies

Savings can benefit people in many of the situations unsuitable for microcredit outlined above, if savings can be protected against losses. For example, after war or other conflicts, people rapidly want to begin saving small amounts of cash so that in the future they can buy more productive assets. Savings facilities also provide a means to reduce vulnerability by managing risk and cash flow.  The product range, information systems, physical infrastructure, and lending capacity (for intermediating the savings collected) of regulated financial institutions may need to be strengthened in order to provide well-designed and secure deposit services to the poor. Non-regulated institutions, at the same time, may first need to transition to a regulated legal form in order to be allowed to offer deposits to the public.

Financial entitlements, such as termination payments and one-time grants, are often more suitable for immediate post-crisis situations, as well as for assisting the chronically poor, retrenched workers, and high-risk groups with little work experience.

Safety-net grants can provide a temporary solution to people hit by crisis. Displaced persons during or immediately following a conflict or those affected by natural disasters, such as earthquakes and floods, may be better suited for targeted "safety-net" grants that enable them to rebuild their livelihoods and replace lost assets. The alternative of providing credit to those not able to use it productively could push already vulnerable people into debt.

Grants can be used to help overcome the social isolation, lack of productive skills, and low self-confidence of the extreme poor, and to prepare them for eventual use of microcredit. Small grants and other financial entitlements can work well as first steps to "graduate" the poor from vulnerability to economic self-sufficiency.  A successful example is the BRAC Income Generation for Vulnerable Groups Development program in Bangladesh.  This program has graduated more than 660,000 destitute women through free food, training, health care, and savings to BRAC‚s mainstream microcredit program.

Investments in infrastructure, such as roads, communications, and education, provide a foundation for economic activities. Community-level investments in commercial or productive infrastructure (such as market centers or small-scale irrigation schemes) also facilitate business activity.

Employment programs prepare the poor for self-employment. Food-for-work programs and public works projects fit this model. In many cases, these programs may be out of reach for cash-strapped local governments but within the purview of donors.

Non-financial services range from literacy classes and community development to market-based business-development services.  While non-financial services should be provided by separate institutional providers, there are clear, complementary links with the demand for and impact of microcredit. For example, improved access to market opportunities stimulates˜and depends on˜securing credit to cover the costs (product design, transport, etc.) of taking advantage of those opportunities.

Legal and institutional reforms can create incentives for microfinance by improving the operating environment for both microfinance providers and their clients. For example, streamlining microenterprise registration, abolishing caps on interest rates, loosening regulations governing non-mortgage collateral, strengthening the judicial system, and reducing the cost and time of property and asset registration can foster a supportive climate for microfinance.

Recommended Reading

W. Brown and G. Nagarajan, Bangladeshi Experience in Adapting Financial Services to Cope with Floods:  Implications for the Microfinance Industry (Washington D.C.: USAID Microenterprise Best Practices Project, August 2000).

Committee of Donor Agencies for Small Enterprise Development, Business Development Services for Small Enterprises: Guiding Principles for Donor Intervention (Washington, D.C.: The World Bank, Small Business Enterprises, February 2001).

C. Dunford, Building Better Lives:  Sustainable Integration of Microfinance with Education in Health, Family Planning, and HIV/AIDS Prevention for the Poorest Entrepreneurs (Washington, D.C.:  Microcredit Summit, 2001).

Syed Hashemi, with assistance from Maya Tudor and Zakir Hossain, CGAP Focus Note No. 21: Linking Microfinance and Safety-Net Programs to Include the Poorest: The Case of IGVGD in Bangladesh (Washington, D.C.: CGAP, May 2001).

Joan Parker and Doug Pearce, CGAP Focus Note No. 20: Microfinance, Grants, and Non-Financial Responses to Poverty Reduction:  Where Does Microcredit Fit? (Washington, D.C.: CGAP, May 2001).

Joan Parker, Microfinance and HIV/AIDS (Bethesda, MD: Microenterprise Best Practices Project, Development Alternatives, USAID, 2000). 

Tamsin Wilson, Microfinance during and after Armed Conflict: Lessons from Angola, Cambodia, Mozambique, and Rwanda (Durham, U.K.: Concern Worldwide/Springfield Centre for Business in Development/Concern Worldwide, DFID, 2001).