Few words are as polarizing in the financial inclusion community as “impact.” While everybody desires impact, we can’t seem to agree on what we mean by it, on methods to measure it, or on how to proceed when we don’t find evidence of it. Nowhere is this clearer than in debates about financial services for micro and small enterprises (MSEs).
Conversations about the impact of MSE finance have quieted down over the past five years for at least three reasons. First, COVID-19 unleashed significant uncertainty on financial service providers and crippling economic shocks on their customers, especially the poor. The survival of financial services providers and their low-income customers became a more pressing concern for the financial inclusion community than longer-term impact. Second, the last wave of impact evaluations found that access to finance had only modest and mixed impacts on MSEs; the financial inclusion community's great expectations of an escape from poverty were woefully unmet. Third, the hype around digital technology’s ability to scale financial inclusion has led many in development to accept “potential to scale” as evidence of impact for newer financial solutions.
But before we move on from MSE finance, it’s important to take stock of, contextualize and understand the available impact evidence. As part of CGAP’s new framework focused on ensuring financial services meet poor people’s needs, we are studying how access to finance for MSEs in the digital age can help improve the livelihoods of people with low incomes. In this project, we will revisit prior assumptions and examine whether there’s a compelling narrative about how access to finance can benefit MSEs.
To that end, we surveyed the existing evidence base and identified knowledge gaps that underscore why it will be important for researchers and donors to continue researching the impact of MSE finance, rather than move on from it.
MSE finance is so much more than microcredit
Much of what we know today about the impacts of access to finance for MSEs comes from evaluations of the first-generation, Grameen-style microcredit programs — programs characterized by group loans, joint liability, high-touch delivery and loan sizes often less than $1,000. In these evaluations, the one-person microenterprise is the unit of analysis.
The results of these evaluations led to several heated debates in the academic community, but they all had an overarching message: microcredit has little impact on the average borrower, although some borrowers, especially those with prior experience of running enterprises, accrue large gains. These evaluations also found that, despite the fears of critics, these programs did not systematically harm borrowers by trapping them in debt.
Without getting caught in these impact debates, it is important to step back and point out that microcredit is just one of the several sources of finance for MSEs. Similarly, one-person enterprises are just one type of MSE, though admittedly the bulk of all MSEs. Evaluations of other types of MSE finance are few and far between.
Examples of other types of MSE finance include individual liability microcredit models; traditional sources of finance like working capital loans, trade credit, invoice discounting and factoring; and digitally enabled sources of finance like merchant cash advances or digital credit. Research on firm-level impacts is also scarce, especially on MSEs with 5 to 19 employees, which account for nearly half of all jobs created in developing countries.
Randomized control trials (RCTs) are great, but they’re not the only way to demonstrate impact
The existing evidence base largely rests on the results of RCTs, which are large, expensive studies with narrow impact hypotheses, usually involving long time horizons to detect effects.
A lot has been written about the promises and pitfalls of RCTs. Even in the MSE finance realm, RCTs suffer from drawbacks like low take-up rates, high drop-out rates, small sample sizes, lack of a standardized research design and so on, which makes it hard to meaningfully interpret or compare findings. The problem is further compounded when funders and practitioners are not vigilant while extrapolating results across contexts and begin to rely only on RCTs as evidence of impact.
A global view on the impact of MSE finance can’t be developed based solely on RCTs. We need other types of evidence to test broader hypotheses, including non/quasi-experimental quantitative methods, qualitative methods like ethnography, case studies and provider-led social performance reports, to complete the picture.
The evidence base misses important geographies, notably in Latin America and the Caribbean
Impact evidence on MSE finance covers only about 20 countries, mostly in South Asia and East Africa. It misses important geographies, especially Latin America and the Caribbean (LAC). Successful microfinance models that coalesced in LAC, especially in the Andean region, are not only distinctive because of their evolutionary history and individual liability style of lending. They are also a massive market, with some 600 MFIs lending around $12 billion to over 10 million low-income borrowers. Any impact narrative of MSE finance will remain incomplete without examining these models.
Similarly, there have been many studies on India, but most are concentrated in the state of Telangana (formerly Andhra Pradesh), paying little attention to other states with competing models of their own. The evidence base needs to be wider, accommodating more diverse experiences.
We’ve barely looked beyond enterprise growth and an escape from poverty
Microfinance may not have been the silver bullet some people hoped for, but it remains relevant, serving over 140 million poor people and providing $124 billion in financing.
We now know beyond doubt that microfinance doesn’t help the average borrower escape poverty. But that doesn’t rule out other positive outcomes for the poor. Existing research reflects first-generation goals and focuses on outcomes like enterprise and income growth. Such an approach assumes that enterprise growth is desirable, inevitable and that relaxing financial constraints will lead to growth.
But experience suggests that most MSEs do not have growth ambitions, are busy subsisting, and consequently, remain small throughout their lifetime. They also face several binding constraints, and access to finance is just one of them. For the minority of entrepreneurs that actually want to expand their MSEs, growth is a worthwhile but often unrealistic goal.
For all of these different types of MSEs, it’s time we meet them where they’re at.
Existing research reflects first-generation goals and focuses on outcomes like enterprise and income growth ... But experience suggests that most MSEs do not have growth ambitions, are busy subsisting, and consequently, remain small throughout their lifetime.
There are other ways that financing MSEs might impact the livelihoods of the poor by helping them seize opportunities and become more resilient. MSE finance could conceivably help MSEs and their employees to stabilize or diversify their incomes, manage household expenses, access markets, respond to economic shocks, feel empowered and find a sense of purpose in their communities, and create jobs for other low-income people. We need to expand our notion of impact in MSE finance, and we need more evidence in support of this broader narrative.
Where do we go from here?
In the coming months, CGAP will further examine the need to update the impact narrative for MSE financing through roundtable discussions with researchers and practitioners. We have identified several directions for future research. Addressing these evidence gaps will also help donors and investors improve their impact hypotheses and support scalable MSE finance business models.
CGAP’s engagement on this issue is part of a broader investigation into the role of financial services in supporting the livelihoods of low-income households. In addition to re-examining the MSE finance impact narrative, over the next two years we plan to:
- Take a fresh look at MSEs, using an in-depth, qualitative research approach to better understand the role of financial and non-financial services in addressing the needs of select MSE segments (especially those with between 5-19 employees, and especially those owned by women). We will also look at the role these MSEs play in supporting the livelihoods of their owners and employees.
- Highlight concrete pathways for MFI digitization, providing actionable guidance for MFIs to improve the reach and quality of the financial services they provide to MSEs.
- Identify new technologies and business models, pointing to solutions that have potential to bridge the MSE finance gap and provide more and better services to the excluded and underserved MSEs that need it most.
What is ignored in this…
What is ignored in this analysis is the fact that most business finance is informal, payouts from savings circles - tandas, susus - and loans from family and friends. My students carried out studies of the role of ROSCAS in immigrant communities and found that payouts from these informal groups was the principal motor of enterprise development and housing. We also found that these informal groups were flexible and highly innovative with each group adapted to local circumstances. In poor countries hundreds of millions members of ROSCAS and it is in these informal groups that the heavy lifting of saving and lending actually occurs. CGAP should put some of its research effort into strengthening informal financial institutions and encourage the best of the leaders of these groups to share their wisdom and encourage them to train groups and the bottom of the pyramid that banks, microfinance and mobile money scarcely touches. Savings is far more important than credit in mitigating poverty and saving in informal groups or the savings groups trained by NGOs is much more effective.
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