Does Microfinance Really Work?

If you follow me via @Anecdoted on Twitter, you’ll notice that I share quite a few articles criticizing microfinance, far more than ones that praise. Despite this evidence to the contrary, I do believe that microfinance “works” – but not in the “silver bullet” transformative way that most people often associate with microfinance and poverty alleviation.

As a Kiva Fellow, I’ve seen the successes. I’ve visited businesses and interviewed clients who have succeeded because of microfinance. These borrowers were able to grow their businesses that not only provide the owners with a comfortable living, but also provide additional livelihoods for hired employees. Abhijit Vinayak Banerjee and Esther Duflo of M.I.T, and Dean Karlan of Yale wrote in their New York Times op-ed “The Role of Microfinance,” microcredit is generally viewed as either “transformative” successes, or “ruinous” failures. Having seen the former, I believe that much of the latter is caused by over-high expectations – that poor people all over the world would be lifted out of poverty through lending. When recent research failed to support this concept of global poverty alleviation, people started to lose faith in microfinance.

HSPFI-Camiguin Borrowers

Again, from “The Role of Microfinance” (which I highly recommend reading if you haven’t already):

…as we see it, microcredit seems to have delivered exactly what a successful new financial product is supposed deliver—allowing people to make large purchases that they would not have been able to otherwise. The fact that some people expected much more from it (and perhaps they are right, may be it will just take longer), is perhaps inevitable given how eager the world is to find that one magic bullet that would finally “solve” poverty. But to actually blame microcredit for not promoting the immunization of children is no different from blaming immunization campaigns for not generating new businesses.

Microfinance is a tool, like a hammer. Some people have natural creative skill with a hammer, whereas others have to invest some time in learning how to put the hammer to best use. Still others might decide that they don’t like using the hammer at all and opt for another tool. Overall though, has the hammer made people’s lives easier? Yes, it has – so it is a successful tool. Can a tool like microfinance be transformative? Yes, for some people. Should the tool be completely discarded (or discredited) because it does NOT transform the lives of everyone? No, definitely not.

In a previous blog post “The Savings Behind the Interest” I had written that the microfinance arena in the Philippines is crowded with players, and that there are a lot of microfinance institutions jousting for clients by offering a variety of attractive programs apart from loans. My host MFI HSPFI for example offers savings, insurance, business training, a small competitive scholarship program for clients’ children, as well as community development initiatives. Other Kiva partner MFIs in the Philippines also have a similar array of programs, as several Kiva Fellows have shared. In other words, if you take product diversification and competitive commercialization as indicators of maturity, the Philippine microfinance industry has clearly “come of age” – largely to the benefit of microfinance borrowers.

To be honest, I believe that most microfinance critiques focus mostly on the effects of lending to the poor. Many other programs like savings or insurance offered by microfinance institutions are ignored, so the critics are out of step with the maturing of the microfinance industry. Case in point – much of the recent public fallout over microfinance was fueled by randomized control trials (RCT) that measured the short-term impact of microcredit on clients, and most of those studies found no evidence of microcredit bring about a transformative improvement in household income or consumption. However, in “Does Microcredit Really Help Poor People?” Richard Rosenburg of CGAP noted that “Interestingly, the only RCT study of microfinance so far that found short-term welfare improvements looked at microsavings, not microcredit (Dupas and Robinson 2009).”

It’s important to remember that “microcredit” or lending is part of a suite of services that makes up “microfinance.” Especially in areas of the world with a mature microfinance industry (like the Philippines), microsavings is a part of microfinance. When you’re making a loan through Kiva to a Filipino borrower, it’s safe to assume that many of those borrowers are utilizing additional programs from partner MFIs in the Philippines, and are receiving other benefits that branch out beyond the loan itself.

Returning to my original question – does microfinance really work? The pragmatist in me says yes – but not in a magical transformative way for every poor person, while the idealist in me adds that the successes would mount if all the other microfinance programs offered by MFIs were taken into account. Rosenburg wrote in “Does Microcredit Really Help Poor People?” that, “For now, it seems an honest summary of the evidence to say that we simply do not know yet whether microcredit or other forms of microfinance are helping to lift millions out of poverty… [but] poor people think this ‘palliative’ is enormously important in helping them deal with their circumstances.” Even as we in the developed world throw up our hands and bemoan the ruinous effects of high interest rates, etc. the poor believes that microfinance has helped improve their lives and are “voting with their feet.” And that, really, is the most important thing.

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