In 2002, Lize, a widow with 5 children, was unable to work for three months due to illness. When she recovered, many of her fishing nets were ruined. Lize decided to apply for a loan with Hluvuku-Adsema Fundo de Credito Male Yeru…Since then she has been granted four loans, the first one in January 2003 for a total of around US$260… With these basic financial services, Lize’s commercial activities recovered allowing her to support her extended family of sixteen members and start building a new concrete house. In addition, her company has generated four permanent job posts, seven temporary ones, and supports the business of self-employed women that buy her fish to sell in Catembe and Maputo.
This story is typical of those used to promote microcredit: the practice of providing small loans to the global poor who don’t have access to existing lending services. Microcredit is a type of microfinance, which includes a variety other financial services provided on a small scale. Microcredit is an intuitively appealing idea, especially for market-oriented people: the global poor can lift themselves sustainably out of poverty, all they need is some capital to start a business!
And it seems to have become one of the most popular ideas in charity. 2005 was named the Year of Microcredit.The microcredit charity Kiva has over 800,000 lenders, the highest possible rating from Charity Navigator, and was endorsed by Oprah… The 2006 Nobel Committee boldly claimed that microcredit “must play a major part” in ending global poverty.
Recently, however, criticism of microfinance has been growing. And that’s a good thing, because it’s far from proven that microfinance, on average, has any positive effects at all.
1) It’s not clearly shown that microcredit makes people better off
Major studies of microfinance struggle to demonstrate causation. The conclusion of Duvendack et al. is typical: “it is widely acknowledged that no well-known study robustly shows any strong impacts of microfinance.”1
Randomized control trials, which can potentially overcome this problem, tend to find that microcredit has little or no benefits.
There have been few studies, but two of the major ones didn’t find any effect. A study in the Philippines found that people provided with microfinance didn’t believe they were any better off. 2 A study by JPAL found that although more businesses were started in the area, there was no effect on business profits, female empowerment, health or education.3 Clearly more research is needed, since this is counterintuitive result. But so far, despite the hype, there isn’t good evidence that microcredit has large benefits.
2) Microcredit is not free or sustainable
Microfinance is attractive because you can loan people money, they pay it back, then you can loan it out again, and again, and again. Or so the story goes.
In reality, microfinance charities incur substantial operational expenses and if the lending occurs at below full interest rates, then it’s more like a cash transfer in disguise. It costs Givewell’s top recommended microfinance charity, the Small Enterprise Foundation, $128 per client served.4 At $5 per net, this is enough to protect about 40 people from malaria.
3) High ‘repayment rates’ can be seriously misleading
The major microcredit charities typically advertise repayment rates over 97%. But there’s no clear definition of what this means. Common definitions of the loan loss rate are often something like “loans lost” divided by “loans outstanding”. This means the measure will be inflated by simply increasing the number of loans outstanding. Since most microfinance institutions are growing, this figure is typically inflated. See GiveWell’s excellent article, and a more recent one for more.
4) A substantial number of borrowers seem to be harmed by the loans
By surveying MixMarket.com, Givewell found that 20-40% of clients drop out of microcredit schemes. It’s unclear why, but the evidence that exists suggests that it’s very unlikely to be success. The most common reason, at around 30-50% of drop outs, seems to be “business failure.” It’s likely that some of these borrowers end up worse-off than they were before they took the loans.
5) Microcredit doesn’t seem to be the best type of microfinance
It’s much less sexy, but one randomized control trial showed that providing zero-interest savings accounts increased investment and how much money people were able to spend.5
Against conventional microfinance wisdom, a study also found that providing consumer loans (loans to buy goods, not for starting businesses) in South Africa increased income and employment.6
This is only two studies, so we can’t draw strong lessons from them. Nevertheless, the evidence we have suggests that microcredit is not the most promising area of microfinance.
Instead of living up to the hype, microcredit is full of myths. There isn’t much direct evidence that it improves welfare. At best, we have some reason to think that microcredit is a service people want, since they often pay considerable amounts of interest for the loans. So, we’d expect it to be doing some good overall. But it’s not a service that seems to have particularly large social returns compared to the other services one could sell to the global poor. A lot more research is needed. In the meantime, it seems that microcredit charities would have more impact by shifting towards consumer loans and microsavings.
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- Social interventions gone wrong
- 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, p.2. (Commissioned by DFID) ↩
- Karlan, D. & Zinman, J. (2009) “Expanding Microenterprise Credit Access: Using Randomized Supply Decisions to Estimate the Impacts in Manila” Yale Economics Department, working paper 68, p. 18 ↩
- Banerjee, A. Duflo, E., Glennerster, R., & Kinnan, C. (2009) “The miracle of micro?nance? Evidence from a randomized evaluation” MIT Department of Economics and Abdul Lateef Jamal Poverty Action Lab ↩
- “Cost per borrower: 128 (USD)” Cost per borrower = (Operating Expense / Average Number of Active Borrowers). Mix Market, “Small Enterprise Foundation MFI Report.” ↩
- Dupas, P. & Robinson, J. (2009) “Savings Constraints and Microenterprise Development: Evidence from a Field Experiment in Kenya” NBER Working Papers 14693, National Bureau of Economic Research, Inc. ↩
- Karlan, Dean and Jonathan Zinman. 2007. Expanding credit access: Using randomized supply decisions to estimate the impacts (PDF). Economic Growth Center Discussion Paper 956. New Haven: Yale University. ↩