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April 6, 2009 / compassioninpolitics

Problems of micro lending and micro finance

Disadvantages of micro loans and micro finance institutions (MFIs)

I’m facsinated with the social change story embodied in micro lending. I’m interested in providing balance to the story, so that a fair evaluation of micro lending and micro finance is possible. The Boston Globe points out in “The Pitfalls of Micro lending” points out:

However, even the most established microlending programs have yet to prove that microlending is more successful than welfare-style programs in lifting people permanently out of poverty. According to studies by anthropologist Aminur Rahman and reporter Helen Todd (both of whom studied the Grameen Bank in Bangladesh) and a world-wide study of microlenders sponsored by Oxfam, microlenders regularly fail to help people attain permanent self-employment, often because they fail to ensure that the loans are actually used by their borrowers to start small businesses.

Most disappointing, as these studies of the Grameen Bank and studies of similar programs (such as one by development experts David Hulme and Paul Moseley) show, such programs have been unsuccessful in reaching the poorest individuals who are the purported targets of their efforts. Meanwhile, as development experts such as Jude Fernando and Philip Nichols have acknowledged, even the most successful microfinance programs are unable to sustain themselves without additional aid.

Like any other development strategy, microlending for the purpose of developing small businesses is a complicated endeavor that requires a localized understanding of the particular economic, cultural, and social factors affecting entrepreneurial success.

Women and Microcredit in Rural Bangladesh. An Anthropological Study of Grameen Bank Lending, by Aminur Rahman. Boulder, CO: Westview Press, 1999, xi, 188 pp.

Analysis of the Criticism of the Grameen Bank:
Initially, its important to point out that the author took a feminist/political economy perspective, both of which should be applied in a comparative way. Additionally, the ethnography would have to follow the women over a three to five year or even seven year period to get a full perspective on the effect that micro lending. Finally, it may be that the Grameen Bank has an organizational culture or structures that need to be changed, so the article may not represent a systemic critique of micro lending as a means for positive social change.

Critique Two: Stanford Social Innovation Review:

In the article “Micro finance Misses the Mark” Aneel Karnani an associate professor of strategy at the University of Michigan’s Ross School of Business points out:

Despite the hoopla surrounding microcredit, few have studied its impact.10 One of the most comprehensive studies reaches a surprising conclusion: Microloans are more beneficial to borrowers living above the poverty line than to borrowers living below the poverty line.11 This is because clients with more income are willing to take the risks, such as investing in new technologies, that will most likely increase income flows. Poor borrowers, on the other hand, tend to take out conservative loans that protect their subsistence, and rarely invest in new technology, fixed capital, or the hiring of labor.

Microloans sometimes even reduce cash flow to the poorest of the poor, observes Vijay Mahajan, the chief executive of Basix, an Indian rural finance institution. He concludes that microcredit “seems to do more harm than good to the poorest.”12 One reason could be the high interest rates charged by microcredit organizations. Acleda, a Cambodian commercial bank specializing in microcredit, charges interest rates of about 2 percent to 4.5 percent each month. Some other microlenders charge more, pushing most annual rates to between 30 percent and 60 percent.13 Microcredit proponents argue that these rates, although high, are still well below those charged by informal moneylenders. But if poor clients cannot earn a greater return on their investment than the interest they must pay, they will become poorer as a result of microcredit, not wealthier.

Another problem with microcredit is the businesses it is intended to fund. A microcredit client is an entrepreneur in the literal sense: She raises the capital, manages the business, and takes home the earnings. But the “entrepreneurs” who have become heroes in the developed world are usually visionaries who convert new ideas into successful business models. Although some microcredit clients have created visionary businesses, the vast majority are caught in subsistence activities. They usually have no specialized skills, and so must compete with all the other self-employed poor people in entry-level trades.14 Most have no paid staff, own few assets, and operate at too small a scale to achieve efficiencies, and so make very meager earnings. In other words, most microenterprises are small and many fail – contrary to the United Nations’ hype that microentrepreneurs will grow thriving businesses that lead to flourishing economies.

Aneel continues:

The fact is, most microcredit clients are not microentrepreneurs by choice. They would gladly take a factory job at reasonable wages if it were available. We should not romanticize the idea of the “poor as entrepreneurs.” The International Labour Organization (ILO) uses a more appropriate term for these people: “own-account workers.”

Creating opportunities for steady employment at reasonable wages is the best way to take people out of poverty. “Nothing is more fundamental to poverty reduction than employment,” states the ILO.

Read the rest of the article at SSRI Review where Aneel argues that the market alone, particularly in India is not enough and that in cases such as health care, which are key to the general welfare, the government must step up to fairly regulate price to ensure the poorest of the poor are not exploited.

Analysis of the Critique:

Karnani’s criticism of the Grameen bank and micro finance as a whole is certainly well argued. Although its seems to point to the undeniable fact that the people at the base of the pyramid (BOP) face a myriad of economic disadvantages that must be addressed with individual care. It cautions those who expect micro finance to be a panacea or one-sized fits all solution to address the interdependent needs and concerns of those at the bottom of the pyramid.

Additionally, Karnani highlights the need for accountable government regulation in his most recent article “Romanticizing the Poor“:

I do not advocate sprawling governments, high taxes, or tightly regulated private sectors. For decades, such statist policies stifled economic growth in countries like India and China, and contemporary economic history clearly demonstrates that the free market system is the best way to achieve overall growth and development. I do believe, however, that states must impose some limits on free markets to prevent the exploitation of the poor. (As the recent collapse of U.S. financial markets shows, they also need regulation to prevent the self-destructive tendencies of free markets.) Another vital role of the state is to provide basic services such as infrastructure, public health, and education. More broadly, businesses, nonprofits, and governments must recognize that poor people face fundamentally different social, psychological, physical, and economic realities than do their wealthier counterparts.

So Professor Aneel Karnani’s argument isn’t entirely about micro finance being good or bad as a solution to poverty, but rather a larger question of government’s role in helping the poor. His suggestion is that where the market fails or is imperfect, particularly with the provision of good or services critical to human welfare, the state should act to rectify the situation.

Criticism Three of Micro Finance and Micro lending:

Michael Miller of The Acton Institute highlights:

While microfinance can play a role in development it is not a panacea for poverty, and the way it is practiced now can have serious unintended consequences that actually undermine development. If it is going to be successful it has to help people move away from borrowing and stop promoting collectivist notions and a zero sum mentality that only hinders development. Microfinance can be the first step on the ladder but macro-finance is needed too. For widespread and sustainable eradication of poverty, an attractive investment climate with secure property rights and rule of law are much more important in the long run. Microfinance is a stop-gap measure: development will have taken place when it is no longer needed.

Analysis of the Criticism of Micro Finance

Michael’s criticism isn’t supported by any data, but represents genuine concerns none-the-less:

• Micro lending institutions should promote savings and a smaller debt burden
• Micro finance is too collectivist due to group borrowing
• Micro lending must work with macro development for sustainable economic growth

Increasingly the micro finance and development industry is shifting to take on more savings programs. For instance, Oxfam is experimenting with a savings oriented program. More generally, the adoption of the BOP Protocol 2.0 should lead to a more nuanced view of micro-finance which doesn’t view it as a magic bullet solution. The self-help groups seem to be a unique way in which micro-finance works, but it would be interesting to hear what Miller would propose in their absence (although truthfully, you could have self-help groups (SHGs) in the absence of collective debt.)



Leave a Comment
  1. markaz18 / Feb 1 2010 12:13 am

    I enjoyed ur post. It brought to light the negative side of microfinance, something which isn’t highlighted often. I would disagree with one point however. Miller mentioned it would be a better idea for the govt to provide security, education, infrastructure…

    the fact is, microfinance is only suitable in places where the govt does not take up these responsibilities. microfinance is the solution while the govt gets its act together.

  2. Nathan Ketsdever / May 26 2010 6:07 am

    For the ultra-poor (those that live on around a $1 a day) something more than micro lending is needed. The poorest of the poor need grants because their income is too inconsistent and a loan may only make the situation worse. They are not handouts–because they help them build skills and businesses. Also, they are one time in conjunction with a) savings and b) training. (“Monitoring and coaching are critical. Weekly household visits allow for monitoring and coaching…business planning…[and many other services]” Trickle Up has a number of strategic partners including BRAC.)

    In this lecture at MIT William Abrams from the 31 year old micro-credit organization Trickle Up. Abrams explains how Trickle Up provide 3 core services:
    1) Business training
    2) Grants (not loans)
    3) Help people become effective sellers

    Here is the lecture for your viewing pleasure:

    He provides examples of two $100 grants to micro-entrepreneurs in the developing world (Trickle Up is opening up to larger grants including $150, $200, and $250 grants). In addition, he also discusses the savings and credit group which is functionally a grassroots bank.

    I’m also increasingly convinced that the work summarized in “Portfolios for the Poor” is critical for getting inside access into how people at the base of the pyramid are using and saving money now (although specific market research is critical as well)

    Abrams even points to BRACs work in this area–that the BRAC experience suggests this segment (the ultra-poor/ $1 a day earners) need a grant model.

    At 22:31 in the video presentation, Abrams has a chart which provides average earnings over time–which provides expectations. (You can find this picture at the following URL, which provides more insight on this issue)

    Later, Abrams points to the Grameen Bank’s Progress Out of Poverty Index:


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