Since microcredit first came to public attention in the 1980′s, the usual story line has been that it funds creation and expansion of microenterprises, producing additional income that lifts the borrowers’ households out of poverty. But is it true?
It has been clear for some years now that many–sometimes most–microborrowers in fact use their loan proceeds for non-business purposes. Recent analysis has cast doubt on some of the older research studies that found that microcredit increases household income. A new generation of more rigorous randomized studies is now in the works. The first two of them to be published have not found evidence that microcredit raised household income and consumption, at least over the 1-1.5 year term of the studies. Does this mean that microcredit might have been a bad idea all these years? I’ve just drafted a brief paper on this question. The paper should be available in a month or two, but in the meantime let me trot out its core arguments.
I think an honest appraisal of the current state of the evidence is that we simply do not know whether microcredit raises incomes and consumption. If the case for microfinance depended on whether it was lifting people out of poverty, then the appropriate response right now would probably be to declare a moratorium on support for microfinance until further research clarifies this question more.
I’ve worked in microfinance for over a quarter of a century, and I’ve always been agnostic about whether microcredit raises incomes. But I’m pretty sure that it does some other things that are very important to poor people, helping them to cope with poverty whether or not it helps them escape poverty. These other benefits are described compellingly in the brilliant new book Portfolios of the Poor by Daryl Collins et al., which gives a high-resolution picture of how low-income households actually use financial services, based on hundreds of 18-month-long financial diaries in three countries. Portfolios points out that the problem with being poor is not just that income is low, but also that it tends to be uneven and vulnerable to disruption. Given the variability and vulnerability of their income, poor households have to save and borrow constantly (more so than richer households) in order to put food on the table and meet other consumption needs. The informal credit and savings mechanisms they have tend to be unreliable. They value formal microfinance highly because it is more reliable, even if it is often less flexible than their other tools to manage their cash flow.
When we hear that microcredit may not lift people out of poverty, we tend to be disappointed, and regard consumption-smoothing as a “mere palliative.” But we react this way only because our own basic consumption needs are seldom if ever threatened. As Portfolios demonstrates, poor people see it very differently.
I think there is strong evidence that poor people find microcredit very valuable in helping to deal with their circumstances. When you offer microcredit in a new setting, you almost never have to advertise: customers come out of the woodwork in droves. Most of them come back for additional loans. Most important, they usually repay those loans at extremely high rates year after year, when the main motive to repay is not collateral or group pressure, but rather their desire to keep future access to a service they find very helpful. They are voting with their feet.
But does microcredit hurt a lot of poor people by over-indebting them? We need more work on this question, but I think the general answer is very probably no. When a lender is over-indebting a lot of borrowers in a bad situation, sooner or later it will show up high default rates, just as it did in the current financial crisis. But the predominant pattern is that the vast majority of microborrowers repay at very high levels year after year.
When all is said and done, a year of microcredit probably doesn’t help poor people as much as a year of girls’ primary education (for instance). The value proposition of microcredit, and microfinance more generally, is that each “dose” costs far less. Education, health, and many other social services require large subsidies year after year. When microfinance is done right–and only when it’s done right–small one-time initial subsidies can generate service delivery to very large numbers of people year after year. Not only is no further subsidy needed, but microfinance providers can leverage their initial subsidies with very large multiples of commercial funds. This is not a pipe dream–it’s happening already in dozens, even hundreds, of cases all over the world. For instance, BancoSol in Bolivia represents a few million dollars of donor subsidies in the mid-1990s that have turned into $200 million of loan portfolio and services for 300,000 active savers and borrowers as of the end of 2008. Whether donors and other public funders now lose interest in microfinance is pretty much irrelevant to such MFIs.
For me, this is the strong value proposition of microfinance. The benefits of each dose may turn out to be more modest than some have claimed, but poor people really value those doses, and you can buy an awful lot of them with relatively little subsidy. We certainly need further research on the nature and extent of benefits of microfinance, but I think it’s a very good bet that the observed behavior of millions of microborrowers is telling us that those benefits more than justify the investment.
What if microcredit was used to develop an asset; one that in itself because of its very nature makes the owner wealthier. I think the less discussed aspect of housing microfinance falls here. In my mind the odds are much much higher for it to really help people.
Mr. Rosenberg. You write , “When you offer microcredit in a new setting, you almost never have to advertise: customers come out of the woodwork in droves. Most of them come back for additional loans.” I haven’t seen data that directly addresses the degree to which microfinance clients return for additional loans. Is there any data/research you can point me to on this issue? Thanks.
Richard’s queries on micro credit are candid and refreshing too albeit a belated one. However they provoke me to probe on certain fundamentals of micro credit , the fact ignored or neglected in the past by the proponents of Micro finance.. Unless these fundamentals, as referred below, are better appreciated, candid answers to his queries would be difficult to be honest..
MF Data ‘prima facie’ shows that millions of micro borrowers are benefited and also appear to justify the investment.. But basically who are they? Do they include the poorest, marginalized and vulnerable? Do they belong to only creamy layer having some wherewithal and skill for income generation in the poverty segment? While this section of the poor who are capable of making positive impact from micro credit also need to be covered, will too much focus on them lead to widening the equity gap even among the poor community ? Do MF data (MIX) include non poor also? Does the poor find MFI system as reliable as formal one? Does MF suffer ethically? How long the poorest have to wait for ‘inclusion’? If MF system failed to rope them in , is there any other alternative one for the said purpose? Any identity crisis?
Are we well placed in the trajectory for uplifting the poorest on one hand and for halving the number of the poor people through MF platform in terms of MDG goals? Is the present performance in MF sector of any indication of candid progress in the battle against poverty? In the context of presence of ‘inequity’ base reflected in the ‘profile of the poor’ in terms of economic disparities, social inequalities , variable physical capabilities (A.Sen), highly susceptible to vulnerability within the poor people given in any area/region, can a single input ‘micro credit alone ‘ that too highly structured, do the ;magic’(income generation) in the so called Micro finance game? Does mere accessibility to finance, guarantee the expected impact? When we universally recognized both the various financial and non financial needs ( capacity building, backward and forward linkages provided either by the same or some other institutions mainly for enhancing the productivity of credit) of the poor, do the MF players ensure supply of all the above inputs for a sustainable jump over the poverty canvas.? What does specifically signify the word ‘ Micro’ prefixed to credit or finance? What makes subtle difference between micro finance or micro credit and bank credit or informal credit for that matter? Is it an ‘ old wine in a new bottle’ ?Does micro credit lending through MFI represent another mode of usury? What is the difference between Micro finance and Micro credit? Is the credit is misused under the popular brand name ‘Micro finance? Any conceptual crisis? ( for clarity on the MF concept: my posting in the BLOG as responses – Change, Growing gone…., What is Micorfinance? The New Micro finance? )
When the portfolio of the poor portrays different socio economic layers among the poor and varied priorities, is it not necessary for designing product differentiation and sequencing the MF inputs ( micro insurance, capacity building, micro savings, micro credit etc.) matching to their needs? In the context of over consumption smoothing ( conspicuous consumption) multiple borrowing and debt trap in the poverty sector ‘Is micro credit a ‘forbidden apple’? Does group system for micro financing facilitate for inclusion or exclusion of the poorest? Why Micro Insurance , an important component of MF having potential values in the process of poverty reduction, remain ‘ Cinderella ? Do Investors / Creditors/ MFIs find the poor as lucrative market ‘niche’ for their commercial lending business at a high social and ethical cost? Does higher repayment year after year mean more number of poor raising above poverty line? MFI turned NGOs were able to make significant social and economic impact of the poor earlier as NGO playing as intermediary role in Micro financing .and gained popularity among the poor community. But after becoming MFI, they are tied up more with financial engineering than social engineering and lost the popularity. Is the fact true?
Further research is needed to find out with more focus on ‘who are exactly benefited within the poor segment ? and how to include the poorest or marginalized or ultra poor and sequence the needed inputs strategically for them ,? than on the nature and extent of micro finance? While we had enough on the technicalities of funding /delivery /supply mechanism lacking adoptability and adjustment and adherence. in the context of variability and vulnerability of the poor, it is high time to probe How to deliver the integrated MF inputs ( not MC alone) to the bottom layer of the poor by the same institution or some others institution jointly ?
Finally, there is a wide gap between the concept and practice in MF arena. If the present functioning of MF system fail to help really the poor, can we contemplate a ‘ denonvo’ conceptualization of MF for the exclusive coverage of the poorest ?
Impact of micro-finance on income depends on a number of factors. When income generating activities are undertaken with marketing support (in case of production activities, chances of getting higher income also increase and their moving out of poverty. But, in a country like India, there are still a very large segment of poor, particularly rural poor, do not have access to savings and credit services from the formal financial institutions. They also have propensity to save in the form of thrift (by foregoing certain expenditure. Their desire to save has been recognised by micro-finance and not by any other strategies. Using micro-finance, thanks to servicces of organisations like CGAP, has become a strategy for governments to provide basic financial services to the poor through the formal financial institutions. In that respect, contribution of micro-finance for the overall welfare of the poor is significant.
sorry sir micro finance and micro credit difference concept still i can not understand but if u tell me about that and clear my concept than i shall be thakfull.
regards umar shahzad
Micro finance is broad concept. It includes small financial services provided by the bank to the needy peoples. e.g. Small loan, small deposits, micro insurance, technical services etc.and micro credit is the small loan granted by the bank to the needy people. micro credit is one activity of micro finance.
The rates of markup on finances charged by the Micro finance Banks are on the higher side as compared to those charged by Commercial Banks . In my opinion to eliminate the poverty these rates should be rational and affordable to the poor people.
Microcredit is good for the lesser off segments only if issues highlighted by writers here can be put into consideration. Credit requires that the borrower understands that borrowed funds are repaid with interest and the ideal situation would be to engage in activities that generate both the interest and some profit in order to add value. If the purpose for which credit is used is to acquire an asset then this would mean that there is another source to support repayment. This other source need not disrupt the comfort of the household. Consequently there is need to understand the cost of credit vis a vis its use. Most of the credit given to the target segment is used to finance saturated business activities whose margin of return is far less than what is charged on the borrowed funds, the outcome is a deficit, pushing the borrower further into debt and in effect making him poorer. Once one is in this predicament, there is the temptation of seeking more credit from other faster sources like the Shylock, sources known for exorbitant interest rates. The expensive credit is used to settle the original debt and the cycle continues. Besides giving credit to the lesser off segments, institutions should consider financial knowledge and advise on cutting edge engagements that can guarantee added value for credit. Models for availing these finances need to be tailor made to get rid of additional costs even if it requires policy interventions so that interest rates charged can come down. It is defeatist when interest is based on perceived risk of the borrower and not the ability to repay particularly when dealing with populations with limited alternatives as a result of compounded exclusions.
Explain with 5 reasons why you think microfinance can contribute to poverty reduction.
Microfinance is the single biggest lie of this century 90% of loans are nonproductive (not invested in the business) usually used to cover household income shortfalls bills, food, healthcare, education costs etc. Microcredit leaves people over indebted and usually in worse shape than when they started and in some cases that MFIs give as an example of success, the person (usually unemployed) starts a very small business with the highest loan cost ever to barely cover his living expenses. If their success example are cases of masked unemployment at best, I hate to imagine their failure stories.
Let us not kid ourselves, microcredit is a tool to suck the blood of the poor by selling them the illusions of becoming a self-employed entrepreneur and peddling unaffordable debt services just so the microcredit financiers can increase their wealth in the shortest time possible. Therefore, I fail to see how by sucking millions of dollars from the impoverished communities they help achieve their goals of poverty alleviation and reducing unemployment rates.
If they really wanted to help why not open factories or big businesses with the same investment and provide jobs and steady income to the poor. When did governments stop doing their job and left their responsibilities for MFIs? Did the government privatize socio-economic development?
Microfinance institution are simply the modern version of loan sharks. They polished their image with fictional goals like decreasing unemployment, poverty alleviation, financial inclusion, Double bottom line (socio-economic development), women empowerment so on and so forth.
Microcredit is really a very useful development tool but gradually it is be coming less productive because converting into commercialize mode of investment.The most of microcredit providers have reshuffled their attention towards profitability instead of poverty alleviation. The track can be make right through to adopt proper way of micro financing
1- To hire staff whose are not bankers but have ability to mobilize the poor through social techniques
2- Proper identification of areas which are not only having poor household but also willingness to uplift their quality of life.
3- Indemnification of Micro Invest Plan through social guidance
4- Initial assessment and training
5- effective and less complex microcredit delivering mechanism.
6- Proper linkages for business productivity
7- Repayment behaviors
Little correlation between demand and social usefulness, or so it seems to me. There is huge demand for alcohol, cigarets, commercial sex, and consumer credit. I am generally a libertarian, and I suspect there is more to lose than to gain in trying to prohibit these things. But that doesn't make them suitable objects for donor subsidy or promotion. The case for microcredit needs to rest on a firmer foundation than simply the fact (which I have observed close up) that there is great demand for small loans.