This Will Make You Understand Why Microfinance Is Not Lifting People Out Of Poverty (4/5)
MICROFINANCE, A LOVE STORY PART 4: REALLY GETTING TO KNOW EACH OTHER
So far we have covered the origins and core working principles of microfinance, discussed the controversies that almost destroyed microfinance’s development credibility. But general psychological perception and human emotion apart, what does research say? Microfinance seems to have the potential to solve many issues of the poor by securing them with funds — when and where as needed — to smoothen consumption, provide disaster aid, invest in businesses, or simply prepare for a rainy day. Of all, business sector incubation has the most potential to facilitate poverty eradication, by inevitably giving way to commercial activities, raise in employment, and reinvestment of business profits. This part will look a bit closer on the evidence behind this possible effect.
In 2011 the UK Department For International Development(DFID) conducted a large systematic review of then existing microfinance studies which claimed that microfinance had a positive impact on the poor. Its main focus was the methods employed to prove positive correlation in these microfinance studies. It was designed to clarify misconceptions and provide concrete evidence to the impact of microfinance, once and for all.
Interestingly enough, an examination of both the studies and their literature research revealed that no study before 2010 has ever measured real, positive impact of microfinance on the income of the poor.
The World Bank forum 2015, Financial Services for the Poor: Lessons and Implications of the Latest Research on Credit, looked into latest research using randomized controlled trials between 2010–2015.
Randomized Controlled Trials
If this sounds familiar, it’s probably because of this article. A Randomized Controlled Trial (RCT) analyzes the effect of treating a group(treatment group) with a specific measure, and comparing it to a non-treated second group(control group).
Compare this with how medical researchers give half a sample group a placebo pill, and the other half a dose of actual medicine. The subjects of the two groups are chosen at random such that on average you are able to compare both groups and can conclude whether a certain treatment had effect and how large that effect is compared to the group that did not receive the treatment.
In our case it would translate to something like: offering credit to 100 people in a village while the other 100 are not. Or, where 50 villages receive credit while 50 others do not. Below is a summary of five recent randomized experiment studies presented at the World Bank Forum. Note that we only factor the location, the target group, the level of microloan uptake, and what the reported impact on income.
The table clarifies there is no great positive impact on incomes of the poor, which is the most widely used indicator in determining the ability of microfinance to lift people out of poverty. Several in India used microcredit to repay old loans while in Morocco, lots dropped out of their enterprise in spite of the very high returns on microloans.
Why was it so? Maybe they didn’t want to run a business — it is stressful and requires effort. Some households actually lose money due to variability in their businesses and become more risk-averse, refusing loans and/or closing businesses.
Ethiopia had a very low uptake in the loans. The authors believe the low market activity in rural Ethiopia did not demand microcredit since there simply isn’t much to spend on; Or that the real employment of the microfinance was poorly recorded. Similar stories can be said for Mongolia and Bosnia and Sergovina
“Most people are entrepreneurs by force — not by aspiring nature , but due to lack of jobs”
The articles pertaining to all the five specific locations and their literature review hasn’t quite satisfactorily explained the drastically low impact microfinance seemed to have on people’s income. The microloans are expected to boost investment in profitable businesses. But, from personal field visits and interactions only proved one thing: Being an entrepreneur is not a common aspiration, or reality. Most often it is a push-comes-to-shove situation that births these entrepreneurs.
“Taking up a microloan can simply make people happier, financial standing not changing”
Whatever little uptake exists in loans, is used up in managing hassle-free cash flows when needed; It helps the poor better absorb emergencies and shocks. It lets them repay a different loan, or simply use it for additional consumption — say, buying a TV. It can simply make them happier for reasons not related to their incomes. In this perspective at least, microfinance looks successful; Or modestly put, it is quite “useful”. Like any other financial product.
Organisers of the same world bank forum also argue that microcredit have rigid regulations. Most MFIs have a zero default rate policy, only blend specific loan sizes, and insist upon strict repayment schedules out of sync with the borrowers’ earning periods. Farmers, for example, enjoy large cash flows during harvest and struggle with it during the seed planting season.
“Risk-averseness of the microlender is transferred to Self Help Groups”
The Self Help Group concept deserves a mention here. MFI rules state that groups that defaulted before are not eligible for a new loan. The MFI’s risk averseness is transferred to the group, thus diminishing their odds of thriving as entrepreneurs, in the process making them riskier borrowers.
Are Randomized Controlled Trials without Trials?
The reasons behind the low uptake, income & job generating impacts of the loans are still fuzzy. The Randomised Controlled Trials are of course, not perfect, and subject to disadvantages associated with social experiments that influence results. I put forward what I think are the four most critical disadvantages:
- It raises the necessary ethical concerns: Are we to not offer microfinance to someone in need of it purely because he/she is not in the treatment group? In some of the studies some from the control group did get a microloan. The researchers controlled for this, but the real result becomes more blurry.
- RCTs are expensive, elaborate, and operation-intensive studies, often with a lifespan of 2–4 years. While this might seem long for a study, it is actually short relative to the long term life of the program. But these long-term effects could deviate largely from current results, never be executed, or obtainable at all.
- The results are also limited to the context of the experiment’s location. The same microfinance model could work miracles in district1_country A, and emerge a spectacular disaster in district2_country B. So to what extent can these results be generalised? You can access Esther Duflo’s to this question in this video. In short her answer is: you need many more experiments in different regions of the world.
- The implicit bias of an RCT: what you look for is what you get. The focus of the RCTs was on finding the positive impact. Although it seems to be non-existent or modest, it completely ignores potential harmful side effects like indebtedness, and the ensuing problems. Or even positive effects that fall out of the study’s main purview.
Let’s now look at another ongoing research employing more of an anthropologic method in understanding the financial lives of the poor.
Financial Diaries: Portfolios of the Poor
Portfolios of the Poor(ongoing) uses financial diaries to exactly track how poor households spend and earn their money. It is a combination of large one-time surveys and small-scale anthropological studies.
They do this in India, Bangladesh, and South Africa, to derive learnings of their finances bottom-up. They review current available financial products, analyse success factors of the Grameen Bank (the one set up by Muhammad Yunus), and attempt to improve microfinance, and related financial products.
One such story is Sita’s. When faced with her son’s sudden illness and daughter-in-law’s death, she struggled to both scrape money from her neighbours and access her fixed deposit. Banks don’t grant access to fixed deposits before they are due without paying a high penalty. Sita’s only remaining option was to sell her profitable farmland.
There is thus a mismatch on both sides; a sudden shock in the lives of the poor cannot be coped with an inflexible financial product from formal lenders. Modern companies can access a credit line when they face a sudden need for cash flow for say, dealing with a large order that comes in and they need to finance the production in advance. A flexible lending (or saving) facility could have helped Sita with her liquidity problem. Liquidity stands for the measure of cash flow that can be obtained.
Financial Diaries observed that microcredit designated for entrepreneurial activities is largely spent on unrelated matters like food, emergencies, and paying off old debts, thus supporting the findings of the RCTs. Important to note is, that there is thus also a mismatch in the type of loan received and its mode of employment.
It is common knowledge that financial institutions offer reliability. Formal lending with all its regulation, minimises the risk of accountability in safe savings and fair terms; Informal lending, though relatively more flexible, doe not boast of this security.
Conclusions so far….
RCT studies think microfinance doesn’t live up to its promises of lifting people out poverty, though it is still a product of demand and utility for the poor. The Financial Diaries agree with this and on top of it recognise the inflexibility and the mismatch of the microfinance products clearly. Hence, microfinance is not sufficient in its current form, and by far, not effective in lifting the masses out of poverty.
Upcoming: Final Part — Divorce or work on it?
So microfinance is not delivering the impact it promised. It also does little harm: It still adds value to the lives of the poor, even with the inflexible financial services, or the lack of them. In the final part, we will review the lessons learned so far: Should we abandon microfinance or simply improve its operating flaws?
Many thanks to Ramyaa Bommareddy, Shahzeb Yamin, Supriya Krishnan and Sabine Kleve for their valuable input and patience in developing this series on microfinance.
