Microfinance Reform Could Lift More People Out of Poverty

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SEATTLE — In 2006, microfinance became the darling of international development. Supporters were enthusiastic about its potential to lift millions out of poverty through small loans that would turn destitute workers into budding entrepreneurs.

Muhammed Yunus — the Bangladeshi banker who pioneered the concept and founded the Grameen Bank, the world’s first major microfinance institution — received that year’s Nobel Prize for his efforts “to create economic and social development from below.”

However, fast forward ten years and microfinance’s luster has faded significantly. Yunus continues to face legal issues thanks to an ongoing feud with the Bangladeshi government. Moreover, a growing number of critics are starting to question microfinance’s ability to effectively fight poverty.

Though the United Nations, the World Bank and many other organizations still consider microfinance a vital development tool, they also think the industry is ripe for reform.

A good place to start would be recognizing that microfinance is not for everybody. According to The Economist, though there is significant evidence that microfinance does help the poor, it does not help them equally. The publication cites one recent study conducted in rural Mali which suggests that some people simply lack the skill and motivation to be micro-entrepreneurs, even when provided with the same financial resources.

The study’s authors also conclude that microfinance’s rates of success are somewhat deceiving because of what they call a “self-selection” effect: those who apply for microloans tend to be those who are most likely to use them productively and successfully.

Other economists have made similar findings.

“It is likely that people who choose to join [microfinance institutions]MFIs would be on different trajectories [than those who do not]even absent microfinance,” notes the Institute of Fiscal Studies in its 2013 paper “The Miracle of Microfinance? Evidence from a Randomized Evaluation.”

Another issue is increased over-indebtedness. According to CGAP (Consultative Group to Assist the Poor), a non-profit housed in the World Bank, MFIs initially had little problem with borrowers repaying their loans. But as the industry expanded and began adding riskier clients to its portfolios, the number of defaults rose as well. In 2010, a wave of defaults precipitated a crisis in India’s microfinance sector–and a string of suicides among poor Indian farmers that prompted calls for reform.

Even in less dramatic examples, MFIs are often focused more on profits than the personal well-being of their clients. As CGAP noted in a study of Ghana’s microfinance sector, “many borrowers only manage to repay their loans on time because they go through unacceptably high personal sacrifices…[W]hat looks as a success from a risk management point of view because it keeps portfolio quality high is a serious concern from a social point of view.”

Thankfully, many proposed solutions to microfinance’s woes would address both these problems. One is to place a greater emphasis on “group lending,” where many households are collectively responsible for their debts. This would both help individuals who otherwise might not benefit from microfinance and reduce borrowers’ risk of default.

Another important step is to strengthen consumer protections. According to Economist Intelligence Unit, a sister company to the magazine, this is one thing that most countries with established microfinance industries lack, though several are making efforts to address the problem.

For example, a number of Indian MFIs recently set up a credit bureau intended to monitor their clients’ debt levels and credit histories and prevent them from taking on too many loans. The government has also launched a campaign to boost financial literacy, especially among the country’s rural poor.

Once regarded as a panacea for world poverty, microfinance clearly has shortcomings. But it has also helped many people start their own businesses and create better livelihoods for their families. Reform could help make microfinance more effective and spread these benefits to more people.

Matthew Housiaux

Photo: Flickr

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