Five reasons why microfinance is in crisis – and why it matters

The popular anti-poverty scheme of providing small loans and other financial services to poor people, generally known as microfinance, is in crisis.

“In one sense, you could say it’s a coming of age,” says Alex Counts, CEO at the Grameen Foundation, a leading non-profit microfinance organization with offices in Seattle and Washington D.C.. “Controversy often comes along with growing in size and impact.”

You could also say microfinance is actually suffering from several different crises: An external appearance of a crisis based on a damaged public image; a related, but slightly different, internal “identity crisis” and, at least according to one leading observer, a cash crisis in reverse — too much money.

Here are five reasons for the crisis:

  1. Microfinance has grown rapidly, from a simple anti-poverty program into a major player in the financial industry.
  2. Some now view microfinance primarily as an investment opportunity, with reducing poverty as either a secondary goal or not really the goal at all.
  3. Microfinance is a multi-headed creature with no agreed-upon strategy or approach.
  4. There is no consensus on how to measure “social performance” — for donors to tell the difference between a program focused on poverty reduction from one focused on maximizing profit.
  5. The evidence that microfinance does bring people out of poverty is mixed. Some say it has helped millions of poor people, mostly women. Others say it hasn’t and is, in fact, a debt trap for the poor.

All of these points, and most of the arguments, tend to circle back to the pioneer of microfinance, or microcredit, the Nobel Peace Prize-winning Bangladeshi economist Muhammad Yunus.

Muhammad Yunus visits with fans Seattle Town Hall May 2010

Yunus used to be golden, uniformly regarded as almost the patron saint of the anti-poverty movement. He still is seen as such by many of his supporters.

But Yunus is also in a bit of trouble these days, fighting off a push by politicians in Bangladesh to force him out of the Grameen Bank (his pioneering microfinance organization). The push comes after a film-maker’s allegations of corruption and the increasingly popular refrain among critics that these microloans hurt rather than help the poor — even driving some debtors to suicide.

Many in the microfinance industry see the power struggle in Bangladesh as more of a political sideshow, unjustified but more importantly unrelated to the real challenges facing the field.

Still, the fight in Dhaka doesn’t help the image of microfinance, which had already been reeling from a controversy in the world’s biggest microfinance market in the Indian state of Andhra Pradesh.

A long-simmering power struggle in India — characterized by government allegations that micro-lenders were abusing the poor and micro-lender allegations of politicians wanting a slice of the financial pie — blew up after a leading for-profit firm there, SKS Microfinance, went public seeking shareholders and potential huge profits.

That set off Yunus, who has long been concerned that some are trying to shift his anti-poverty scheme away from its social mission towards a more profit-oriented commercial enterprise. The outspoken Bangladeshi economist didn’t mince words; he condemned it as “loan sharking” and asked them to stop calling it microfinance.

Beyond the attacks aimed at the iconic father of microfinance, the controversy in India reverberated globally.

In Seattle, the abrupt closure of the for-profit microfinance firm Unitus — which had invested in SKS and took in huge profits when it went public — remains unexplained. The possibility that these people who claimed to be fighting poverty just took the money and ran continues to disturb the local microfinance community here.

Is microfinance losing its way?

Is what’s happening to Yunus a symptom of a humanitarian cause that has either failed in its mission to help the poor or, conversely, is so successful financially it is being taken over by the greedy?

“There is a crisis caused by all the negative press, but I don’t think the industry itself is in crisis,” said Elisabeth Rhyne, a senior vice-president for the microfinancier Accion International. “This whole debate about profits is more of an ideological battle than about what is working and what isn’t working.”

Grameen’s Alex Counts agreed that for-profit groups can still have a social mission. But he said there is no question some microfinance organizations have been more focused on making a profit rather than reducing poverty. Excessive profit-seeking has certainly caused a lot of consternation if not an actual crisis, he said.

“I think many have skewed more toward commercially motivated capital, away from the social mission, and that this is dangerous,” Counts said.

Both said part of the problem in microfinance is that it has grown rapidly as a branch of the financial industry but without a clear definition of “social performance” — basically, what makes microfinance different from other kinds of financial services. There are also as yet no clear, uniform standards for assuring poor borrowers are protected against the kind of abusive lending practices that set off the conflagration in Andhra Pradesh.

Rhyne said everyone agrees that there is a need for these measures and standards. She is one of those leading in this effort known as the “Smart Campaign,” an effort which aims to have consumer protection standards in place by the end of this year

“But, yes, right now it’s pretty mushy,” she said.

David Roodman, an independent analyst of microfinance rather than a practitioner based at the Center for Global Development in Washington D.C., says the primary reason for the current challenges (everyone likes to avoid the word “crisis”) facing microfinance stem from its rapid growth as an industry, this lack of precision as to its intended social good and, lately, just too much money for easy credit.

“We all know why easy credit is bad,” said Roodman. “Whenever credit grows too fast it’s dangerous whether the motive is to be generous or make a profit.”

“In India, they grew too fast and this certainly led to the crisis,” he said. Yunus is partially correct that some engaged in excessive profit-seeking, Roodman said, but he agreed with Rhyne that there is nothing inherently wrong with making a profit if it can be shown to be serving the organization’s clearly defined social purpose.

Unfortunately, all agreed, much remains poorly defined and unclear about microfinance right now. This was be supposed to about reducing poverty.

“But there’s still little rigorous evidence that microcredit reduces poverty,” Roodman said. The most convincing studies that found little evidence, he noted, only ran for 18 months so you could likewise argue they didn’t really disprove these loans can, over a longer time period, help the poor.

Given all of this uncertainty, how can someone who wants to support a microfinance organization know which one will make the best use of your donation?

“Actually, that’s part of the problem right there,” Roodman said.

The idea of microfinance as if it is some sort of grassroots humanitarian initiative is largely an obsolete notion, he said. Sure, you can give $100 to an organization like Kiva.org based on your belief that you are making a personal connection in microfinance.

But, as Roodman has written, this is based on Kiva’s misleading sales pitch appealing to your mistaken idea of how microfinance works and the fact that it is rapidly becoming a major financial industry in its own right.

That’s neither good or bad, he says.

“It’s just that we need to move away from the old idea of microfinance,” Roodman said. “Building a bank with a solid and sustainable portfolio that serves the poor is not nearly as exciting or appealing as donating to Kiva, but that’s what’s needed.”

Share.

About Author

Tom Paulson

Tom Paulson is founder and lead journalist at Humanosphere. Prior to operating this online news site, he reported on science,  medicine, health policy, aid and development for the Seattle Post-Intelligencer. Contact him at tom[at]humanosphere.org or follow him on Twitter @tompaulson.