Photo Credit: Shirine Bakhat/Mercy Corps
The future of microfinance will depend on organizations ability to create solutions that are not only economically sustainable but also socially sustainable.
Introduction
Promoters have hailed microfinance as the silver bullet of development. Advocates say that providing small amounts of credit to the world's poor can break their cycle of poverty. Moreover, they claim, this can be accomplished through self-sustaining programs. Just lend to the poor at market rates, and their high levels of repayment can fund the effort. Both of these claims, however, remain inconclusive after numerous studies. The mixed results of a wide array of impact assessments leave skeptics wondering whether microfinance really does alleviate poverty beyond anecdotal instances. While stories abound of people who have used microfinance to improve the lives of their families, it has yet to be demonstrated that microfinance makes a substantial difference at the macroeconomic level. Self-sustainability is also suspect, with data indicating that even those microfinance programs committed to financial sustainability cover only 70 percent of their costs. Almost all programs are still substantially subsidized, especially those with explicit social objectives. Some experts have suggested that no more than five percent of microfinance institutions (MFIs) worldwide will ever be sustainable. Layer on the unfortunate press surrounding cases of oversaturated markets with hopelessly indebted, hopelessly poor borrowers, and one begins to question whether microfinance is all that its proponents claim.
Donors should accept microfinance for what it is: not a silver bullet but an important tool in the development tool kit.
The reality is that microfinance may be guilty of over-promising and under-delivering, but it is still an effective development tool. First and foremost, microfinance provides financial services to the poor, and the poor, like the rich (perhaps even more so because of their vulnerability), benefit substantially from the ability to smooth their income. Second, microfinance has been shown to support a number of other important development objectives—including improving school enrollments, child nutrition and health, maternal health, and female empowerment. Third, even if most microfinance initiatives require some ongoing support, few other development programs come close to its cost-effectiveness. For all of these reasons, donors should accept microfinance for what it is: not a silver bullet but an important tool in the development tool kit. The rich world should redouble its efforts to extend additional resources to microfinance, continue to push for regulatory changes to make local financial systems more conducive to microfinance, and search for ways to bring successful programs to scale. Those organizations committed to poverty reduction must focus explicitly on serving the very poor, better tailoring products and services to meet their needs, even at the expense of other objectives.
The Evolution of a Movement
Thirty years ago, in a small village in Bangladesh, Mohammed Yunus and a few volunteers began a radical experiment. Yunus believed that providing credit to the poor was not only financially sustainable, but could unleash a development wonder by giving the destitute the means to help themselves. He started providing small loans, with no collateral, to groups consisting of mostly female borrowers to start their own businesses. His efforts grew into the renowned Grameen Bank and became a major impetus behind the microfinance movement. From its humble roots, microfinance has grown tremendously over the last three decades. Although microfinance started out simply as small, non-collateralized loans, the term now covers a whole range of services provided to the poor, including savings, money transfers, payment services, and insurance. Today, more than 70 million of the world's poorest families have access to microcredit and that number has been growing by more than 35 percent a year. The industry should come close to meeting the Microcredit Summit Campaign's ambitious goal of reaching 100 million of the world's poorest by 2005.
The US has committed more than USD 2 billion to microfinance projects in the next 15 years, averaging USD 155 million annually across almost 50 countries.
Impressive as this may seem, it only scratches the surface of need. More than 900 million households in developing countries still have no access to formal financial services. The US, a leader in supporting microfinance since the 1980s, has committed more than USD 2 billion to such projects in the next 15 years, averaging USD 155 million annually across almost 50 countries. Although this might seem like a large line item, it is a little more than half of what the US plans to spend on one new attack fighter plane. World Bank funding for microfinance is similar both in absolute size (support for microfinance averages about USD 170 million per year) and in relative importance to overall funding priorities (less than one percent of the Bank's lending).
To boost microfinance initiatives around the globe, the UN General Assembly in 1998 designated the year 2005 as the International Year of Microcredit. A group of development agencies and industry leaders came together the following year to create the Consultative Group to Assist the Poor (CGAP). With a USD 10 million budget, the consortium acts as a resource center for the whole industry, incubating ideas, launching new products, and setting standards and legal frameworks. CGAP was created not a moment too soon, as a lack of standards has been taking a toll on the industry. Already, some regions, including parts of the Caribbean and Africa, are now oversaturated with MFIs pushing loans on the poor, leading to declining repayment rates and a spreading culture of default. Microfinance is non-viable in several Caribbean markets due to the prevalent attitude that loans are an entitlement that do not need to be repaid. In some countries, like Uganda, microfinance loans have been given out by corrupt leaders to political supporters prior to elections. A core challenge for CGAP is to find effective ways to stop bad practices, (which usually take the form of government interventions), from ruining the market for other providers.
To Fight Poverty, Focus on the Poor
A number of studies have reached what is now perhaps an obvious conclusion: programs that focus on poverty alleviation rather than those that focus on financial results are more effective at reaching the very poor. What is still missing from most microfinance initiatives is an innovative mix of products targeted to reach the very poor (for example, loans with long grace periods before interest is due, loans with graduated interest rates to reach market rates, more flexible savings products). Some studies have shown that delivering microfinance in conjunction with other services, such as health information, basic literacy, and business training achieves better poverty reduction (although perhaps at a cost to financial sustainability). Not only does a comprehensive approach to poverty reduction (for example, providing credit along with primary health and education) create positive synergies that are more likely to break the cycle of impoverishment, but the regular meetings of microfinance groups provide an effective delivery mechanism for other social services.
A number of studies have reached what is now perhaps an obvious conclusion: programs that focus on poverty alleviation rather than those that focus on financial results are more effective at reaching the very poor.
It is important to remember that not everyone is cut out to be an entrepreneur and therefore not suited for microfinance. While those at one end of the curve might excel in their business ventures and succeed in lifting their families out of poverty, the vast majority of borrowers simply use their loans to improve their chances of survival in the short term. Those at the other end of the curve fail in their endeavors, risking indebtedness, the wrath of their borrowing group, and shaming their families. Programs targeting the very poor should take steps to minimize the number of borrowers who fall into the latter group - for example, by screening business concepts and providing aid instead of loans to those who cannot produce a repayment plan. Also, it should be recognized that some segments of the poorest populations - the old, the infirmed, those displaced by war - might not be suitable microfinance clients.
In 2000, Congress passed legislation establishing microenterprise as an integral component of US foreign assistance, and specifying that half of all grants must go to the very poor. The US Agency for International Development (USAID) now partners with more than 700 US, local, and international organizations to implement this initiative. As more established financial institutions expand into microfinance, their efforts increasingly supported by foreign equity capital, the US and other development agencies should increase their commitment to reaching the very poor. (USAID's goal should be revised to focus 100 percent on the very poor.) The result may be lower levels of repayment, and therefore reduced financial sustainability, but a significant expansion of services to the un-banked. USAID should assume the risk to promote poverty alleviation among the poorest.
Microfinance as a Driver of Other Development Objectives
Microfinance has been recognized as an important tool for achieving several key Millennium Development Goals (MDGs). In addition to poverty alleviation, microfinance has a positive impact on school attendance, increasing gender equality, reducing infant/child mortality, reducing maternal mortality, and increasing access to reproductive health services. Microfinance also promotes free markets and entrepreneurship, reduces the dependency of poor people, and contributes to the emergence of a middle class.
Microfinance promotes free markets and entrepreneurship, reduces the dependency of poor people, and contributes to the emergence of a middle class.
As conceived by Mohammed Yunus, microfinance has an intentionally significant social component, with Grameen borrowers required to abide by the program's social contract. At the beginning of each weekly loan collection meeting, they must reaffirm Grameen's "Sixteen Decisions," which include having smaller families, educating all their children, practicing home improvement, and helping fellow group members during difficult times. Many other microfinance initiatives, some modeled explicitly on Grameen, have replicated the social contract concept (with some tailoring to the local population). Today, across Asia, Africa and Latin America, there are millions who abide by a social contract as part of their loan eligibility. The social contract and the group dynamic (regular meetings of members) are recognized as important elements in the social change that accompanies microfinance initiatives, particularly with regard to the empowerment of female clients.
In many microfinance initiatives around the world, women comprise the majority of borrowers. This is true for several reasons: women make up the majority of the poorest citizens of the world and are therefore targeted for poverty alleviation programs; women are more likely to be credit-constrained than men, have restricted access to the wage labor market, and have an inequitable share of power in household decision making. The repayment rates of women clients are also superior to men's, especially in group-responsibility-based lending programs like Grameen's, where the ‘shame' factor within a close-knit society encourages minimal default.
Moreover, a variety of social benefits are more likely to accrue if the loans are given to women rather than to men. For example, women are more likely to invest profits in their families and men are more likely to invest profits in their businesses. Loans to women are more likely to benefit male consumption than male loans are to benefit female consumption. Other studies have noted that household consumption increases more when women borrow than when men are the borrowers. In these cases children are the prime beneficiaries. Additional income in the hands of mothers is associated with substantially larger improvements in child survival and nutrition than additional income in the hands of fathers:
Women are more likely to invest profits in their families and men are more likely to invest profits in their businesses.
for child survival the marginal effect of female income is nearly 20 times larger than that of male income; and for child nutrition, the effect is four to eight times larger. Studies have also noted that women who take micro-credit loans have a significantly higher demand for formal health care than women who do not, and that expenditures on women's health needs increased. This only happened when the recipients of loans were women, and not when they were men.
Female Empowerment - A Long-Term Benefit
A whole cottage industry has developed around determining to what extent microfinance results in female empowerment. Empowerment of women is usually defined as an improvement in the woman's ability to influence or make decisions that affect her life. These include family planning, her children's lives, household expenditures, and her microfinance-supported business. In many markets, including Bangladesh's relatively mature microfinance environment, a majority of women loan recipients do not fully control their loans (husbands, fathers, or brothers make investment decisions). Nor do they get direct market access, which is an important route to empowerment. Yet, in all instances, women are left with the responsibility of paying back the loans, which are sometimes appropriated by husbands and frittered away on alcohol and drugs.
It seems likely that reduced domestic violence against women borrowers is a consequence of women being regarded as more valuable economic members of the family.
These are valid concerns, and should be addressed programmatically by MFIs specifically targeting women. However, a broad set of studies concludes that micro-credit indeed empowers women in terms of their ability to make large and small purchases, involvement in major family decision making, participation in public action, mobility, and political and legal awareness. Some have also observed reduced domestic violence against women borrowers and speculate that this is a consequence of women being regarded as more valuable economic members of the family once they start generating income via their micro-credit loans. Other more specific studies have confirmed these findings: female borrowing increases female control of non-land assets, increases their role in household decision making, and elicits greater acceptance by their husbands of their participation in market-based economic activities.
Not surprisingly, programs which exclusively target women are more likely to have a positive impact on women's empowerment. This is especially true when they are enhanced by other features such as putting women in charge of their own bank, letting them make decisions on the feasibility of each others' proposed activities, electing their leaders, or setting the terms and conditions of internal loans. Regular meetings also develop women's links and knowledge about one another and any education received helps boost self-esteem.
Kashf Foundation—Improving Pakistan's Prospects One Woman Borrower at a Time
To understand the promise and the challenge of microfinance, it is helpful to look at a microfinance institution that has the potential to make a positive impact. In Pakistan, a country of 150 million people, 34 percent of the population lives on less than USD 1 a day, while 86 percent lives on less than USD 2 a day. Sixty-five percent of households have no access to financial services, so the demand for microcredit is high. The Kashf Foundation was started in 2000 by Roshaneh Zafar, a Yale-educated Pakistani woman on a mission to unleash the productive capabilities of Pakistan's poor female population (70 percent of whom is illiterate). Kashf is focused on achieving financial sustainability: it targets not the poorest of the poor in Pakistan, but those living on USD 2 a day, since in its experience, repayment rates are better among the working poor as opposed to the truly destitute. With a 20 percent interest rate, and a 98 percent repayment rate, it is the only financially sustainable MFI operating in Pakistan today.
Female empowerment is an explicit Kashf goal. One hundred percent of its borrowers and about half of its loan officers are women. However, recognizing the reality of its patriarchal society, Kashf allows male relatives to direct the loans. Recent impact assessments confirm that even with men directing the loans, women borrowers feel their stature in the family has improved. Clients report a 30 percent rise in income after one year. Over the course of the year, nearly a third of Kashf clients crossed over the poverty line, as opposed to almost no change in poverty levels in the control group. Kashf clients also report spending significantly more on health care than those in a control group, despite no differences in levels of illness.
Over the course of the year, nearly a third of Kashf clients crossed over the poverty line, as opposed to almost no change in poverty levels in the control group.
Although Kashf has grown rapidly since inception, to more than 65,000 clients in a few short years, its growth prospects are constrained by insufficient resources. It costs about USD 8,000 in start-up funds to open a new branch, making it difficult to fund expansion through its existing operating budget. Franchising is under consideration as a means of more rapidly expanding to meet the vast needs of Pakistan's poor. Kashf's challenge is to find ways to achieve scale, which then allows it to reap the benefits of size and lower costs. Pakistan, a country burdened by intense poverty, a rapidly growing population, and political and religious extremism, depends on organizations like the Kashf Foundation succeeding. Kashf undoubtedly makes a significant difference in the lives of its female clients. Whether it can make a difference to Pakistan as a whole remains to be seen.
Conclusion and Recommendations
Microfinance is an important development tool. While overall economic impact is still hard to demonstrate, this could be because MFIs have not invested sufficiently in data collection and impact assessments, and also because few MFIs have achieved the scale they need to start showing up in national accounts. Yet, to focus on measurable macroeconomic results risks losing the forest through the trees. An evaluation of microfinance programs should not be based simply on how profitable, or even sustainable they are, but how cost-effective they are in realizing their development objectives. At a minimum, microfinance brings crucial financial services to the poor at market rates.
Successful poverty alleviation requires a multi-pronged strategy, and microfinance should be part of that strategy. It is an important contributor to achieving the MDGs. Women's empowerment is perhaps the most complex, and potentially the most powerful of these goals, and microfinance clearly helps drive female empowerment.
The greatest challenge facing the industry today is how to achieve scale cost-effectively. At some point in the next 12 to 18 months, a milestone will be attained of serving 100 million of the poorest families. But that still leaves nearly 1 billion more to reach. Current growth rates would have to increase exponentially for microfinance to make a measurable dent in global poverty. And the world's unbanked populations live today not in relatively accessible locations like the Caribbean and Central America (which have already experienced over-saturation), but in hard-to-reach locales like rural Africa and Afghanistan. Providing microfinance cost-effectively in areas largely devoid of roads and any modern communications presents new challenges. New models, such as franchising, must be considered. New sources of capital, such as foreign equity, and tapping increased savings through new products in local markets should be explored. With 2005 as the International Year of Microcredit, it is time for the world to embrace microfinance.
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