The great Microfinance debate: Comments on the Comments, some loose ends and some new info

August 27, 2009

     By Duncan Green     

Back from Bangladesh and still processing both the real life and blog discussions on microfinance institutions (MFIs), following last week’s post and the good debate in the comments. A few final (probably…) observations:

Microcredit v Microfinance: point taken. A lot of the doubts and criticisms apply to microcredit (loans), not to the wider range of financial services (insurance, savings etc) that MFIs sometimes provide. Non-loan financial services can avoid people getting into a debt trap, and be tailored more to their individual needs. The problem here (ref Nicholas Colloff) is that the business model skews efforts towards microcredit because it is more profitable. Interesting thoughts from Suyash on how the Hyderabad experiment could have been transformed if non-credit products had been part of the package, and what looks like a fascinating microsavings project from Oxfam America, which should generate some useful research in due course (when’s that due, Jeff?). I was a bit worried about 49% rates of return in Mali though – where does that money come from? If all the capital is generated internally and members lend to each other, it must come from net borrowers in any group, right? If so, what is the equity impact – do we risk creating a new class of community loan sharks? But I don’t fully agree with Milford Bateman’s critique of Saving for Change – doesn’t what it is doing resemble the credit coops that Milton praises in China? And the planned RCT can check whether the impact is greater than merely the injection of $x into the community via the scheme.

Interest rates and equity: microcredit providers may be better than loan sharks, but they still charge a lot of interest. I’m a bit baffled by the numbers on this, to be honest: the nominal rate charged by large MFIs is 10-15%, but according to the book by QK Khan mentioned in a subsequent post, the effective rate is about 2.7 times greater, mainly because the interest repayment applies over the whole year to the full value of the loan, whereas because repayments commence immediately, the average value of the loan over the year is half the initial amount (on a one year payback schedule). If this is true, MF borrowers are paying effective interest rates of 27-41% a year, far more than commercial bank rates. This would make credit a bit like clean water – poor people in shanty towns often pay several times more for it than rich people, driving up inequality, as Mukta points out.

Springboard or Safety Net? Sure, if MF provides a woman with a way to reduce her vulnerability eg a loan to buy a goat, that is a good thing, but wouldn’t it be better if she didn’t have to repay the loan? If MF is actually acting as a safety net rather than a means to finance would-be entrepreneurs, it starts to look more like poor quality social protection, as Kate Carroll argues.

Gender impact: MF advocates have simply seen money flowing to women as a ‘good thing’ (see this recent article in the New York Times for an example). They need to try a bit harder – the actual gender impact of MF appears more complex and interesting, but needs research.  The study by QK Khan found that only 10% of women fully controlled decisions on how the money was spent (but they still all bear the responsibility for repayment). Even more alarmingly, it found that one of MF’s unintended consequences is to aggravate the problem of dowry (the money, goods, or estate that a woman brings to her husband in marriage). 82% of the 2,500 women interviewed in Khan’s study reported that dowry had increased since enrolment. This would presumably (the book isn’t clear on this point) mean that the loan is wrapped up into the dowry payment, while the bride’s family is expected to meet the repayments. MF loans are in effect being diverted into boosting a discredited practice, rather than creating new businesses.

On the other hand, there is evidence that micro-credit stengthens bonds between women in borrowing groups, leads to reduced incidence of domestic violence and increases in community involvement. This reminds me of some of the research on the impact of fairtrade, which found that the main benefit is from its encouragement for cooperative action, rather than the direct benefits from a premium price for coffee, cocoa etc.

Fund-raising via MF – a conflict of interest?: In Bangladesh in particular, numerous NGOs now run MF businesses as a way to cross-subsidise their core costs and other activities, through what Mukta calls ‘primitve accumulation’. The danger is that financial dependence on the proceeds from microcredit will make it harder for them to take an objective view of the developmental pros and cons of microfinance. It could also mean (shades of the fairtrade movement, here ) that MFIs spend far more time making their business models work than using their clout to press for changes in public policy.

Reforming microcredit: Unlike some of the commenters, I am not inherently anti-bank, or for that matter, anti micro-finance – poor people need a range of financial services and they are not getting them. Sso I was interested in some of the good ideas for reform. These include, to quote Nicholas, ‘placing specific and regulatory obligations on interest, credit recovery, community reinvestment and community participation in governance.’ Requiring both banks and MFIs to publish accurate information on charges and real interest rates (as Russia has done) would be a good start. As would rebalancing microcredit with other microfinance products. The codes of conduct for MFIs that I’ve seen are incredibly vague (see here and here) – anyone got better examples? The best thing I’ve seen on this very superficial look at the issue comes from some MF industry leaders who, aware of these criticisms and concerns, met in 2008 and drew up the ‘Pocantico Declaration‘.

Some fair criticism of both the original blogpost, and the studies it reported. On the latter, Alan points out that the Poverty Action Lab study, as with most (all?) others, ignores the issue of whether setting up a business via MF actually destroys another business in the vicinity – it measures gross business creation, not net. And Suyash is absolutely right to say it’s very harsh to draw conclusions after only 18 months – let’s hope MIT has plans to return and continue the research in Hyderabad, but I can find no suggestion of this in their paper.

Finally, if, as Chris pointed out, these criticisms have been circulating for well over 10 years, how has microfinance retained its Teflon magic bullet status? This is where ideology trumps evidence, I think – it was just too good a fit with the neoliberal spirits of the age to let a little thing like evidence stand in the way. Might the Teflon start to peel off in these new Post-Washington Consensus times? President Obama’s recent award of the Medal of Freedom to Grameen Founder Muhammed Yunus and the appointment earlier this month of MFI Accion International’s President and CEO, Maria Otero, as US Under Secretary of State for Democracy and Global Affairs suggest that view is at best premature.

August 27, 2009
Duncan Green