Microfinance not a quick escape from poverty, studies show

Microfinance group meeting in India. (Credit: Tom Murphy)

For years, microfinance has been touted as a way to “empower people around the world,” as leading microfinance organization Kiva puts it.  Stories are told of people from all parts of the world using microloans to start businesses, create jobs and help their families. That happens sometimes, but there is now evidence that the average person who takes a microloan does not see much change at all.

Six studies from different parts of the world, published today in the American Economic Journal: Applied Economics, all find that microcredit is not an effective tool at helping people escape poverty. The findings corroborate calls that microfinance advocates have oversold the benefits of providing loans to the world’s poor, especially women.

“Microcredit is a useful and generally beneficial product. It is not a one-stop get-out-of-poverty card,” said Timothy Ogden, managing director of the Financial Access Initiative at NYU, in an interview with Humanosphere. “This research does not say that financial access in general does not help much. It says credit is not sufficient to quickly move people out of poverty permanently.”

A lot of financial offerings fall under the microfinance umbrella, but it is the small loans that are championed and often synonymous with the term microfinance. Microfinance grew in large part due to a seminal study nearly 20 years ago that found significant positive benefits for women who were given loans. The study has since come under question and it will persist thanks to the collection of new research. Overall, the studies found that women were not more empowered nor was more money spent on things like child education in families that received loans.

Randomized control trials were used to determine what happened when people in Bosnia and Herzegovina, Ethiopia, India, Mexico, Mongolia, and Morocco took out microloans. They were conducted independently of one another and covered a total of 37,000 people. All six showed that loan recipients experienced “modest, but not transformative, improvement” in their lives.

Table: Study Results Compared (click to expand)
Microfinace study table 1

Microfinace study table 2

Microfinace study table 3

“One of the things that is interesting is how consistent the findings are, based on very different contexts and even quite different products,” said Ogden. “It can boost your confidence a lot that we got this right. But, it is equally important to know that people are not being harmed.”

DSC08933One study was conducted in rural areas of Morocco in 2006. It expanded access to micoloans, which more people used. The results were mixed. Income through self-employment increased overall, in part due to investments in things like livestock. However, income from other work, such as day labor, decreased. The increase in self-generated income was essentially offset by the decline in income from other work, the researchers found. They also noted that businesses already making good money were helped by the loans while businesses with small profits were not.

The other research showed the same varying results. Research in Mexico saw modest positive results and in Ethiopia the majority of people experienced no impact. While the papers show improvements brought by microloans are small, they are causing some level of positive change.

“Microcredit has a lot more evidence of usefulness than other poverty programs that are marketed in the same way,” said Ogden

The industry came under storm five years ago when reports of debt-fueled suicides in India’s Andhra Pradesh state led to a backlash against microlenders. A confluence of unrestrained growth of lenders coupled with sensationalized stories, based in some bit of truth, sent ripples through the industry. The ouster of Muhammad Yunus, who won a Nobel Prize for his pioneering work on microfinance in Bangladesh from his Grameen Bank, was one of the high profile results of the crisis.

Microfinance as a whole has come back from those events. While concerns about pressures applied by loan sharks on borrowers persist, the larger story is that well-managed micro loan packages do not cause harm on average. What comes next, agree Ogden and the authors of a paper introducing the research, is that industry must find ways to maximize the potential positive impacts and calculations are needed to determine whether microloans are a cost-effective investment for donors.

“These loans do help, but the changes are not transformative, certainly not transformative enough to justify charitable donations to the standard microcredit model. We have seen, though, that these are viable profit-making products, and so investors interested in a double-bottom line should take note,” said MIT economist Esther Duflo, co-author of two of the studies, in a news release.

DSC08892Lending will still appeal to investors, Ogden said. While cash transfers have emerged as an alternative with significant impact, there are people and organizations looking to make a financial return on investment. That is something loans can provide as opposed to just giving people money. The new research helps open opportunities for considering new ways of lending.

“With an industry the scope and size of microfinance, you are not going to see rapid change,” Ogden said. “The real opportunity for change is for microfinance institutions to start another round of innovation of products to maximize the benefits. Recognizing that it is a more humble goal, but there is plenty of ways to tweak what they are doing.”

Examples of such tweaks include allowing breaks for repayments, shorter loans, changing when loan cycles begin and more. Such changes could help people use their money to generate more income and increase the overall effectiveness of microcredit. It also means looking beyond credit and towards the suite of options made available through microfinance in general.

“We must think beyond the standard microcredit model. Modern microfinance—savings and insurance, and more flexible credit products—often has generated larger impacts than simple credit,” said Dean Karlan an economist at Yale University, founder of Innovations for Poverty Action, and co-author of the Mexico study, in a press release. “Financial services can make important differences in people’s lives, but we need more innovation and evidence to determine what is best to do, and meanwhile we should set our expectations appropriately.”

Taken together, the research is by no means a death-knell for microfinance or even microcredit. Center for Global Development’s Justin Sandefur blogged today that the studies do not answer the question as to the impact of microcredit. It is a question that is likely impossible to answer, but the new studies move us a lot closer to knowing what happens.

“The bottom line is that policymakers should be extremely cautious in extrapolating the results of impact evaluations across contexts.  Notably, the authors in this new AEJ volume focus on nuances and underlying mechanisms, and carefully avoid such extrapolations,” Sandefur wrote.

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About Author

Tom Murphy

Tom Murphy is a New Hampshire-based reporter for Humanosphere. Before joining Humanosphere, Tom founded and edited the aid blog A View From the Cave. His work has appeared in Foreign Policy, the Huffington Post, the Guardian, GlobalPost and Christian Science Monitor. He tweets at @viewfromthecave. Contact him at tmurphy[at]humanosphere.org.

  • Bob Spencer

    Most of the time, inserting just one new factor is not sufficient to cause significant change. I would like to see samples of any assessments to determine all or most of the complex factors in a person’s or a community’s life that play a part of rising out of poverty. What is done to deal with the multiple factors?

  • Isabel Whisson

    Agree with Bob. At BRAC which is a large provider of microfinance we believe strongly in the need for other interventions that address the complexity of poverty. With that said, even within microfinance there is a huge amount of scope to meet the needs of the poor, that goes beyond simple microcredit, and impact studies should start to give these greater attention.
    A response by BRAC to the RCTs can be viewed here.
    http://blog.brac.net/2015/02/the-best-studies-on-the-impact-of-microcredit-remain-inconclusive-where-do-we-go-from-here/