Since coming into the spotlight in the early 1980s, microfinance has undeniably grown into a sizeable global industry estimated to exceed $180 billion USD and serve about 200 million customers. Over this decades-long trajectory, microfinance institutions have achieved financial sustainability; they have diversified their offering beyond credit while serving many customer segments, and industry leaders have embraced the digital age. This evolution has captivated the financial inclusion community in many ways (see for example Brookings Institute review of the state of the industry) but none so much as what such changes have meant for the poorest customers the industry intends to serve.
Two stubbornly unresolved debates keep casting doubt on how much benefit microfinance brings to its customers and fuel what seems like a never-ending cycle of support and criticism for the industry. Here, we propose ways to resolve persistent knowledge gaps that perpetuate these debates about microfinance, which are also relevant for the broader financial inclusion community.
The first debate relates to the impact that microfinance has on its customers. And the second —closely related to the first— revolves around customer protection. The nature of these debates over time says a lot about what the microfinance industry needs to tackle to understand and build consensus on how to better serve its customers.
Making sense of the existing impact evidence
The impact debate has consistently been hijacked by a focus on credit, despite microfinance today being about a broader suite of financial services. Early quarrels on the impact of microcredit revolved around a study in Bangladesh done by Pitt and Khandker in 1998, which showed microcredit received by women led to increased household consumption. This was considered sound evidence of the positive impact microfinance can have. However, the study was followed by a refutation from Jonathan Morduch claiming the research method used by Pitt and Khandker was flawed, and positing that microfinance smooths consumption and builds resilience – a slightly different kind of impact but positive nonetheless. This debate led to a series of replies and counter-replies focused on the accuracy of impact measurement – rather than the reasons for impact and related policy implications – that lasted for over a decade and were ultimately addressed by the rise of randomized control trials (RCTs) in the early 2000s. RCTs were able to more accurately measure the sign and magnitude of the impact of microcredit — as well as that of other microfinance services like savings, insurance and payments.
However, despite increasing measurement accuracy, RCTs never came close to settling the impact debate. These studies showed that the same set of financial services can have a different impact depending on context. Although it’s possible to find mixed results for all types of financial services studied, the impact of credit is more disparate (i.e., can fluctuate from positive to negative) compared to the more consistently positive impact found for savings, insurance and payments, which can fluctuate from positive to neutral. These findings have been disappointing to many and led some to claim that the whole microfinance sector is flawed, lumping all financial services into one basket.
Yet again, these findings were followed by a clear refutation, this time from influential RCT critics who highlighted that the RCT methodology alone can never explain why the impact observed —positive, neutral, or negative— happens, since it does not document the dynamics that led to that result. This greatly limits the value of RCTs in informing financial development policy, as we have no generalizable idea of what conditions allow various microfinance services to have a positive rather than negative impact on different customer outcomes.
Considering all of this, we can say that microfinance services can sometimes, but not always, have positive effects on customers' lives. As mentioned, it’s possible to find reports of positive to neutral effects of savings, insurance and payments across studies, and for credit, these effects can fluctuate anywhere from positive to negative. Unfortunately, we don’t yet know exactly what makes those positive effects happen. Given these persistent unknowns, nay-sayers can find evidence to generalize microcredit’s negative impact results across the entire microfinance sector, and proponents can find support for grand claims about microfinance’s positive impacts – all of them using select RCT impact studies to support their views.
Lacking consistent enforcement of customer protection
The unanswered questions about impact have been fueled further by very shocking claims of abusive lending practices by some microfinance institutions (MFIs). This brings us to the second unresolved debate around customer protection. One of the first examples was a highly visible case a decade ago of customer over-indebtedness leading to a string of suicides in the state of Andhra Pradesh, India. Soon after these claims of abuse came to light, more representative and nuanced studies came to the defense of the microfinance sector by showing mental health, restrictive social norms and bad practices by some MFI actors as the root of such events.
Since then, every few years, customer protection issues return to the spotlight. Very recently, Bloomberg’s Gavin Finch and David Kocieniewski painted a harsh picture of microfinance in Cambodia and Sri Lanka based on reports of abusive microcredit. It illustrated how in the absence of appropriate consumer protection regulation and supervision, abuses occur. To give a sense of rigor and given the limited evidence available to quantify how widespread these abuses actually are, the Bloomberg authors cited only microcredit impact studies showing no positive impact on customers, without citing those that show the benefits microcredit can have.
As expected, the anecdotal customer evidence the article presents was quickly dismissed by groups that support microfinance, like 60 decibels, a market research firm, that recently started to systematically collect cross-country and self-reported views from 18,000 microcredit users. They are finding a relatively positive picture of how microcredit benefits its customers, with 70% of those interviewed reporting improved financial resilience and 75% saying repayment is not a problem. Only 6% report repayment as a heavy burden.
All the while, these debates are happening around an industry that has changed profoundly since its beginnings. As the range of microfinance providers has multiplied, the industry has gone from consisting primarily of financial cooperatives and narrowly focused, highly subsidized NGOs in its beginnings, to a thriving microfinance sector that includes regulated deposit-taking institutions, specialized banks, nonbank finance companies, fintechs and other providers with a spectrum between social and commercial objectives. The conditions in which microfinance services are offered to customers are not always uniform – based on the type of institution and range of services offered, different providers can be subject to different regulations within the same market, and consumer protection rules are not always enforced consistently by varying supervisory agencies. Regulatory compliance can also place an undue burden on providers, particularly small ones. These regulatory issues have a direct bearing on the degree to which the microfinance sector is held to account for delivering responsible services to its customers and creating a positive impact.
Proposing a way forward
What can we conclude from all of this? These long-standing debates reveal a need for collective action in the microfinance and financial inclusion communities on the following three fronts:
First, there is a need for more countries to adopt customer protection frameworks seeking improved financial health and customer outcomes within their financial regulation and market conduct supervision models.
Despite significant progress made to date (see for example SPTF), there are still too many countries that do not apply these frameworks or at best leave them to be self-enforced by industry groups. To address this, regulation and supervision should incorporate guidelines on data protection and privacy safeguards; mainstream product suitability, customer financial capability and transparency assessments; and ensure the availability of recourse mechanisms to monitor and quantify abuse trends and develop early warning systems, like this example from the Philippines.
Without such progress, the microfinance and financial inclusion community will remain unable to quantify claims of abuse. Worse, anecdotal claims can become the main force driving policies and regulations without a more nuanced understanding of their incidence on the ground. This can lead to ill-informed policies and regulations that cause net harm to communities or sectors of customers because they restrict the provision of services that would otherwise benefit many.
Second, regulators should adopt activity-based approaches to regulating microfinance that apply a consistent customer protection framework to the increasingly diverse types of companies providing microloans.
Regulatory frameworks for market conduct need to be applied with a much broader scope than those typically applied by prudential regulators who set their focus on safety, soundness and systemic risks. These regulatory frameworks should also emphasize proportionality, striking an adequate balance between the benefits of reducing risks and the costs of compliance. Additionally, the various government entities setting and enforcing MFIs’ consumer protection rules should apply a common set of regulatory and supervisory principles and practices to avoid arbitration and gaps in the market. This would help enforce customer protection frameworks more evenly across various types of MFIs.
Third, despite countless studies on the impact of various microfinance services, there should be concerted efforts between the industry, researchers and the funder community to strengthen the impact evidence base by scaling a new generation of studies that can help put together a more accurate narrative of what microfinance can do for people.
Previous CGAP work (see here and here) shows this new type of mixed-methods technique already exists and provides insights on when, how and for whom different financial services can strengthen people’s resilience and ability to take advantage of investment opportunities. With results from this new type of study, it will be possible to refine a more holistic and accurate impact narrative.
For example, these new studies could help determine if positive credit impacts are associated with contextual factors like proximity to a feeder road or market, high school education or vocational training, or certain features of the credit product and the organization providing it. Understanding these connections would be very useful for policy design. However, these studies would need to be scaled across a wider set of countries and customer segments to be able to distinguish more generalizable circumstances in which various microfinance services can help poor people improve their well-being and avoid negative outcomes. Without this, it won’t be possible to design more effective financial development interventions that are a core component of any socio-economic development agenda today.
Advances on these three fronts would certainly help all stakeholders build consensus on how to improve the value that microfinance —and financial services in general, for that matter— offer to poor people. Not least, they would help the financial inclusion community focus its efforts on advancing knowledge and positive solutions rather than on endless debates full of contradicting and misleading assertions in favor of, or against, microfinance.
As CGAP embarks on its new strategy, consumer protection and the impact of financial services will remain a priority, and we will work with partners to ensure better and broader implementation of related good practices in the larger financial sector.