Module 8: Pitfalls in Microfinance

Recently, the provision of financial services dealing with very small deposits and loans—microfinance—has been promoted as an effective means of poverty reduction. Roughly 80% of the world's population is without access to credit and savings facilities beyond that provided by family members, friends, or money lenders.(1) Microfinance interventions (MFIs) may increase incomes, contribute to individual and household livelihood security, and change social relations for the better. However, they cannot always be assumed to be doing so. This article draws together some important lessons and pitfalls to avoid in microfinance poverty reduction programs.

Pitfall 1: High Interest Rates

One pitfall in microfinance work is to charge high interest rates on loans. High interest rates often sink consumers further into debt and poverty. For example, Compartamos Banco, a Mexican microfinance firm, has been denounced by Muhammad Yunus, founder of Grameen Bank, for charging interest rates of close to 100% a year.(2) Yet many MFIs claim that interest rates are not the problem as they have high loan repayment rates, a commonly touted indicator of success. However, repayment rates only indicate that borrowers are able and willing to repay, and they say virtually nothing about impact on well-being.

Case Study: Loan Recipients in Mozambique and Bangladesh

The organization Beyond Good Intentions is committed to uncovering innovative and effective approaches to international aid worldwide and has recently made a documentary in order to catalyze a much-needed dialogue about aid effectiveness. This film reports that many micro-lending organizations in Mozambique charge 35-55% interest on their loan each year. Franca Chilengue, a farmer and Kiva Loan Recipient in Mozambique, remarks on his experience:

“The interest rate is the problem because it’s steep.  We end up paying a lot of money. I am not educated, so I don’t understand much about interest rates.  I asked others and they explained to me what it is and how it works…that is where I realized that it’s steep. It’s helping, but it’s not enough.”

Franca’s story reveals the barriers that high interest rates pose to impoverished people. Not only do such rates deter individuals from using micro-lending services, they can also perpetuate the cycle of debt and poverty. A woman’s experience with the Bormi Branch, Grameen Bank in Bangladesh reveals this cycle:

“A third woman then stood up, and with tears welling in her eyes described how the shame of not being able to repay her Grameen Bank loan had driven her to the local moneylender, which in the long run of course had only intensified the desperation of her situation. Caught in a double debt spiral, she seemed to be at the breaking point as she turned her head, paused to gather her composure, and then silently sat down. I hoped that giving members the opportunity to ask me questions might help to lighten things up (as it usually did), but instead there was an uneasy silence, followed by a mumble from the back: ‘We are too ashamed to ask you any questions.’”(3)

Pitfall 2: Lack of Sustainability

An underlying issue in the microfinance discourse is the question of sustainable action. Despite the business model of MFIs and awareness of “best practices,” nearly all programs remain substantially subsidized. According to a UN study, only 10% of micro-lending organizations are self-sufficient.(4) The majority rely on donations and subsidies to stay in business which endangers the long-term viability of such organizations. This is especially true for programs with explicitly social objectives. For example, a recent survey shows that the programs that target the poorest borrowers generate revenues sufficient to cover just 70% of their full costs.(5)

"While subsidy rates will surely fall as more programs gain age and scale, even many older, larger programs are far from being able to make ends meet with their own revenues. Some donors believe that little more than 5% of all programs today will be financially sustainable ever."(6)

Lack of financially-sustainable programs is a problem because sustainable ventures can achieve greater scale than subsidized programs. Thus, they can make a bigger dent in poverty, and low-income customers are also more likely to borrow from institutions they see as financially sustainable.

Case Study: The Ijebu-Ode Experiment

A microfinance experiment in poverty reduction began in 1998 in the city of Ijebu-Ode, Nigeria where an estimated 90% of the population lived below the poverty line of $1.00 per person per day.(7) While early successes were seen, the default rate began to rise and by 2005, 16% of the funds loaned were in default. The failure rate for enterprise development has been much larger, and overall 25% of funds loaned and interest have been in default.

These problems have led to concern about the amount of funds that can be obtained to meet the rapidly growing demand of potential beneficiaries. Evaluators of this program noted that the funds available to the microfinance initiative to meet its administrative costs are grossly inadequate.(8) In fact, they claimed that the board has been unable to service one-tenth of its stakeholders and that there are no fewer than 500 member-beneficiaries awaiting loans. Thus, the dependency of beneficiaries on the program puts a ceiling on how far and how many individuals can actually be helped out of the poverty trap. 

Pitfall 3: No Business Training

Another pitfall that microfinance ventures may suffer from is the failure to assist and empower borrowers through training. Few micro-lending organizations provide any type of formal business training to their recipients, as they assume that all loan recipients are entrepreneurs and that they understand how to succeed in business. However, this is rarely the case.

For example, many loan recipients have failed in their businesses because they attempted to join an already saturated market. According to the organization Beyond Good Intentions, this has led to repeated failure. “One woman in Mozambique started a vegetable stand… right next to the other five identical stands in town. The market was oversaturated and none of the women could make much of a profit. A little business training probably could have prevented this from happening.”(9)

Case Study: Myrada in South Indian

An NGO called Myrada was originally formed in 1968 in response to the refugee crisis from China's war with Tibet. Myrada's early work with Tibetan refugees centered on the development of local credit cooperatives, the precursors of microfinance initiatives. However, the project as a whole was soon declared a dismal failure.

When staff consulted villagers for their input, they received feedback that women were eager to form groups and participate, but that they lacked the necessary skills for entrepreneurship. With this insight, Myrada "institutionalized" these groups among the villagers, requiring members to give their group a name and to commit themselves to weekly meetings in order to begin training in basic financial management. Myrada decided that its task was to build upon, refine, and formalize pre-existing social relations among the poor, while simultaneously linking them with “broader commercial and political constituencies.” 

“To facilitate greater interaction between the commercial banks and the poor, Myrada has not only done extensive work among the poor in terms of giving them the organization skills needed to participate in the commercial banking sector, but has also been the leading voice in helping to shape laws and national policies that make commercial banks more amenable to the poor.”(10)

Pitfall 4: Lack of Awareness About Social Factors

In order to design services which are relevant and useful to poor people, microfinance initiatives should understand local social and economic structures as well as macro-level trends. For example, the social perception of entrepreneurial qualities is an important factor in the receptivity to MFIs. In societies that place low status on economic individualism, for example, entrepreneurial endeavors are likely to be limited. In addition, different groups (by tribe, religion, gender, or educational status) may be expected to operate certain types of enterprise and not others. If MFIs wish to encourage the adoption of particular enterprise activities and ensure the success of their venture, they must understand the local environment.

“The manner in which wealth is managed can take particular forms dependent partly on such factors as the supernatural, superstition and social appearances."(11)

Case Study: Women and Microfinance

The importance of understanding social values is underscored by the example of women and microfinance. Traditionally, MFIs have focused on providing women with economic opportunities. According to Kiva, financial services have improved the status of women within the family and the community. “Women have become more assertive and confident. In regions where women's mobility is strictly regulated, women have become more visible and are better able to negotiate in the public sphere. Women own assets, including land and housing, and play a stronger role in decision making.”(12)

However, recent evidence indicates that the actual gender impact of microfinance may be more complex. One study found that only 28% of women fully controlled decisions on how the money was spent but they still bore the responsibility for repayment.(13) In addition, it has been found that one of microfinance’s unintended consequences is to aggravate the problems associated with dowry (the money or goods that a woman brings to her husband in marriage). On the other hand, there is evidence that microcredit strengthens bonds between women in borrowing groups, leads to reduced incidence of domestic violence, and increases community involvement.(14)

Clearly, more research is needed to evaluate the effects of microfinance initiatives on cultural norms and gender empowerment. By understanding local values, microfinance initiatives can be better placed and tailored to help those most in need. In the end, it should be remembered that microfinance is a tool, not an outcome. Microfinance on its own cannot alleviate poverty, as many issues besides access to financial services keep people in poverty. However, microfinance can be an effective part of the solution if researched and implemented alongside other social empowerment programs.

Footnotes

(1) Robinson, M. 1995. The paradigm shift in microfinance: a perspective from HIID. Development Discussion Paper #510, Harvard Institute for International Development.

(2) Stanisljevic, Zoran. “MICROCAPITAL STORY: Tori Hogan's Ninth Episode (Entitled ‘Micro-Lending’) of the Ten-Part Film Series ‘Beyond Good Intentions’ Takes a Critical Look at the Realities of Micro-Lending by Questioning the Impact of the Kiva Model.”MicroCapital, 16 June 2009, www.microcapital.org/microcapital-story-tori-hogan%E2%80%99s-ninth-episode-entitled-%E2%80%9Cmicro-lending%E2%80%9D-of-the-ten-part-film-series-%E2%80%9Cbeyond-good-intentions%E2%80%9D-takes-a-critical-look-at-the-rea/.

(3) Woolcock, M. "Learning from Failures in Microfinance: What Unsuccessful Cases Tell Us about How Group- Based Programs Work."  American Journal of Economics and Sociology, Vol. 58, No. 1 (Jan., 1999), pp. 17-42.

(4) Stanisljevic, Zoran. “MICROCAPITAL STORY: Tori Hogan's Ninth Episode (Entitled ‘Micro-Lending’) of the Ten-Part Film Series ‘Beyond Good Intentions’ Takes a Critical Look at the Realities of Micro-Lending by Questioning the Impact of the Kiva Model.”MicroCapital, 16 June 2009, www.microcapital.org/microcapital-story-tori-hogan%E2%80%99s-ninth-episode-entitled-%E2%80%9Cmicro-lending%E2%80%9D-of-the-ten-part-film-series-%E2%80%9Cbeyond-good-intentions%E2%80%9D-takes-a-critical-look-at-the-rea/.

(5) Robert, C., & Jennifer, M. D. (1998). MicroBanking Bulletin. Boulder CO: Economics Institute. Issue 2: 1998.

(6) Morduch, J. “The Microfinance Schism.”World Development, vol. 28, no. 4, Apr. 2000, pp. 617–629., doi:10.1016/s0305-750x(99)00151-5.

(7) Ijebu-Ode Development Board on Poverty Reduction (2006) Sixth Annual Report and Account for the Year Ended December 31, 2005 (Laimedia Nig. Co, Ijebu-Ode, Nigeria).

(8) Odugbemi OO, (2006) Impact Assessment of the Ijebu-Ode Development Board on Poverty Reduction (Olabisi Onabanjo University Consultancy Services, Ago-Iwoye, Nigeria).

(9) Stanisljevic, Zoran. “MICROCAPITAL STORY: Tori Hogan's Ninth Episode (Entitled ‘Micro-Lending’) of the Ten-Part Film Series ‘Beyond Good Intentions’ Takes a Critical Look at the Realities of Micro-Lending by Questioning the Impact of the Kiva Model.”MicroCapital, 16 June 2009, www.microcapital.org/microcapital-story-tori-hogan%E2%80%99s-ninth-episode-entitled-%E2%80%9Cmicro-lending%E2%80%9D-of-the-ten-part-film-series-%E2%80%9Cbeyond-good-intentions%E2%80%9D-takes-a-critical-look-at-the-rea/.

(10) Woolcock, M. "Learning from Failures in Microfinance: What Unsuccessful Cases Tell Us about How Group- Based Programs Work."  American Journal of Economics and Sociology, Vol. 58, No. 1 (Jan., 1999), pp. 17-42.

(11) Buckley, G.J., 1996. The supernatural, the family and values in microenterprise development. Small Enterprise Development7 4, pp. 14–21.

(12)“Loans That Change Lives.”Kiva, www.kiva.org/.

(13) Goetz, A.M. and R. Sen Gupta 1996, ‘Who takes the credit? Gender, power, and control over loan use in rural credit programmes in Bangladesh’, World Development, 24(1), 45–63.

(14) Kabeer, N. “Money Can't Buy Me Love? Re-Evaluating Gender, Credit and Empowerment in Rural Bangladesh.” IDS Discussion Paper 363, Brighton: IDS. OpenDocs Home, Institute of Development Studies, 25 Jan. 1998, https://opendocs.ids.ac.uk/opendocs/handle/20.500.12413/13879.