Does Microcredit Really Help Poor People? How? And how do we know?

by Richard Rosenberg: Monday, October 5, 2009

Since microcredit first came to public attention in the 1980’s, the usual story line has been that it funds creation and expansion of microenterprises, producing additional income that lifts the borrowers’ households out of poverty. But is it true?

It has been clear for some years now that many–sometimes most–microborrowers in fact use their loan proceeds for non-business purposes. Recent analysis has cast doubt on some of the older research studies that found that microcredit increases household income. A new generation of more rigorous randomized studies is now in the works. The first two of them to be published have not found evidence that microcredit raised household income and consumption, at least over the 1-1.5 year term of the studies. Does this mean that microcredit might have been a bad idea all these years? I’ve just drafted a brief paper on this question. The paper should be available in a month or two, but in the meantime let me trot out its core arguments.

I think an honest appraisal of the current state of the evidence is that we simply do not know whether microcredit raises incomes and consumption. If the case for microfinance depended on whether it was lifting people out of poverty, then the appropriate response right now would probably be to declare a moratorium on support for microfinance until further research clarifies this question more.

I’ve worked in microfinance for over a quarter of a century, and I’ve always been agnostic about whether microcredit raises incomes. But I’m pretty sure that it does some other things that are very important to poor people, helping them to cope with poverty whether or not it helps them escape poverty. These other benefits are described compellingly in the brilliant new book Portfolios of the Poor by Daryl Collins et al., which gives a high-resolution picture of how low-income households actually use financial services, based on hundreds of 18-month-long financial diaries in three countries. Portfolios points out that the problem with being poor is not just that income is low, but also that it tends to be uneven and vulnerable to disruption. Given the variability and vulnerability of their income, poor households have to save and borrow constantly (more so than richer households) in order to put food on the table and meet other consumption needs. The informal credit and savings mechanisms they have tend to be unreliable. They value formal microfinance highly because it is more reliable, even if it is often less flexible than their other tools to manage their cash flow.

When we hear that microcredit may not lift people out of poverty, we tend to be disappointed, and regard consumption-smoothing as a “mere palliative.” But we react this way only because our own basic consumption needs are seldom if ever threatened. As Portfolios demonstrates, poor people see it very differently.

I think there is strong evidence that poor people find microcredit very valuable in helping to deal with their circumstances. When you offer microcredit in a new setting, you almost never have to advertise: customers come out of the woodwork in droves. Most of them come back for additional loans. Most important, they usually repay those loans at extremely high rates year after year, when the main motive to repay is not collateral or group pressure, but rather their desire to keep future access to a service they find very helpful. They are voting with their feet.

But does microcredit hurt a lot of poor people by over-indebting them? We need more work on this question, but I think the general answer is very probably no. When a lender is over-indebting a lot of borrowers in a bad situation, sooner or later it will show up high default rates, just as it did in the current financial crisis. But the predominant pattern is that the vast majority of microborrowers repay at very high levels year after year (cf. my posting a couple of weeks ago on repayment rates).

When all is said and done, a year of microcredit probably doesn’t help poor people as much as a year of girls’ primary education (for instance). The value proposition of microcredit, and microfinance more generally, is that each “dose” costs far less. Education, health, and many other social services require large subsidies year after year. When microfinance is done right–and only when it’s done right–small one-time initial subsidies can generate service delivery to very large numbers of people year after year. Not only is no further subsidy needed, but microfinance providers can leverage their initial subsidies with very large multiples of commercial funds. This is not a pipe dream–it’s happening already in dozens, even hundreds, of cases all over the world. For instance, BancoSol in Bolivia represents a few million dollars of donor subsidies in the mid-1990s that have turned into $200 million of loan portfolio and services for 300,000 active savers and borrowers as of the end of 2008. Whether donors and other public funders now lose interest in microfinance is pretty much irrelevant to such MFIs.

For me, this is the strong value proposition of microfinance. The benefits of each dose may turn out to be more modest than some have claimed, but poor people really value those doses, and you can buy an awful lot of them with relatively little subsidy. We certainly need further research on the nature and extent of benefits of microfinance, but I think it’s a very good bet that the observed behavior of millions of microborrowers is telling us that those benefits more than justify the investment.

TAGS: Impact of Microfinance, Interest Rates, microcredit, microlending, Portfolios of the Poor, Repayment Rates, Rich Rosenberg

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14 Comments

October 8th, 2009 at 4:11 am, Michael ()

What if microcredit was used to develop an asset; one that in itself because of its very nature makes the owner wealthier. I think the less discussed aspect of housing microfinance falls here. In my mind the odds are much much higher for it to really help people.
October 9th, 2009 at 12:38 pm, Elie Hassenfeld ()

Mr. Rosenberg. You write , “When you offer microcredit in a new setting, you almost never have to advertise: customers come out of the woodwork in droves. Most of them come back for additional loans.” I haven’t seen data that directly addresses the degree to which microfinance clients return for additional loans. Is there any data/research you can point me to on this issue? Thanks.
October 10th, 2009 at 6:34 pm, Microfinance in the short & long term « Africa | Critical Geography | Development Economics | Microfinance ()

[...] to for-profit status. The answer to the former question is looking increasingly like, “not necessarily, but it often provides other important benefits.” The latter, however, is entering its nth round of debate on mailing lists such as [...]
October 11th, 2009 at 2:53 am, V.Rengarajan ()

Richard’s queries on micro credit are candid and refreshing too albeit a belated one. However they provoke me to probe on certain fundamentals of micro credit , the fact ignored or neglected in the past by the proponents of Micro finance.. Unless these fundamentals, as referred below, are better appreciated, candid answers to his queries would be difficult to be honest..
MF Data ‘prima facie’ shows that millions of micro borrowers are benefited and also appear to justify the investment.. But basically who are they? Do they include the poorest, marginalized and vulnerable? Do they belong to only creamy layer having some wherewithal and skill for income generation in the poverty segment? While this section of the poor who are capable of making positive impact from micro credit also need to be covered, will too much focus on them lead to widening the equity gap even among the poor community ? Do MF data (MIX) include non poor also? Does the poor find MFI system as reliable as formal one? Does MF suffer ethically? How long the poorest have to wait for ‘inclusion’? If MF system failed to rope them in , is there any other alternative one for the said purpose? Any identity crisis?
Are we well placed in the trajectory for uplifting the poorest on one hand and for halving the number of the poor people through MF platform in terms of MDG goals? Is the present performance in MF sector of any indication of candid progress in the battle against poverty? In the context of presence of ‘inequity’ base reflected in the ‘profile of the poor’ in terms of economic disparities, social inequalities , variable physical capabilities (A.Sen), highly susceptible to vulnerability within the poor people given in any area/region, can a single input ‘micro credit alone ‘ that too highly structured, do the ;magic’(income generation) in the so called Micro finance game? Does mere accessibility to finance, guarantee the expected impact? When we universally recognized both the various financial and non financial needs ( capacity building, backward and forward linkages provided either by the same or some other institutions mainly for enhancing the productivity of credit) of the poor, do the MF players ensure supply of all the above inputs for a sustainable jump over the poverty canvas.? What does specifically signify the word ‘ Micro’ prefixed to credit or finance? What makes subtle difference between micro finance or micro credit and bank credit or informal credit for that matter? Is it an ‘ old wine in a new bottle’ ?Does micro credit lending through MFI represent another mode of usury? What is the difference between Micro finance and Micro credit? Is the credit is misused under the popular brand name ‘Micro finance? Any conceptual crisis? ( for clarity on the MF concept: my posting in the BLOG as responses – Change, Growing gone…., What is Micorfinance? The New Micro finance? )
When the portfolio of the poor portrays different socio economic layers among the poor and varied priorities, is it not necessary for designing product differentiation and sequencing the MF inputs ( micro insurance, capacity building, micro savings, micro credit etc.) matching to their needs? In the context of over consumption smoothing ( conspicuous consumption) multiple borrowing and debt trap in the poverty sector ‘Is micro credit a ‘forbidden apple’? Does group system for micro financing facilitate for inclusion or exclusion of the poorest? Why Micro Insurance , an important component of MF having potential values in the process of poverty reduction, remain ‘ Cinderella ? Do Investors / Creditors/ MFIs find the poor as lucrative market ‘niche’ for their commercial lending business at a high social and ethical cost? Does higher repayment year after year mean more number of poor raising above poverty line? MFI turned NGOs were able to make significant social and economic impact of the poor earlier as NGO playing as intermediary role in Micro financing .and gained popularity among the poor community. But after becoming MFI, they are tied up more with financial engineering than social engineering and lost the popularity. Is the fact true?
Further research is needed to find out with more focus on ‘who are exactly benefited within the poor segment ? and how to include the poorest or marginalized or ultra poor and sequence the needed inputs strategically for them ,? than on the nature and extent of micro finance? While we had enough on the technicalities of funding /delivery /supply mechanism lacking adoptability and adjustment and adherence. in the context of variability and vulnerability of the poor, it is high time to probe How to deliver the integrated MF inputs ( not MC alone) to the bottom layer of the poor by the same institution or some others institution jointly ?
Finally, there is a wide gap between the concept and practice in MF arena. If the present functioning of MF system fail to help really the poor, can we contemplate a ‘ denonvo’ conceptualization of MF for the exclusive coverage of the poorest ?
October 12th, 2009 at 2:25 am, S Santhanam ()

Dear Sir
Impact of micro-finance on income depends on a number of factors. When income generating activities are undertaken with marketing support (in case of production activities, chances of getting higher income also increase and their moving out of poverty. But, in a country like India, there are still a very large segment of poor, particularly rural poor, do not have access to savings and credit services from the formal financial institutions. They also have propensity to save in the form of thrift (by foregoing certain expenditure. Their desire to save has been recognised by micro-finance and not by any other strategies. Using micro-finance, thanks to servicces of organisations like CGAP, has become a strategy for governments to provide basic financial services to the poor through the formal financial institutions. In that respect, contribution of micro-finance for the overall welfare of the poor is significant.
October 23rd, 2009 at 11:39 am, Weekly Favorites – Micro Finance ()

[...] Favorites – Micro Finance On 10.23.09, In Posts, Weekly Favorites, By Mario Balistreri Does Microcredit Really Help Poor People? How? And how do we know? – [...]
October 24th, 2009 at 1:41 am, Monwuba Nonso ()

I think this is a very important discourse that bothers on the existence of MFIs. As a resident of Nigeria, hopes have been dashed on the possibility of Micro Finance to help in alleviating poverty. Consider this for example, a situation where micro finance institutions basically for the poor get themselves in stiff competition with the conventional banks, wanting to drive the same cars with them and operate in the same types of buildings as offices. By the time this is done, I wonder the funds that will be left available to the banks to give out as credit to the poor.

Secondly, I discovered that most of their clients have not been able to access their funds, though this is due to a peculiar problem. Most of the deposits kept with these small institutions were used to purchase shares from the Nigerian Capital Market before the market nose-dived. This has led to loss of huge sums of Naira that has already began to threaten the existence of some MFIs in Nigeria.
October 26th, 2009 at 12:04 am, John Lothman ()

Great points about the true impact of MF in comparison with other forms of development like female education. So often we hear the positives of microfinance, which I am not dismissing. However, in order to accurately the extent of a difference MF and MFI’s make we must look at the whole picture. What structure is actually best for MF to operate in, with existing development strategies as a more latter stage method or can MF be applied without accompanying investments from private, government or NGO’s? Another question that I often contemplate is how greatly the positive growth and great publicity for MF has impacted the mindset of managers who continually think of expansion rather than long term sustainability of their respective MFI’s. What will happen when the growth phase of MFI’s reaches maturity, or when economic conditions actually have an affect on the growth of MF (unlike the current environment from what I have read). I believe in the underlying story behind the success of microfinance, but believe that it must be done right and due diligence must be exercised on the part of donors when evaluating choices in this field.
November 4th, 2009 at 9:47 am, Sophie Chitedze ()

The issue that determines whether microcredit/microfinance improves incomes of people and reduces poverty levels depends on the delivery mechanisms, the strategies used, etc. Very many times, I have seen that poor people are enticed to get loans and yet the delivery organization’s aim is solely to make profits and success is measured through indicators like “default rates, delinquent loans, repayment rates, etc-not a win-win between the provider and the client” without much concern about whether lives are changing. Most of the time, such loans are given out without systematically checking credit worthiness, capacity to manage by members and the poor are always left out - because credit is not what they need most, it is savings services.

What I have seen working beyond doubt and which no one can convince me otherwise is that microcredit reduces poverty levels if it incorporates the poor and unbanked into informal self managed savings led microfinance services and incrementally graduates them into formal microfinance clients voluntarily. Clients education on financial products helps them choose options to access. Just pumping huge billions of cash to people in form of credit without without working out the how, what, when, to who and why does not yield any good and has put me off several times when most of what is discussed in microfinance forums is microcredit and not micro savings that lead to microcredit and incremental graduation to formal financial services.
November 12th, 2009 at 11:43 pm, The Savings behind the Interest « Kiva Stories from the Field ()

[...] up the conversation, my mind floated back to a great CGAP Microfinance Blog post, in which author Richard Rosenberg wrote, I think there is strong evidence that poor people find [...]
November 12th, 2009 at 11:57 pm, The Savings behind the Interest - Anecdoted ()

[...] up the conversation, my mind floated back to a great CGAP Microfinance Blog post, in which author Richard Rosenberg wrote, I think there is strong evidence that poor people find [...]
November 17th, 2009 at 3:38 am, Sadananda Paul ()

Micro Finance is easy for discussion. But its implication is not so easy. A lot of NGOs providing Micro Credit. Some of the NGOs operating Micro Credit for their organizational financial sustainability. Those who are providing Micro Finance they have social responsibility. Maximum fails motivate people. So a negative impression caries those NGOs who are actually trying to do disadvantage people. If they overcome this they need to opperate another pacage program. Those who will work as a organizer they have to capability to motivate the people. In the present situation the field staffs are not convinced unskill, less motivation, less knowledge about their job. they must know the answer of these question-
* What is Micro Finance?
* Why Micro Finance?
* Who will get Micro Finance ? (Specify the Indicator)
* Why huge number of organization operating MF?
* What is commercialization and Socialization?
* Why I will do this kind of job?
* What is the nature of the job.
* From MF really the recevier will benifitted?
December 15th, 2009 at 11:52 am, FCRWizard ()

Being a microcredit practitioner of last two decades in Bangladesh, my experience that only microcredit is not sufficient enough to creating an enabling sustainable position for poor. But microcredit plus (microcredit plus means health, education, skill development training and market linkage) definitely is an effective tool for poverty reduction. From my own organizational experience (Eco Social Development Organization, Bangladesh) more than ten thousand success story shown the effective role of microcredit plus programs.
January 18th, 2010 at 1:36 am, Anita Sharma ()

Sir, you have raised doubts about whether microcredit really lifts poor households out of poverty and argued that most of the borrowers use microcredit for non-business purposes, and therefore it is uncertain that it increases household income.
Indeed, poor households use microcredit for different purposes, and creation/promotion of businesses for income enhancement is one of them. Consumption smoothing is another important purpose of micro loans, which can play an important role in the alleviation of poverty. Therefore, the overall impact of microcredit needs to be understood in a broader sense than just as impacting on reducing income poverty.
We now have some strong evidences from the field which show that the benefits of microcredit are indeed significant in the lives of the poor. For example, ‘Portfolios of the Poor’ by Daryl Collins et al. show that savings and credit services help the poor to deal with different vulnerabilities in their lives. The RCT study on the impact of microfinance by Abhijit Banerjee et al. reports the creation of durable assets by those households which own businesses, and increase in consumption by those which do not intend to start businesses.
These results from empirical studies clearly show that access to microcredit helps the poor in tiding over various situations arising from their small, uncertain and irregular incomes. This is an important contribution in helping them cope with poverty – a point that you also subscribe to – and a step in helping them out of various forms of poverty, including income poverty.
Further, we should not perceive that microfinance, and other social programmes such as health and education compete for financial resources (subsidy). Access to education is fundamental, and access to primary education, particularly of girls, can certainly enhance opportunities for these households. However, that doesn’t make access to financial services less important. Continuous and reliable source of financial services can have a significant impact on the poor households in the long run; even leading to a rise in the health and education status of poor households.
Overall, access to microcredit offers several pathways to households to cope with poverty, which is bound to have an impact on their income levels subsequently. Thus, we should understand the contribution of microcredit to alleviating poverty in a much broader sense than just in increasing incomes.