Richard Rosenberg

People who favor a commercial approach to microfinance and people who oppose interest rate caps have argued for years that competition would bring meaningful reductions in microcredit interest rates. Others have been skeptical about this prediction. A new study by Guillermo Baquero, Malika Hamadi, and Andreas Heinen seems to shed considerable light on this question. The study uses a comprehensive data set including not only MIX Market information but also data on 329 microlenders provided by three rating agencies, for a total of 1335 institutions.

The headline finding is that increased competition in a country is associated with substantial declines in interest rates. Interestingly, this effect is driven by for-profit lenders; the study found a much smaller correlation between competition and changes in non-profit rates.

In for-profit institutions, the size of the effect is surprising. The opposite of competition is market concentration, typically measured by the Herfindahl Hirschman Index (HHI). If a given country moves from the 90th percentile on the distribution of HHIs down to the 50th percentile (i.e., the industry is becoming less concentrated, more competitive) the associated drop in the interest rate is almost eight percentage points. This is about triple the rate decrease reported in studies of the regular commercial banking sector. Competition seems to work better in microfinance than in conventional finance. Of course, these are average results. They di not mean that interest rates will decline in every microcredit market that becomes more competitive.

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CGAP has just published a study that Jessica Schicks and I have written on over-indebtedness among microborrowers. The paper is not exactly bedtime reading: I’m slightly embarrassed to say that it runs to 43 pages. So some readers may feel like the third grade student whose book review began, “This book told me more about whales than I wanted to know.”

It’s been an interesting exercise to go back over the paper’s detailed discussion and cull out a few conclusions that feel important enough to highlight in a blog. The first big message has to do with the question in this blog’s title. After many years of enviable repayment performance, serious default problems have broken out in recent years in Morocco, Nicaragua, Bosnia/Herzogovina, Pakistan, and Andhra Pradesh in India. Some of this default is probably “strategic”—borrowers who could easily repay take advantage of political or other situations to stop making payments. But much of the default appears to be due to over-indebtedness.  (Without going into the complications of defining “over-indebtedness,” let’s just say for now that it refers to borrowers who can’t repay their loans without serious difficulty. Note that this is a client-centered definition, and that it implies that borrowers can still be over-indebted even if they manage to pay off their loans.) Read the rest of this page »

Jessica Shicks’s post in this series argues that from a consumer protection perspective–I assume that’s the most relevant perspective for development practitioners–the notion of over-indebtedness should include not just situations where the borrower can’t repay, but also situations where the borrower can repay but only at the cost of “unacceptable” sacrifices. Adrian Gonzalez made much the same point in his doctoral dissertation; likewise Beth Rhyne in a blog post a few months ago. I think that they’re right, and that it makes sense to incorporate this sacrifice dimension into a definition of over-indebtedness for research purposes.

But there’s a knotty problem here.  When we talk about “over-indebtedness,” we usually assume that it’s something that ought to happen pretty rarely if credit is being delivered responsibly.  But take Jessica’s example of a woman who is “over-indebted” in the sense that she has to go hungry in order to make a loan payment.  Suppose she goes without food for three days to pay off a loan: at first blush, this probably sounds like an unacceptable sacrifice. But further suppose that she borrowed the money in the first place to avoid going without food for three weeks.  This is a loan that resulted in over-indebtedness as we’ve defined it, even though the loan may have been a good deal for the borrower, and we’d want the same deal to be available to plenty of other borrowers if they’re in similar circumstances.

Paying off a loan is just one among many payments that poor people have to make. The fact that they’re poor implies that coming up with cash for any  purpose can be associated with serious sacrifices—someone may, for instance, have to go hungry or sell productive assets to pay school fees or medical expenses.  With this in mind, maybe we should expect  to find substantial levels of over-indebtedness (thus defined) among poor microborrowers, even if the lending is responsible.

Of course, a lot depends on how high we set the bar in defining which sacrifices are “unacceptable.”  This is really a tough one. It’s hard to argue with Jessica’s position that the answer has to come from the borrowers themselves. But like everything else about over-indebtedness, this involves complications too. Do we wind up defining over-indebtedness as loans the borrowers wish they hadn’t taken?  I’ll be very interested to see how this is operationalized in Jessica’s forthcoming paper on her Ghana research.

(Adrian Gonzalez’s dissertation avoided the question of what was “unacceptable,” and focused instead on whether a sacrifice was “unanticipated.” This may be easier to determine in a field interview, but it further weakens the link between “over-indebtedness” thus defined and a conclusion about whether the lending operation is a responsible one.)

–Rich Rosenberg

In a video-taped interview seven months ago, I expressed a degree of optimism that, historically at least, we had not been over-indebting unacceptable numbers of poor microborrowers, based on an admittedly tenuous inference from high repayment levels in most of the world. Since then, various conversations and data points have left me less comfortable with that inference.

• My guess was that most large, sophisticated MFIs had gotten pretty good at the reporting collection performance accurately. This may have been naïve: for instance, Sanjay Sinha says that recent portfolio testing by M-CRIL in a range of leading Indian MFIs revealed unsustainably high loan losses, notwithstanding published financial reports saying all was well. (Assuming this is true, is the problem data systems that still can’t do the job, or is it a deliberate pre-IPO window dressing by management?)
• But let’s assume that reports of high repayment in most markets are true. If, as many practitioners think, the preponderant motivation to repay uncollateralized loans is the borrowers’ desire to keep future access to a valued service, then high repayment would seem to suggest that few of those borrowers think that they’re getting too deeply in debt. But conversations with David Roodman, Esther Duflo, and Abhijit Banerjee have forced me to recognize that we don’t really know how much of the loan repayment is driven by other factors, including pressure from groups or loan officers. If these latter motivations are widespread, borrowers may be repaying even if they haven’t experienced their loans as helpful.
• Most importantly, microcredit markets are becoming saturated in more and more places. (This can happen at penetration levels that seem low: we microfinance enthusiasts tend to overestimate the percentage of the eligible population that will want a loan at any given time.) Gabriel Davel, South Africa’s former consumer credit regulator, observes that when competitive retail credit markets approach saturation, problems with over-indebtedness are almost inevitable: One probably shouldn’t expect microcredit to be an exception, given that few microcredit markets have good credit bureaus that allow a lender to check a loan applicant’s repayment of loans from other providers.

The point is not to assert that we have a generalized problem with over-indebted microborrowers. The point is that for most markets we simply don’t know.  We’re flying blind in the face of a clear and present danger.  Fortunately, more researchers are starting to look at levels of debt stress. But we’re still a long way from having solid, practical tools—especially early-warning tools—to identify problems.  High default levels sometimes (not always) can tell us, after the fact, that a lot of clients have gotten over-indebted. But low default levels don’t mean that everything has been OK, even if the reporting is competent and honest. Borrowers might be repaying only at the cost of unacceptable sacrifices.

The obvious question here is what “unacceptable” means. That turns out to be an annoyingly complex topic that I don’t have time to write about, and you probably don’t have the time to read about, just now. I’m sure the question will rear its head in connection with later blogs in this series.

–Rich Rosenberg

This post is the next in the blog series on over-indebtedness. In the coming weeks we’ll be featuring a variety of voices from across the globe on this topic. We welcome your participation in this discussion through comments.

David Freedman in the November issue of The Atlantic  profiles John Ioannidis, one of the world’s most respected and sought-after experts on the credibility of medical research.

Ioannidis argues that much of what biomedical researchers conclude in published studies is misleading, exaggerated, and often flat-out wrong. “Gold-standard” randomized controlled trials (RCTs) are not immune: 25 percent of published RCT results are subsequently convincingly refuted. When Ioannidis narrowed the focus to the very pinnacle of the research pyramid—49 of the most highly regarded medical research findings of the past 13 years—he found the same problems.

The causes are varied and complex, including researcher bias (and sometimes even outright fraud), publication bias that highlights certain types of findings and buries others, inadequate statistical procedures, and of course financial conflicts of interest when pharmaceuticals are tested.

“Medical research is not especially plagued with wrongness,” says Freeman. “Other meta-research experts have confirmed that similar issues distort research in all fields of science, from physics to economics (where the highly regarded economists J. Bradford DeLong and Kevin Lang once showed how a remarkably consistent paucity of strong evidence in published economics studies made it unlikely that any of them were right).”

Does any of this bear on the credibility of microfinance RCTs? I could speculate about some differences.  For instance, I wouldn’t expect financial conflicts of interest to very much of a problem in current microfinance RCTs. And publication bias may be lesser; after all, a major reason that Dean Karlan and his buddies started IPA was to carry out research that academics would have a hard time getting published.

But I’m a statistical illiterate with no business opining on these issues.  Watch this space tomorrow for Jonathan Morduch’s much more informed reflections on the matter.

In an August 22 post on DevFinance Dale Adams opined that my CGAP paper on impact “dismissed” expressed demand (also called “revealed preference”) as a way to find out if microcredit helps borrowers:

“In an otherwise excellent note [thanks, Dale!], Rosenberg dismisses expressed-demand as an indicator of the usefulness of microloans: (CGAP, Focus Note No. 59, “Does Microcredit Really Help Poor People?”). This leads him to conclude that more rigorous (and costly) studies are needed to measure the benefits of microloans…. 

My first concern is with the comparison he uses to justify dismissing the votes-people-make-with-their-feet as a measure of the usefulness of loans to borrowers.   To support his claim he says that ‘…repeated use does not by itself prove that a service is benefiting users.  No one would make this argument about repeated use of heroin, for example.’  He goes on to mention that borrowers might be caught in a debt trap and seek loans to keep their heads above water.

Using comparisons, analogies, and parables can be useful (and tricky) in making a point, but equating loans to a habit-forming drug is a stretch.  Does CGAP really want to take the position that microloans are habit forming and therefore dangerous to the health of borrowers?   Even if a tiny percentage of borrowers do fall into debt traps, is it useful to extend the habit-forming analogy to cover all microborrowers? Should we think of the millions of women who take loans from the Grameen Bank as addicts?”

That’s how Dale read it. On the other hand, a May 17 New Yorker article quoted prominent researcher Esther Duflo as saying that our position was “moronic” precisely because it embraced (!) the expressed-demand argument. 

(Were Drs. Adams and Duflos both reading the same paper?) 

I thought the paper expressed a middle position. On the one hand, I used the admittedly extreme example of addictive substances to make the point (a correct one, I think) that you cannot automatically assume that repeated use means something is good for someone.  However, the whole discussion both before and after the sentences that worried Dale was a series of arguments about why we should take the revealed preferences of micro-borrowers (and especially micro-repayers) seriously as evidence that they benefit from their loans. I ended with the point (also correct, I think) that the revealed-preference arguments I was making do not conclusively settle the matter. And that therefore further research would be a good idea.

Rigorous impact studies are fairly expensive–the only on whose price tag I know was high six figures. But I find it a little hard to take this seriously as an argument against more studies.  As a percentage of the mutiple billions that donors and socially-oriented investors have already spent on microfinance, the cost of impact studies is inconsequential. Given how much we still don’t know about what kind of impact all this investment is producing, I think further research makes pretty good sense.

What’s the moral of this little story?  That impact is a really complicated topic? Or maybe just that I should work at writing more clearly?

Richard Rosenberg

(Plus afterthoughts on mission drift and the quality of Bangladeshi microcredit products.)

I recommend reading David Roodman’s blog from last Wednesday about framing a “bottom line” verdict on microcredit.  I was particularly interested in his concluding observations:

…[W]hile high-quality impact studies are valuable, they can never give us the whole story, for each is a static snapshot. (Often, it should be said, of impacts at low doses, because randomized trials are often performed as MFIs roll out services to new customers, which in microcredit means making those small first loans.) Much of the story of the impact of credit lies in the dynamics of the market, how it evolves over time, as we have just seen here in the United States. You don’t understand those through traditional impact studies.

It also means, by the way, that impact studies ought to report doses and impacts with equal prominence.

Some would argue that USAID’s AIMS impact studies did not successfully screen out selection bias.  But my recollection is that the impact that they found (whether truly caused by the microcredit or not) tended to be associated with a series of loans, not just one, let alone the initial MFI loan that is often far below what the client wants and can handle.  That doesn’t mean that we should ignore the results of randomized trials that cover 15 or 18 months of entering clients’ experience.  But it does suggest that longer-term results, if obtainable, should be a lot more significant.

While we’re on the subject of small initial loans…  People tend to see loan size as a rough proxy of client poverty, which appears to be more or less true as long as you say the word “rough” very emphatically.  But the first few loans that an MFI makes to a client typically reflect, not the client’s ability to use and repay the amount, but rather the MFI’s risk management policy (i.e., we’ll give the client more serious money only after she’s established a good track record in repaying little—i.e., low risk—loans.)  This is one of several reasons why it is a serious mistake to view increase of average loan size as ipso facto evidence of mission drift in an MFI.

When Compartamos started out, no client could get an initial loan bigger than $50.  After some years of great loan collection performance, management decided that they could loosen the reins a bit, and give clients the choice of a range of initial loan sizes, from $50 up to several hundred.  Once the new policy was implemented, almost no one chose a $50 loan, and most new clients took the maximum loan size.  This produced a big increase in average loan size, which had nothing to do with the poverty level of the incoming clients.

Microloans per 1000 households (or per 1000 poor households) are a lot higher in Bangladesh than anywhere else.  Why is the country such an outlier, with some other countries appearing to approach market saturation at much lower levels?  And why haven’t we seen more signs of price competition and pressure on profit levels in Bangladesh, given that large percentages of potential clients have access to multiple providers.  My speculation is that both of these things may reflect MFI loan size policies that are not well matched with client needs and repayment capacity.  Anecdotally, one hears that there are very high levels of multiple indebtedness in Bangladesh.  But I’ve seen a couple of studies reporting that in Bangladesh, unlike most other countries, multiple indebtedness has not been strongly correlated with repayment problems.  Maybe the MFIs are handing out loans that are too small, forcing clients into the hassle of going to multiple MFIs to borrow an amount that fits their needs and repayment capacities.  If I want loans from all three MFIs in town, the fact that one of them charges a little more interest than the others is unlikely to deter me.  In an environment like that, one wouldn’t expect to see much price competition.

If any readers have any data bearing on this speculation, I’d be very interested to hear about it.

To the Editor of the New Yorker

Dear Sir,

As I read the excellent May 17 article  on Esther Duflo and her randomized evaluations of social policy tools, I was surprised to find CGAP (a World-Bank affiliated research and policy center for microfinance) lumped together with the microfinance networks that have been discounting the results of recent studies by her and other randomistas. On the CGAP blog, I have been criticizing—tactfully, I hope, but clearly—the defensive reaction of these networks. Far from discounting randomized trials, CGAP has been supporting them to the tune of $1.2 million of our own money and funds we raised from our members.

Prof Duflo dismissed a line I had written (Does Microfinance Improve Their Lives? The Poor Say Yes) as “the moronic revealed-preference argument,” that is, the argument that if people keep using something it must be good for them. The offending line occurred in a position paper I wrote  for CGAP. It was the title of a section that included the statement: “Of course, repeated use does not by itself prove that a service is benefitting users. No one would make this argument about repeated use of heroin, for instance. People do not always borrow wisely.” 

The CGAP paper clearly acknowledges that randomized studies by Prof. Duflo and others have raised fundamental questions about the claim that microcredit raises incomes and consumption, lifting poor people out of poverty—so much so that funding solely on the strength of that claim would not be justified at present. The paper then argued that there were reasonable (not conclusive) grounds to think that microfinance at least helps poor people to cope with poverty, for instance by smoothing irregular consumption and cushioning against shocks.  Consumption gaps and uncontrollable calamities are serious problems for poor people. They place a high value on financial tools that help them cope with these problems. And well-executed microfinance can create such tools at very low cost in terms of public subsidy. Finally, the paper recognized that these arguments need to be tested by further research.

Richard Rosenberg
Senior Adviser, CGAP

A recent blog by Chris Dunford and colleagues at Freedom from Hunger–Different Levels of “Knowing” the Impact of Microfinance–struck me as balanced and insightful.  It recognized, with a refreshing lack of defensiveness, that evidence from randomized controlled trials is essential (not just useful) for testing claims about the effects of microfinance.  At the same time it insisted—correctly, I think—that practitioner experience during years of work with poor clients constitutes real knowledge.

Maybe the question is “knowledge for whom?” For instance, my own 27 years of unsystematic experience with a variety of development funding agencies have left me with some conclusions regarding them that I feel very confident about—confident enough to base career decisions on those conclusions. But it’s quite another matter to communicate that knowledge publicly in a way that justifies others who haven’t shared my experience to be equally confident about those conclusions, or to accept my conclusions rather than differing conclusions that someone else might be offering. That’s why we need social sciences.

On another subject, Chris recognizes that in the real world individual stories raise more funding than statistics do. So none of us should complain if fund-raising brochures are long on anecdotes and short on regression analyses.  At the same time, I think Chris would agree that stories which may be appropriate in a fund-raising brochure are much more problematic when they are trotted out as evidence in a serious discussion about how we can know whether microfinance is effective or not.

I’m sensing an upsurge of interest in small and medium (as distinct from micro) enterprise.  There’s talk of a “missing middle”—the underserved hole between conventional finance for big-business fat cats and microfinance for tiny low-income entrepreneurs.  The list of reasons to support SME starts with the well-documented role of such enterprises in job creation, and goes on from there.  Certain folks over at the World Bank and elsewhere are asking whether development funders ought to organize some sort of consultative group, á la CGAP, for SME.  I don’t have a view on that question, but I do have some observations and impressions.

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