Microfinance is not a new concept. Different variations of microfinance have been in practice since the 15th century but the field is more commonly associated with Muhammad Yunus’ founding of the microcredit and the Grameen Bank. Microfinance is a subset of financial services whose consumers are of the lower income brackets. This section of society’s socioeconomic ladder is found in the bottommost rungs, hence known as the Bottom of the Pyramid (BoP). To give you a better idea of what this level of poverty entails, imagine living in a tarp tent or an unfinished construction site and trying to make a living from virtually nothing. While not all cases are as romanticized, this type of lifestyle is by no means pretty and it is strikingly rampant in many regions of emerging economies. And as many articles about wealth disparity point out, many of those who live in deep poverty tend to experience very little socioeconomic advancement. This issue is accredited to many variables, which includes but is not limited to low quality of life, little to no education, and poorly established infrastructure. What microfinance hopes to target are people with nonexistent credit. Many of us take the idea of credit for granted. It’s a no-brainer to pay for your bills and expenses on your credit card; “put it on my tab” as many say. However, there are millions of people who do not have a reliable line of credit, which greatly limits their ability to find economic sustainability for they are not able to take out loans and partake in financial activities that seem like the norm to us. Not being able to amass any capital limits many from growing their businesses and expanding their incomes. Microfinance aims to provide the starting point for many of these people and gives in essence a springboard at a chance for a better life. Thus on paper, microfinance seems like a brilliant idea. Giving millions the opportunities of economic empowerment and financial inclusions by issuing different types of loan products, such as group loans, which have been found to have lower levels of credit risk since group members are able to account for one another — absolutely genius! And theoretically it is. Muhammad Yunus received a Noble Peace Prize and 2005 was deemed the international year of microcredit. But is this financial technique as perfect as it appears to be?
In 2010, India experienced a microfinance crisis like no other. Andhra Pradesh, a state on the eastern coast of the country, was afflicted by a large number of suicides. Farmers and other BoP individuals defaulted on their loans and were pressured by debt collectors to pay up, but with poor crops and no savings, they had nothing to offer. While the crisis was overly exaggerated by the media, the issues surrounding microfinance were indeed very real. There were lots of systemic problems, not to mention institutional corruption and inefficiencies. And interestingly enough, microfinance crises like these have happened in India and other developing nations all around the globe. Regions in Africa, South America, and Southeast Asia are no strangers to microfinance defaults and the adverse psychological and economic effects that occur in tandem.
Microfinance in action definitely has its flaws. As much as microfinance institutions (MFIs) try to control their environments and their clients, there is only so much that can be defined and predicted. Success of microfinance initiatives revolve around various psychological and economic assumptions, and even upon creating such parameters, the metrics of the outcomes of these practices are not guaranteed to be positive, let alone measured correctly. Poverty Action Lab’s 2015 report, Where Credit is Due, provides a comprehensive analysis on how microfinance affects variable groups in different regions all around the world and the results are pretty fascinating. For example, expanded credit allowed numerous entrepreneurs to increase their businesses, but not as many as one would expect. There were positive results in Bosnia, Herzegovina, and Mongolia while enterprise ownership in Ethiopia, India, Mexico, and Morocco was generally unaffected. Furthermore, even with enterprise expansion, profits, and accordingly household income, in a lot of these areas did not see any significant growth, which is accredited (pardon the pun) to numerous factors. Just because low-credit borrowers now have the credit to potentially expand their businesses, do they have the expertise and technical knowledge to effectively use their newfound capital? This is pretty important to ask seeing how the success of microfinance system hinges on the fact that borrowers are expected to experience economic empowerment that would facilitate a sustainable system of self-growth, but this self-growth is not possible merely with slightly deeper pockets. With the increase in revenue and business operations usually comes a subsequent increase in costs to maintain day-to-day functions. Many of these individuals receiving microcredit have little to no business experience and may not know how to effectively control expenditures, let alone make worthwhile investments. Moreover, it is important to note that these businesses are not your product-driven companies that reign in the free markets of developed economies. These enterprises are tiny smoke shops, fish stores, and other small-scale businesses that are relatively undifferentiated and are in a very saturated market. And it should go without saying that a lot of these privately owned shops and stores do not have expansive marketing capital or know-how. Thirdly, chances are that a lot of these business owners simply splurge their increased incomes. This phenomenon is trademark to a lot of individuals who fall within the lower income brackets. With an immediate increase in wealth, these individuals feel a surge of confidence to spend without considering the repercussions of deferred costs. Interestingly, this mostly occurs with single men, while women do an incredibly better job saving and thinking towards the future (go women!). Lastly, it’s also important to ask whether or not the quality of life of these borrowers increases just because their enterprises experience growth.
To add salt to the wound, microfinance has had negative effects in certain regions. In Ethiopia and Mexico, household spending and consumption dropped with the introduction of microcredit (although, one caveat to this is that families might be earning more and just saving; In Ethiopia, there was no significant data about income growth to support either stance while in Mexico, both business revenues and expenditures increased without stating which one grew at a greater pace). Most striking is the drop of social well-being of microfinance clients in the Philippines. There was also very little done to improve women empowerment and education for children.
Now, while it may sound I have a lot of grievances against this system, microfinance does have numerous merits. Overall, there have been positive results (albeit marginal in some cases). Despite the more straightforward benefits, such as increased revenue and business expansion, households were able to gain more freedom in how they earned and utilized their incomes, which is an extremely important concept. Many of us have disposable incomes that can help us choose between different options for, let’s say, lunch. This is an ability that is unbeknown to many in emerging economies. Households were able to gain access to healthier food and more household necessities. To answer my own rhetorical question above, the quality of life of many of these borrowers did increase and have shown signs of further improvement, although entirely not guaranteed.
One thing is clear though in that microfinance is far from picture-perfect. We must ask ourselves where do the inefficiencies of microfinance lie. Are loan products falling short somewhere? Are we failing to understand the cultural and social aspects of these regions? Is perhaps the goal of microfinance (to end poverty) too grandiose and is there a need to streamline the mission? Or are there a lot of institutional errors at play here? Overindebtedness and credit risk may be the two biggest concerns but there are other factors that impede on microfinance’s success. In Banana Skins’ 2014 CSFI survey of microfinance risk, Facing Reality, it becomes quite apparent that the blame of microfinance’s shortcomings is not only in the hands of the borrowers but also the ones who provide the credit. In the Middle East, Northern African countries, and South Asian nations, political interference is one of the most growing concerns. The volatility of the political environment and security fragility in these regions are worsening the economy and creating pockets of instability within the microfinance sector. In addition, elected officials and political parties construct constraints that obstruct the true potential of microfinance practices. In Eastern Europe and Central Asia, macro-economic risks are one of the main forces that deters the success of microfinance. Ultimately, though, creditors, investors, and other stakeholders from various regions fear how MFIs govern and manage their operations and how they oversee and strategize risk. Upon further analysis, it can be argued that all of these issues are byproducts of the fact that the microfinance market is oversaturated. It’s odd to think that this sector is “hot,” but a lot of financial institutions have seen these unique loan products with astronomical interest rates (~24% to even ~200% in some areas) as worthwhile ventures to invest in. As a result, corporations with larger capital reserves and greater outreach are pushing out small MFIs, requiring a lot of organizations to tweak and design credit requirements, loan products, interest rates, repayment structures, and other aspects of the like in more unreliable, riskier ways. Now the question arises, are these institutions actually working for the people or just working for the profits?
What are the next steps forward? Unfortunately, I don’t have any concrete solutions at the moment. One thing that comes to mind is perhaps it’s time to treat these low-income borrowers like actual free market consumers, which means providing them with more information about the products they are purchasing. These BoP individuals are in a way being force-fed the loans that are in front of them. Most of these people have not received proper education, let alone an understanding about how financial instruments work. Perhaps a nonprofit intermediary service is necessary to teach BoP consumers about the microfinance products that are available to them and help them choose the loans that work best for them. This may force a lot of MFIs and banks to alter their product designs more in favor with their clients so they can stay competitive. Another idea is to bolster the regulations behind these financial services. I am not too well-versed in the legal implications behind microfinance, but I’m assuming that fiduciary duties to BoP consumers are essentially nonexistent. Again, it is imperative that we treat these individuals like regular consumers and regulations should be created and enforced to protect their interests. At the core though, I think many microfinance institutions and financial corporations need a wake-up call. They need to remember who they are serving and why and reevaluate their missions accordingly.
Maybe there is a need to look into financial inclusion without the use of microfinance and dive into new practices. Emerging economies are leapfrogging anyways. For example, in India, there is very poor infrastructure for large-scale markets, but online e-commerce platforms such as Flipkart successfully serve millions daily. Thus, it’s not absurd to say that microfinance may no longer be as effective as it once was. With greater initiatives of development all around the world, perhaps it is time for microfinance to encounter some changes of its own. But for now, back to cranking out these models.
Last weekend, we went to Mysore! Most of our time was spent going to forests and hills, which was an awesome getaway from the city life. I apologize for the lack of pictures — didn’t carry my phone around with me so they’re in the hands of my fellow CASI mates. Nonetheless, these were some highlights:
- Rode a camel (I also ate one the week before, so I had some internal strife riding one. They could’ve been family, ya know?)
- Ate on banana leaf plates
- Traveled up that hill you see above and then got kicked out by corrupt police officials who wanted money (we were venturing in areas that were blocked off since there are tigers, elephants, and other wildlife in the region)
- Saw glimpses of Mysore palaces at night
- Was on a safari jeep that ran over a small rodent — fresh roadkill, lovely
- Saw elephants, peacocks, lots of deer, and more monkeys
Time to get ready for the final stretch — only two and half weeks left! Where has all this time gone?