Microfinance: don’t believe the hype

Muhammad Yunus, who founded the Grameen Bank. Photo by schipulites

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In response to Emma Howard’s post in favour of microfinance, DiA blog writer Nate Barker argues that it is not the best way to alleviate people out of poverty.

At best, it’s merely ineffective. At worst, microfinance institutions can damage the very communities and people they claim to be helping.

The concept is seductive; investing in poor people by giving them access to credit to start their own businesses and thus lift themselves out of poverty. The left applaud its emphasis on empowering women and working with communities at the grass-roots level, while those on the right approve of the focus on encouraging the poor to become self-sufficient through entrepreneurialism, rather than relying on aid handouts.

Rigorous studies on the efficiency of microfinance institutions (MFIs) are hard to come by, but the limited data that does exist throws up a lot of questions, and showing that results are equivocal at best. What these studies do agree on is that MFIs tend to be most effective when targeting the moderately poor, but can often exacerbate the situation for the very poor. To their credit, the more reputable MFIs are aware of this – the Grameen Bank, for example, only lends to homeowners – but a policy of helping the moderately-poor and upwards doesn’t quite fit with the rhetoric surrounding MFIs.

We also need to challenge the underlying assumptions as these do not stand up under close scrutiny. For a start, is entrepreneurialism really the best way to lift people out of poverty? Most people simply don’t have the necessary skills to set up and run their own business – that’s why we see more people in waged or salaried positions than as entrepreneurs in developed economies, and why start-ups have such a high failure rate.

Although MFIs aren’t too keen to highlight it, the credit they offer is primarily used for consumption, not investment, and while this could be seen as indirectly boosting local businesses, in practice it can often lead to families being trapped in a vicious cycle of debt, struggling to meet repayments – sometimes with tragic consequences. In late 2010, a suicide epidemic in Andhra Pradesh, India was linked to people defaulting on micro-loans, with more than eighty people taking their lives.

The problem is only exacerbated by the semi-official support given to MFIs by governments and NGOs, which often encourages people to take out loans that they cannot afford to repay. And as for empowering women – another key plank in the microfinance story – studies have shown that Bangladeshi women only retain full or significant control of these loans in 37% of cases.

Giving the world’s poor a chance to help themselves out of poverty is a laudable aim, but there are better ways. Helping establish larger enterprises means businesses can employ people for a decent wage, due to the higher levels of productivity obtained through economies of scale. Here’s a great example from Aneel Karnani, an academic at the University of Michigan:

Rather than lending $200 to 500 women so that each can buy a sewing machine and set up a microenterprise manufacturing garments, it is much better to lend $100,000 to an entrepreneur with managerial capabilities and business acumen and help her to set up a garment manufacturing business employing 500 people.  Now the business can exploit economies of scale, deploy specialized assets, and use modern business processes to generate value for both its owners and employees.”

I’m not saying that there isn’t a place for MFI – but in being seen as a panacea for poverty, it risks diverting funds from other, more effective ways of helping the poor – and at the end of the day, that should be our yardstick.


The views expressed in this article are those of the author and do not necessarily represent the views of Development in Action.

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0 comments
  1. An important discussion and I enjoy that you give space to both sides! I do agree however with the answer to this post: it’s what we make of it, MFI is not THE solution but maybe A solution of worked out carefully?!

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