The Limitations of Microfinance

If you pay any attention to economic development in the third world, you have heard about microfinance. It’s the hottest thing going. Development organizations announce their involvement in microfinance with a kind of sacred hum. People are appropriately fascinated by the rise of Kiva.org, a website that enables you to engage in microcredit from the comfort of your computer chair.
Microfinance organizations offer financial services to people too poor to attract the services of traditional banks. They offer small loans—microcredit—and may also offer savings accounts, insurance, and fund transfer services. For example, I wrote a forthcoming article for Christianity Today Magazine about a wonderful Filipino group called CCT. The article features a woman named Cindy Caro who first borrowed $85, which she put into a processed meat business, selling hotdogs, sweetened beef and pork, ham and spiced beef door to door. Now she operates a small store.
Some microcredit organizations place borrowers in small groups that meet together and guarantee each other, so that nobody can get a second loan until everybody in the group has repaid their first loan. Peer pressure and peer encouragement help borrowers stay on task. They are less isolated and less prone to discouragement.
I’ve been amazed how many organizations have taken up microfinance. They all offer stories of families transformed by small businesses made possible through small loans—usually less than $100, at least to begin. Women buy supplies or equipment with these loans and (typically) make and sell food, leather goods, or clothing. Their profits enable them to send children to school, provide food for the family, improve their homes, and build an expanding business.
Without question, microfinance is a wonderful development. Still, its quick rise to prominence, and its adoption by practically every last development agency, says a lot about how tough development is. They must not have had very effective tools, if they are all so eager to adopt this new one.
Microfinance promises to be something different—an approach that really does transform lives and communities. Here’s a short list of the benefits of microfinance:

  • –Taking out loans, buying insurance, and saving money all teach people how to be future oriented. Instead of living day to day, they have to think about their lives into the future, plan for the future, make sacrifices in anticipation of a better future, and work toward improved lives. This is the essence of capitalism. It is worth noting that development agencies that have historically had mixed feelings about capitalism are devoted to teaching small-scale capitalism through microfinance.
  • –Microfinance helps women. Almost all micro-borrowers are women, who develop home businesses. Women are generally more responsible than men, as any development worker will tell you. They use their profits to feed and educate their children, instead of blowing it on booze and gambling. In many patriarchal societies men control all the resources, and waste them. Microfinance gives women some power over their own lives, which they often use for the benefit of their families.
  • –Because many microfinance programs rely on peer pressure and peer support, they promote community building and mutual accountability. A culture of responsibility and encouragement can be built up.
  • –Microfinance programs can be self-funding. Some microfinance organizations even operate successfully as for-profit banks. For charities, there’s the prospect of investing once and moving on, rather than continually pouring resources into a bottomless pit.

However, microfinance has its limitations. This you won’t probably learn from the websites of development organizations.

  • –Microfinance helps women. That’s good, but not good enough to transform communities. Communities are formed of equal parts of men and women, who have a strong affinity for forming bonds with each other. Development that helps women but doesn’t involve men has a natural self-limitation. You can’t have transformational community development without transforming men and women. (For more on this, see my article “Where are the Men?” http://www.christianitytoday.com/ct/2005/august/23.41.html)
  • –Microfinance is small scale. True, small businesses become large businesses sometimes. But more often they don’t. A family may be greatly helped by the extra income from selling sandals at the market. Creating something larger, something that fully supports the family and creates jobs, is rare. (This is probably one reason men don’t participate. They are attracted to larger enterprises outside the home.)
  • –Microcredit loans are expensive. Interest rates charged by microfinance programs are often over 20%. They have to be, because overhead is high for administering tiny loans. That means it’s hard for borrowers to make enough profit to really get ahead, after they pay loan costs. My friend Wachira counsels poor people to start with what resources they have or can borrow interest-free from family members.

Certainly all microfinance organizations tell amazing stories of family transformation—and sometimes even of community transformation. When you hear those stories, though, keep in mind what I call developmental cherry picking.
In every community, whether rich or poor, there are a few people who are naturally curious, adventurous, and adaptive. Their lives may be indistinguishable from their neighbors’ because there have been so few opportunities in their community. But as soon as some outside force comes into the neighborhood, they see opportunities and take them.
If you read missionary stories from earlier times you will often learn of such people. When missionaries came into their community the early adopters sent their children to the missionary school, they tried missionary medicine instead of traditional remedies (sometimes violating their own community’s strongly-held customs), and they adopted European agricultural methods. In these missionary stories a common plot development has to do with the difficulty of getting the rest of the community to stop persecuting these early adopters, but to follow their example.
Similarly, when microfinance programs go into an Indian slum, they will unfailingly find people who seem to be waiting for just such help. They not only take loans, they build businesses. Their transformed lives make great stories, and since they appear just like other slum dwellers, it seems as though microfinance will transform other lives too, as it spreads.
It’s not necessarily so. Others will take loans, which will help them augment their incomes, but microcredit won’t necessarily change their lives. As I understand it, research studies have yet to demonstrate the power of microfinance to alleviate poverty. There’s a big difference between transforming early adopters and transforming everybody else.
Which brings me back to an earlier point: development is tough. Where it happens on a large scale—in China, Taiwan, Korea, and Vietnam in recent decades, in Europe and America many generations ago—it is not brought about by agencies. There is some combination of opportunity (usually brought about by a decent government) and a widespread cultural mindset and mood. We don’t know how to develop those. Microfinance helps teach future thinking and planning, and that may contribute to a large-scale cultural shift. But nowhere is it written that alleviating poverty on a small scale naturally leads to community transformation.
Our job is to help people in need. Microfinance is a good way to do it. But don’t think it’s the final solution. We’re still looking for that.

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4 Responses to “The Limitations of Microfinance”

  1. chasta Says:

    The impact of microfinance programs in notoriously hard to credibly measure, because of all the problem of endogeneity, including what you mention about the entrepreneurial types self-selecting as microfinance participants. My microfinance prof says there are very few good microfinance impact papers, but he does like this one: http://www.microfinancegateway.org/p/site/m/template.rc/1.9.34827/ It shows a mixed picture in line with this blog post.

  2. jun Says:

    In a recent seminar in the Philippines a Prof. in economics shared the result of his study about MF. He entitled his presentation as “MF, a promise too many.” His paper basically agrees with your observation, but I took issue with him. I told him that from our experience in CCT his paper should have been entitled “MF, a promise too little.” Yes, it is true that MF is not a miracle as others would have us believe. This view is what the economics prof is debunking. But it is a tremendous platform for other development intervention given its in placed delivery structures. A case in point is our program to provide access for our community partners to the government health insurance. Our in-placed MF delivery structure made it possible for our community partners to be enrolled in the government health insurance in an affordable way. Thus, the challenge for us is to leverage our MF program for other non-MF services that the poor needs, to make MF to promise more!!! Thanks for your incisive article.

  3. Asiepet Joan Mary Says:

    What are the limitations of financial services to the poor

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