Microfinance Must Return to its Roots

Microfinance has become something of a buzzword in recent years (depending on which circles you run in), and the industry’s increase in popularity has also lead to an increase in criticism.  You may remember my last post about microfinance, as well as the posts written by my colleagues, but for those of you who don’t, here’s a quick overview: Microfinancing companies operate by providing low-cost loans to low-income borrowers, who often do not have access to traditional banking services.  Women tend to be the focus of the loans, since they typically do not have access to banks or financial institutions and because they have proven to be more successful at repaying loans.  Microfinancing activities include a wide variety of banking activities, such as microlending and microcredit, and those terms are typically used interchangeably by us lay-persons.

Supporters of microfinance point to the large number of people who have been lifted out of poverty in countries like India and Ghana as a result of microfinance institutions.  For example, a recent survey conducted by the Microcredit Summit Campaign found that approximately 9 million Indian households involved in microfinance rose above the $1.25 poverty threshold between 1990 and 2010. The microfinance industry boomed in India after 1998, so the 9 million increase is quite significant.  A survey in Bangladesh found similar results, reinforcing the link between microloans and poverty reduction.

Critics, however, are quick to point out that the surveys were not intended to show causality, meaning that the results cannot be used to imply that microfinancing institutions lead to poverty reduction.  The EPPI-Centre conducted an exhaustive examination of the microfinance sector and found that there is currently no clear evidence that microfinance programs have positive impacts.  The industry is too new, and there are no adequate research methods to determine whether or not there is a true link between microfinance and reducing poverty.

Perhaps the biggest criticism of microfinance, however, is simply that the popularity of the industry has prompted companies seeking only profit and companies focused on offering loans for consumption smoothing to pop up.  Those two things run counter to the original goals of microfinance.  Microfinance institutions originally offered small, low-cost loans to people without access to banks or financial services, and so raising the rates on the loans in order to make a profit would only contribute to poverty, not reduce it.  The industry is mostly unregulated, and so it was easy for people to hop on the microfinance bandwagon while focusing more on profit than a sustainable impact.  Further, the loans were intended to be just that—loans—and to be given only to entrepreneurs and enterprises.

Think of it like the American economic crisis from a few years back.  Loans were offered to pretty much anyone who bothered to ask for one, regardless of whether or not they had the capacity to pay it back, at very high interest rates.  So people kept borrowing and borrowing, using the new loans to pay back their old loans and to continue their standard of living (consumption smoothing), and only ended up going further and further into debt (of course, this is a simplification of the crisis for the purposes of comparison).  If microloans are offered to anyone, regardless of whether or not they have a business plan or the ability to pay off the debt, at high interest rates, how is that going to help anyone?  The way I see it, the microfinance industry has to go back to its roots as an industry dedicated to helping small businessmen (and women) get enough money to fund their enterprise.  That will result in job creation, which will do much more for poverty reduction than handing out loans left and right.

Getting the microfinance industry to return to its roots, however, will not be easy.  As I mentioned earlier, the industry is almost entirely unregulated, meaning there is no one to stop microfinance companies from giving loans at high interest rates to people without business plans or the ability to launch a new enterprise.  One thing I think is interesting, though, is that some microfinance companies, like SKS Mircofinance, offer programs for the extremely impoverished that teach them how to run a profit-generating business.  Such a program not only improves their own business (the more people who have the desire and ability to start a small business, the more people who will request microloans from them) but increases the chance that the loans they give out will actually make an impact.  I think more microfinance companies should offer programs like that, or else that an NGO or other multinational organization should.  Such programs would help to ensure that people are not being taken advantage of by less-scrupulous microfinance companies who offer loans at high rates and operate like loan sharks.  Also, the people who participate in the programs gain the knowledge of how to operate and maintain a small business, and those small businesses create more jobs, which improves the economy overall.

Michelle Bovée is a SISGI Group Program and Research Intern focused on international affairs, economic development, and responsible tourism. To learn more about the SISGI Group visit www.sisgigroup.org


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