Monday, June 15, 2015

Taylor Swift, Zombies, and why Microfinance isn't evil

"The failure of microfinance is recognised at even the highest levels, and yet for some reason it retains its staying power, like a zombie that refuses to die. "
Ok, what is up with all the comparisons between microfinance and zombies? Seriously? Zombies freak me out, so please stop.

Since January, when six randomized control trials "definitively" stated that microcredit did NOT have a significant impact on household well-being, microfinance has been taking a lot of heat in the media.

What's kind of funny is that the researchers themselves actually weren't quite so negative, not that anyone would take the time to read a massive research document. Here's a line I liked,
"These results suggest that although microcredit may not be transformative in the sense of lifting people or communities out of poverty, it does afford people more freedom in their choices (e.g., of occupation) and the possibility of being more self-reliant."

So why the backlash? It's partially the sector's own fault. Because microfinance was billed as the "silver bullet" to eliminate poverty, long-time critics are gleefully pointing to the research as proof that it's only the industry's own greed that keeps us going.

Wait, what's that, Taylor? "Haters gonna hate, hate, hate, hate, hate....."?

Don't be a hater!! Fight the madness! To shake it off, here are a few questions you can throw into one of these arguments and sound REALLY smart. Extra points if you say it with a big "duh" look on your face.

But wait, the studies only looked at microcredit. Are microcredit and microfinance the same thing?
No, they aren't! Credit is just one type of service. Microfinance encompasses all financial services, usually credit and savings, and sometimes insurance, pensions, etc., that are offered to the poor. Most microcredit providers will opt to provide a mixed basket of services, in regulatory environments that allow them to without a banking license.

It must be risky to provide credit to poor clients, without any collateral or guarantee. Maybe that's another explanation for why the interest rates are higher than commercial banks?
Wow, you're right. Remember that microfinance clients are usually people that no other banks will give credit to! On top of that, many countries are at risk of floods, cyclones, or droughts, during which they often will defer or write off client loans. Not to mention, many microfinance institutions write off loans when a client or her spouse dies. So they have to plan for certain potential losses when calculating their interest rate.

In part because many MFIs (MicroFinance Institutions) are restricted from taking deposits, they often take loans from banks for their own capital. This means that they incur a cost of funds that's reflected in their interest rates.

While haters love to quote a seemingly-absurd interest rate of 200% in Mexico, the global average is closer to 35%. In some markets, interest rates are capped; in Bangladesh, 27% (declining balance) is the limit.

Have there been any other studies on microfinance that found other positive results?
Plenty of them!! One of my favorites is the one that looks at microcredit as an income smoothing tool--that is, when other cash flows are lower, or big expenses are looming--microcredit enables families to avoid selling off assets or going hungry.

Case in point: I met a woman a few weeks ago who lives in a remote area and has a small farm. While her crops are growing, her husband travels to other areas to help with harvesting there, and/or take other odd jobs. Before microfinance was available in her area, she essentially had to wait for him to come home with money, and just survive on whatever meager savings they had. Now, she takes a loan to fund her basic consumption while he's gone, and uses the money he sends home to pay it off. Her stress level has reduced a lot and her consumption is much more stable. Significant? I think so.

Another obvious example is in financing people to seek employment abroad. It's definitely a better option for families than selling off their land and/or taking loans from informal lenders (who can charge rates that make Banco Compartamos look charitable). And soon I'll have research to support that!

Most microfinance institutions are financially sustainable, as opposed to income grants and many other development interventions cited as "better options". So why are we comparing them?
Last month, six more randomized control studies concluded that BRAC's model to help households move out of ultra poverty was "definitively" effective across a range of contexts. Very exciting! But a key piece of that program is proper targeting; that is, finding ultra-poor households that will experience transformational improvements in quality of life from two years of comprehensive support. And guess what? It's expensive, ranging from about $1,538 per household in India to $5,732 in Peru. Should we be comparing this model with microcredit (or microfinance), which targets slightly better-off clients and serves them sustainably? Should we be surprised that the outcomes aren't the same? One thing that the studies did not report was whether microcredit experiences a range of effects. It's possible that for certain profiles, the impact of microcredit is much bigger than for others. It would be really interesting to know more about whether there are sub-groups who did experience significant improvement, as that could help microcredit institutions refine their lending criteria and loan appraisal processes.

Should we be hating on the players or the game? Who makes the rules here?
In my mind, it's regulators that should really be consuming the research findings and asking good questions: Does this have implications for consumer protection? What about for policies regarding interest rates and deposit taking? Again, they'd probably need a much better breakdown of the results than what's currently available. But since microfinance institutions have to abide by the policies set out by regulatory bodies, influencing the policy environment seems like a much better use of time than harping on providers themselves (unless you're a hater and just want to hate).

Is anyone actually suggesting that we should abolish microfinance and give up on financial inclusion? 
I hope not! 

In that case, shouldn't researchers and journalists stop hating on microcredit, and instead think about when it IS an appropriate tool for poverty reduction?
Yes! Or just have a dance party and move on.


  1. It baffles me how much bad blood there is towards the microfinance sector. Yes microfinance is not the definitive solution capable of solving poverty, but that's no reason for researchers to break up and never ever get back together. Without microfinance there is a huge blank space for accessing financial services that are extremely useful for poor people. And they certainly help to displace the super high interest moneylenders who you know are trouble when they walk in. It hasn't been a perfect love story - impacts of MF, such as choice, and stable consumption, as you point out, were not they were looking to get out of it- so I understand the frustration. But they don't have to be so mean.

    1. lol Oh, the pun! That's a good one, I must say!