The myth of microfinance is powerful. The idea that providing small loans to people in poverty will alleviate their conditions both satisfies our longing to be more altruistic and appeals directly to our belief in “old-fashioned hard work.” Vowing to promote gender equality worldwide, the myth arouses our passion for social justice. Perhaps most powerfully, its guarantee that the fight against global poverty can be won in such a simple manner appeals to our desire for neat solutions and makes an overwhelming problem seem like a manageable issue.
The appeal of the myth has led to widespread support for microfinance – so much support, in fact, that the United Nations declared 2005 the International Year of Microcredit and Muhammad Yunus, a pioneer of microcredit, was awarded the Nobel Peace Prize in 2006.
The problem is that the myth is just that: a myth.
To understand the myth’s falsities and to salvage its truths, we first have to define microfinance and microcredit. While commonly confused, the two concepts are distinct: microfinance refers to financial services, ranging from loans to savings accounts, which are provided to under-resourced people in poverty. Microcredit is a component of microfinance, referring specifically to the extension of small loans to poor entrepreneurs and small business owners. These borrowers typically lack collateral, stable employment, and credit history. The hope is that the borrowers, who are overwhelmingly women, will use their microloans to begin or expand profitable enterprises such as farming, weaving, or holding livestock. Both microfinance and microcredit aim to promote financial inclusion by providing quality financial services to impoverished communities.
Like all myths, the image of microfinance has deep, historical roots. From the Star-Bowkett Society[1] to Friedrich Wilhelm Raiffeisen,[2] capitalist visionaries have provided financial opportunities to poor people for centuries. The modern conception of microfinance, however, was largely crafted by Yunus’ establishment of the Grameen Bank in Bangladesh in 1983. Since the creation of Grameen Bank, more than 3,000 other institutions have emerged to provide services to the poor around the world.[3] Some of the most financially successful microcredit institutions include the Brazilian Banco do Nordeste, the Microcredit Foundation of India, and the Moroccan FONDEP Micro-Credit.[4]
Soon after its inception, the microfinance industry experienced impressive growth. The number of borrowers from Grameen Bank, for example, grew from 15,000 in 1980 to almost 100,000 by 1984,[5] and by 2011, the bank’s membership stood at an astonishing 8.4 million borrowers.[6] Recent estimates suggest that the wider microfinance industry has reached approximately 130 million clients over the past 15 years.[7] Of interest is the fact that the rise in the number of microloans has not severely decreased repayment rates; even today, the Grameen Bank, a major microcredit bank, reports that repayment rates have remained between 95-98% for decades. Other financial services, such as savings accounts, have also expanded; in Bangladesh, group savings have reached 7,853 million taka (approximately USD 162 million).[8]
The ostensible success of the microfinance industry extends beyond financial figures – supporters of the current microfinance regime have insisted that microfinance promotes gender equality around the world through its serving a majority female client base. For example, loans to women worldwide make up more than 90% of the microfinance savings in the Grameen Bank, and more than 94% of the banks’ borrowers are women.[9] The Grameen Bank is not alone in its commitment to low income women; banks and NGOs such as BancoSol, WWB, and Pro Mujer cater exclusively to women.[10] Today, women compose seventy-five percent of all worldwide microcredit recipients.[11]
Using these figures, supporters of the current model have effectively constructed an image of the industry as a way to both foster global economic development and empower women worldwide. Its image is, in many ways, a shield for the industry; after all, it’s difficult to denounce a technique that seems to provide opportunities for millions of intelligent, motivated women to escape poverty.
The myth is so powerful because we want to believe it. We want microfinance to work. We want to think that a simple distribution of $100 loans will make the world a better, fairer place. That’s why when you ask an average person what they think about microfinance, you’re likely to get a positive response – few people examine the myth.
Unfortunately, upon further analysis, a much darker picture of microfinance emerges. As humanitarians, politicians, economists, and celebrities glorified the industry in the 2000s, some researchers began to conduct studies to measure the industry’s exact impact on poverty alleviation. Their results stand in direct opposition to the dominant narrative of microfinance as poverty panacea.
Esther Duflo, Professor of Poverty Alleviation and Development Economics at the Massachusetts Institute of Technology, conducted the first randomized study of microcredit, and ultimately concluded that microcredit had no effect on household expenditure, gender equity, education or health.[12] Milford Bateman, an economic development consultant and professor, stated that research on microfinance programs in India found that, on average, “only 1 per cent of microenterprises were still in operation three years after their establishment.”[13] After reviewing 58 papers on microcredit, a report from the University of London concluded that “there is no good evidence for the beneficent impact of microfinance on the well-being of poor people” and that “the greatest impacts are reported by studies with the weakest designs.”[14]
In other words, research indicated that microfinance was not actually helping anyone. The truth, however, was much darker than this. Microfinance wasn’t just ineffective – it was also lethal.
“When a business venture fails,” Bateman explained, “the microloan still has to be repaid, which means the poor typically have to sell off personal assets (including land), savings have to be drawn down, relatives are tapped for their support and other income flows (especially remittances) are diverted into loan repayment.” [15] Many impoverished borrowers end up defaulting on their loans, and tragically, as a result, the industry has reportedly caused a suicide epidemic in multiple poor nations around the world. In India, Bangladesh, and other nations, hundreds of people, most of them women, have taken their lives after defaulting on their microloans.[16][17]
The overwhelming evidence against microfinance, and more specifically microcredit, begs the question: why are millions of people still taking out microloans, and who is actually benefitting from this institution?
The driving force behind the continued expansion of microfinance is simple – microfinance is profitable. Acknowledging the faults of the industry he pioneered, Yunus explains that “troubles with microcredit began around 2005 when many lenders started looking for ways to make a profit on the loans by shifting their status as nonprofit organizations to commercial enterprises.”[18] Understanding the desperation of these poor communities, many microcredit institutions know that they can charge ludicrously high interest rates to maximize profit for their shareholders.
In 2010, for example, the average microloan interest rate in Mexico was around 70% and stood at about 37% globally.[19] To put those numbers into perspective, Microrate, an independent rating agency, states that any firm charging interest rates of 20-30% is “unconscionable;” Yunus asserted that charging interest rates above 15% of the cost of raising money constituted loan sharking.[20] Yet, an analysis of over 1,000 microlenders revealed that approximately 75% of microfinance institutions would fall into Yunus’ “red zone.”[21]
Despite its deep flaws there is hope for the microfinance industry, provided certain steps are taken. In order to realize the industry’s original dream – the alleviation of global poverty –three reforms must be concurrently initiated.
First, countries around the world must develop advanced, comprehensive microfinance regulatory industries. While critics may denounce such action as inherently opposed to capitalism, quite the opposite is true; Azish Filabi, CEO of Ethical Systems at New York University Stern School of Business, explains that “for free market competition to work effectively, the borrower needs to receive the price per unit to be able to compare offers. In the case of loan pricing, however, discerning what is a ‘unit’ price for a loan involves difficult mathematics.” Predictably, lenders rarely disclose and explain the complexities of loan pricing. They have little incentive to offer a transparently-priced product to their clients because such action would make their clients move to less transparent competitors; thus, third party regulation, usually in the form of government oversight, is necessary.
Secondly, philanthropists and development agencies should concentrate on funding nonprofit microcredit institutions that have remained mostly true to the approach’s original goal of economic development rather than “financial inclusion.” 50/50, a nonprofit with 501(c)3 status, provides a good example: half of their microloans are in the form of an interest-free loan and the other half are grants, with no expectation of repayment. Rather than simply providing predatory loans with no support structures, 50/50 helps entrepreneurs identify viable business ideas, determines the resources necessary to begin, and provides business training to each of their clients. They minimize costs by employing an all-volunteer staff and ensuring complete transparency. Such organizations need to be properly funded and fostered for microfinance to flourish as a truly humanitarian institution.
Finally, while microfinance institutions have largely concentrated on offering microcredit, they should instead refocus their efforts on creating financial services beyond loans, such as savings accounts or insurance plans. Compartamos Bancos, a microfinance institution in Mexico, offers a model for this shift: in addition to offering microcredit loans, the institution ranks among the country’s largest life insurers.[22]
These shifts may just be enough to save the dream of Yunus and many other microfinance pioneers. However, if microfinance is to survive, the myth surrounding the industry must be critically examined and steps must be taken to address problems currently plaguing the global microfinance community.
Footnotes
[1] Darnell, Maxine. The Alternative Building Society – Starr-Bowkett Societies: function, growth and operation. Presented at Asia Pacific Economic and Business History Conference, Sydney, 12–14 February 2007.
[2] “Raiffeisen, Friedrich Wilhelm”. Encyclopedia Americana. 1920.
[3] Gibbs, Walter. “Nobel Peace Prize Winner Will Urge Banks to Lend to the Poor.” The New York Times, December 10, 2006. http://www.nytimes.com/2006/12/10/world/asia/10nobel.ready.html.
[4] Swibel, Matthew. “The Top 50 Microfinance Institutions.” Forbes, December 20, 2007. http://www.forbes.com/2007/12/20/microfinance-philanthropy-credit bizcz_ms_1220microfinance_table.html.
[5] Grameen Bank. “Breaking the vicious cycle of poverty through microcredit.” http://www.grameen.com/breaking the-cycle-of-proverty/.
[6] Grameen Bank at a Glance”. Grameen Communications. Retrieved 2009-07-07.
[7]International Finance Corporation, World Bank Group. “Microfinance” http://www.ifc.org/wps/wcm/connect/Industry_EXT_Content/IFC_External_Corporate_Site/Industries/Fi ancial+Markets/MSME+Finance/Microfinance/.
[8] See footnote 5.
[9] See footnote 5.
[10] Armendariz, Beatriz (2005). The Economics of Microfinance. Cambridge, Mass: The MIT Press.
[11] See footnote 10.
[12] Banerjee, Abhijit; Esther Duflo; Rachel Glennester; Cynthia Kinnan. “The miracle of microfinance? Evidence from a randomized evaluation”. Retrieved 17 April 2012.
[13] Bateman, Milford. “The Illusion of Poverty Reduction.” Red Pepper, September 2010. http://www.redpepper.org.uk/the-illusion-of-poverty-reduction/.
[14] Duvendack M, Palmer-Jones R, Copestake JG, Hooper L, Loke Y, Rao N (2011). What is the evidence of the impact of microfinance on the well-being of poor people?. London: EPPI-Centre, Social Science Research Unit, Institute of Education, University of London. ISBN 978-1-907345-19-7.
[15] See footnote 13.
[16] AP. “Hundreds Of Suicides In India Linked To Microfinance Organizations.” Business Insider, February 24, 2012. http://www.businessinsider.com/hundreds-of-suicides-in-india-linked-to-microfinance-organizations 2012-2.
[17] Melik, James. “Microcredit ‘Death Trap’ for Bangladesh’s Poor.” BBC News, November 10, 2003. http://www.bbc.co.uk/news/mobile/business-11664632.
[18] Yunus, Muhammad. “Sacrificing Microcredit for Megaprofits.” The New York Times, January 14, 2011. http://www.nytimes.com/2011/01/15/opinion/15yunus.html.
[19] MacFarquhar, Neil. “Banks Making Big Profits From Tiny Loans.” The New York Times, April 13, 2010. http://www.nytimes.com/2010/04/14/world/14microfinance.html?pagewanted=all.
[20] See footnote 17.
[21] See footnote 17.
[22] Roodman, David. “Microcredit Doesn’t End Poverty, despite All the Hype.” The Washington Post, March 10, 2012. https://www.washingtonpost.com/opinions/microcredit-doesn’t end-poverty-despite-all-the hype/2012/01/20/gIQAtrfqzR_story.html?utm_term=.711c193b6257.