In last few years, the randomized program evaluation has become the gold basis for evaluating the development programs and also the bread and butter of many development economists. The evaluations sometimes uncover the valuable new information, but are contentious, and can also be prohibitively expensive to implement, for small NGO’s. Appreciating how the microfinance affects clients is not straightforward for the reason that there are several possible explanations for why, say, a borrower is doing well as compared to her non-borrowing peers. The credit may be helping–or conceivably the borrower was already comparatively prosperous and would have fared better even without the loan. These new papers clarify cause and effect by performing controlled experiments, in which a few parameters are arbitrarily varied and the effects measured. The idea of ‘experiments’ sounds good because it gives scientific legitimacy to what are in actual fact social phenomena marked by complex correlations, multiple variables, and extraneous and often invisible factors. Let us look at these reports to see just how ‘controlled’ they are.
No discussion of microfinance can start without congratulating the recent awarding of one of this year’s Four Freedom awards to Muhammad Yunus. Since 1982 these bi-lateral awards which celebrate the Four Freedoms – freedom of speech and expression, freedom from want freedom of worship, and freedom from fear - have been organized in collaboration with the Roosevelt Foundation in Zeeland. Professor Yunus was given this prestigious award in celebration of his work in championing for the Freedom from want. The United States government’s principal aid agency, the Agency for International Development, universally known as USAID, is the leading donor for microenterprise development. This aid reaches more than 3.85 million households and entrepreneurs worldwide through the USAID’s support of NGOs, credit union networks, and financial institutions, and credit union networks.
America and microfinance
Both the Americans and the Dutch, are familiar from their experience in developing countries that microfinance can be successful in that it empowers the poor by creating higher incomes and more jobs, promotes macroeconomic growth and stabilization. It also encourages the economic and social inclusion and also distinguishes that societies face similar challenges of poverty and unrestricted economic opportunity. But how, then, can both countries use microfinance in the developed market economies to help eradicate poverty in our own countries? This is a noble and complicated question and many of the sharpest economic minds, are applying their expertise and experience to devising more creative solutions. To appreciate the current microfinance paradigm in the U.S. today, one needs to first distinguish how the market economy influences the development and relevance of microfinance programs. But while both the Grameen Bank and the U.S. share the goal of alleviating poverty, each must meet that the difference of opinion under fundamentally different economic conditions. For the microfinance programs in the U.S. it means competing in the financial market which is dominated by the healthy commercial credit. Banks and other lending institutions in the United States have been slow to develop the microfinance concepts because they face strong competition, they have lower profit margins, and carry greater risks than mainstream lending practices ( Fuglesang, 243)The very nature of microfinance is the small financial transactions, such as weekly collection, which needs more labor, thus resulting in higher costs per loan for the financial institution. For any institutions seeking profit and financial resources, they are not able to recoup these transaction costs through the higher interest rates which are regularly charged in the developing countries due to American regulations. But profitability is fundamental to the future growth of the American microfinance as it must compete with the more established financial services such as the credit cards and check-cashing which targets those with lower wage earnings. In addition to the commercial lending infrastructure, the U.S. presents other systemic market challenges to the function and growth of microfinance tools and the business licensing requirements and market saturation stops many of the poor from successfully launching their personal service businesses such as food preparation, childcare, or hair care. These challenges are firmly entrenched in the American economy and so too, is the American Dream. The pull of the American Dream is very tough and in response, many microfinance providers label their services as microenterprise and aims at the microentrepeneurs. But sadly, insufficient collateral, poor credit, and the lack of business education can discourage the poor and other minorities from engaging fully in building the American economy better. The microfinance principles supplies the framework for larger economic inclusion of the socially and the economically marginalized. But unfortunately the government’s programs are not big enough to make available the funding for all who applies for it. In such a vacuum, not-for-profit and private lenders have biologically proliferated and tended to diversify their services, together with the savings, technical assistance, and business training. Currently, there are about 650 organizations that define themselves as involved in microenterprise development or microfinancing. However, the definitions differ, but in the U.S. the terms most frequently refer to services for a business with five or fewer employees needing less than $35,000 in start-up capital. Private, for-profit lenders have also stepped in to make available microfinancing services and with the technology now connecting lenders and borrowers, websites such as Circle-Lending and Prosper.com have produced a market for themselves by linking the private individual lenders with borrowers. Even though these are normally classified as personal loans, they are a creative response to the requirement to finance innovative ideas. The assimilation into the bigger economy through the small business ownership is an essential pillar for the overall social cohesion since it combats the feelings of alienation and strengthens the feelings of social belonging. Women report an increased feeling of independence from receiving a business loan from a micro-lender and thus ensuing in running their own business. This feeling of economic empowerment normally spills into other areas of civic participation, as well as the deepening of the community networks and some increased political integration. But despite the well-developed financial fields in both countries, some groups, mostly recent the immigrants and minorities, still do not have access to the capital they need so as to launch or augment their small business and fully integrate into mainstream markets. These persons do not want charity, but instead want opportunities and through the targeted loans to the poor, microfinance promises to generate new livelihoods and enhanced capability for self-improvement. In spite of how much developed a country’s economy is, the microfinance tools can often make the difference required so as to move the marginalized persons and families out of poverty and into the mainstream (Bhatt, 345)
Social Impact – Profit vs. Development Benefits
First, there is an intrinsic tradeoff between microfinance as a business and as a development tool. Microfinance will predominantly benefit one of two stakeholders commercial enterprises and their shareholders, or poor borrowers. So, how might one test this assertion? By evaluating the interest rates presented by MFI’s and asking the following questions may offer a few clues:
How do MFI rates measure up to with what a money-lender was offering? And how do they measure up to those of Grameen Bank – which says it can offer lower interest rates by being ‘non-loss, non-dividend’? Is there a trend towards the higher interest rates and the higher the commercial pressure on an organization? Do the banks offer higher rates than independent MFIs, than grassroots NGOs? Did an MFI’s interest rates go up after it partnered with a bank? Have aggregate interest rates gone up over time, as the need to prove development benefits has gone down?
This is an essential test, because if true it lets us to categorize MFIs into two groups and then test for development impact across them and it might also show that most MFIs today embrace the rhetoric of a ‘market based development solution’, by ignoring the fact that development benefits mount up only when the solution is priced somewhat below the market rate as set by the money-lender. This is to say that the major benefit of these providers is to develop the market by bringing in external funds, not any development impact, per se ((Adams, 456)
Generating Enterprise – Equity vs. Debt
My second contention is that microfinance is intrinsically flawed as a tool to create any sustainable enterprise. Studies show that microfinance ends up funding consumption of individuals and this may well be commendable in itself. But if our goal is to create an enterprise for a long-term economic growth how then can microfinance be more effective?
The problem is that the incentives of MFIs are not leaning towards generating sustainable enterprise, but they are oriented basically towards the repayment of loans. However, the latter is not an indication of success of the former and one way to generate private enterprise through the market might then be to use the equity, not debt, to fund the micro and small entrepreneurs.
So, here is another test. Do these organizations which take equity stakes in micro and small enterprises (MSE) have a better incubation success rate than the microfinance providers?
A good example of a success microfinance success is the Grameen Bank which is a Bangledesh organization that gives small loans to the poor and needy families in order to help those families establish themselves. And for its success story, the Grameen Bank and its founder Muhammad Yunus were recently awarded the Nobel Peace Prize on (Fuglesang, 167)
But is micro finance effective and does micro credit decrease poverty? The Consultative Group to Assist the Poor (or CGAP) points out that investigational evidence documents that micro finance can alleviate poverty, improve the status of women, increase their education, and maternal health. The empirical evidence shows that, among the poor, those who are in microfinance programs and had access to financial services were able to progress their well-being both at the individual and household level much more than those who did not have right of entry to financial services. Particularly they point to the statistical evidence of a spectacular positive effect on poverty. For instance, the Bangladesh Rural Advancement Committee (BRAC) clients increased their household expenditures by 28% and assets by 112 per cent and after more than eight years of borrowing. It was noted that 57.5% of Grameen borrower households were no longer poor as contrasted to 18% of non-borrower households (Ahmed, 45) In the city of Lombok, in Indonesia, the standard income of Bank Rakyat Indonesia (BRI) borrowers amplified by 112%, and 90% of households moved out of poverty while in Vietnam, the organization called Save the Children customers condensed the food deficits from three months to one month. And at Kafo Jiginew in Mali, customers who have been with program for as little time as one year were extensively less likely to have experienced a period of acute food insecurity than those that had experienced the food shortage in the shorter period. But those with the need to evaluate the economic and social impact and the appropriately named “double bottom line” of micro lending CGAP’s need not look far, but in the microfinance organizations.
Fuglesang and D. Chandler, Participation as a Process - what we can learn from Grameen Bank, NORAD, Oslo, 1986.
Adams, Dale W. , “The economics of loans to informal groups of small farmers in low income countries,” (Columbus, Ohio: Agricultural Finance Program, Dept. of Agricultural Economics and Rural Sociology, Ohio State University, 1978).
Ahmed, M.U. “Financing Rural Industries in Bangladesh,” The Bangladesh Development Studies, Vol.12, No 1&2, Special Issue on Rural Industrialisation in Bangladesh, 1984.
Bhatt, N. Microenterprise development and the entrepreneurial poor: including the excluded? Public Administration and Development, (1997). 17, 371-386.