Does Microcredit Really Help Poor People? - CGAP

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1 Does Microcredit Really FOCUS NOTE Help Poor People? E ver since microcredit first began to capture find a group of people who are like the loan public attention 25 years ago, the usual story recipients in all relevant ways except for not line has been that it is a tool of extraordinary having gotten a loan. Up until recently, most of power to lift poor peopleespecially women the few studies that addressed this challenge out of poverty, by funding their microenterprises seriously found that microcredit produced and raising their incomes. This picture has been important economic and social benefits. But buttressed by hundreds of inspiring stories of there has always been controversy about the microentrepreneurs who used tiny loans to start validity of these studies.2 A recent analysis of the or expand their businesses, and experienced most widely cited one raises grave doubts about remarkable gains not only in income and its methodology and conclusions (Roodman and consumption but also in health, education, and Morduch 2009). These doubts probably apply to social empowerment. But how well do these some of the other early studies as well. individual anecdotes represent the general experience of the hundreds of millions who In the last three years, a few researchers have have gotten microloans and other microfinance started using randomized controlled trials (RCTs) services? Is microcreditor microfinance more to test microfinance impact. They select a large generallybeing oversold?1 enough group of study subjects so that when it is randomly divided, the two subgroups can A Claim in Doubt be presumed to be statistically identical. The first subgroup gets loans; the second subgroup Unfortunately, scientific testing of the impact of does not. If one subgroup experiences better microcredit is surprisingly difficult. If we find that outcomes than the other, the researcher can people who got microloans are doing better than be reasonably sure that it is due to the loans, those who didnt, does this mean that the loans because the loans are the only ex ante difference caused the improvement? Maybe not. There between the groups. are several other plausible explanationsfor instance, that the people who apply for and get So far the few published RCT studies of the loans may have more drive and ambition, microfinance have been able to track short- in which case they would probably tend to do term results only. Two that looked at standard better than others whether or not they get the microcredit clients over a short period (1218 loan. months) found no evidence of improvements in household income or consumption, although No. 59 Dozens of studies have looked at the experience they did find some other possible benefits January 2010 of people who have received microloans. The (Banerjee, Duflo, Glennerster, and Kinnan 2009 challenge has been to identify a control group and Karlan and Zinman 2009). Interestingly, Richard Rosenberg for comparison: it is difficult and expensive to the only RCT study of microfinance so far that 1 The term microfinance refers to the full range of financial services that low-income people use, including not only credit but also savings, insurance, and money transfers. 2 For a summary of research on microloan impact up to 2005, including the methodological limitations of the studies, see Goldberg (2005).

2 2 found short-term welfare improvements looked Portfolios begins with a central observation: at microsavings, not microcredit (Dupas and [o]ne of the least remarked-on problems of Robinson 2009). A South Africa RCT found living on two dollars a day is that you dont income improvements from small, high-interest literally get that amount each day (p. 2). In other consumer loans, but such loans are not usually words, economic poverty is not just a matter of thought of as microfinance (Karlan and Zinman low incomes, but also of irregular and uncertain 2008). (See the Annex for a brief summary of incomes. To put food on the table every day, these four RCTs.) Many more of these studies, and to meet other basic consumption needs, including especially longer term ones, will be poor households have to save and borrow needed before general conclusions can be constantly. For all the households we came to drawn. For now, it seems an honest summary know through the diaries, living on under two of the evidence to say that we simply do not dollars a day requires unrelenting vigilance in know yet whether microcredit or other forms cash-flow management (p. 17). Whether or of microfinance are helping to lift millions out not financial services lift people out of poverty, of poverty. they are vital tools in helping them to cope with poverty. The poor use credit and savings not But are we looking for impact in only to smooth consumption, but also to deal the right place? with emergencies like health problems and to accumulate the larger sums they need to seize If the only value proposition in microfinance were opportunities (occasionally including business the claim that it raises poor peoples income and opportunities) and pay for big-ticket expenses consumption by funding their microenterprises, like education, weddings, or funerals. then perhaps it would be best for donors, governments, and social investors to declare a For the diary households, flows into and out of moratorium on microfinance support until there financial instruments (mainly loans and savings) is better evidence to think that the claim is true. ranged from 75 to 500 percent of annual But before reaching that conclusion, we need income. The poorer the household, the higher to step back and take a broader look at how that percentage tended to be. On reflection, poor people actually use financial services like this is not surprising: the closer a household credit and savings, and why they value them. A is to the edge of subsistence, the more it will remarkable new book, Portfolios of the Poor: have to scramble to keep basic consumption How the Worlds Poor Live on $2 a Day (Collins, stable and to accumulate larger amounts when Morduch, Rutherford, and Ruthven 2009), it needs them. Over the year, the average presents the results of year-long financial diaries diary household used 8 to 10 different types of collected about twice a month from hundreds of financial instruments, and most types were used rural and urban households in India, Bangladesh, multiple times. (The notion that microcredit and South Africa.3 These diaries reveal that brings loans to people who previously had no financial instruments are critical survival tools access to them is widespread but mistaken, as is for poor householdsindeed, that these tools the notion that the strong majority of microloans are even more important for the poor than for are used for business purposes.) richer people. 3 Many of the same points were made in Rutherford (2000) and Rutherford and Arora (2009).

3 3 If poor people have so many financial tools came to the weekly meetings on time, in all available to them already, does formal kinds of weather; they disbursed loans in the microfinance add much? Informal instruments amount they promised and at the price they (e.g., informal savings and loan clubs, or loans promised; they didnt demand bribes; they from family, friends, or the local moneylender) tried hard to keep passbooks accurate and up- are usually more flexible than microfinance from to-date; and they showed their clients that they formal providers, so the poor continue to use took their transactions seriously. these informal tools even when they have access In return, we noticed that these Bangladeshi to microfinance. But the informal instruments microfinance clients often prioritized the have severe shortcomings, the greatest of which repayment of microcredit loans above those of is their unreliability. When poor people need to other providers. (pp. 2627) get a loan, or to withdraw money that they have deposited with (i.e., lent to) someone else, Portfolios shows us that poor households value that someone else may not have the money on microfinance because it is very helpful in dealing hand, or may be unwilling to provide it for some with their vulnerability, even though the nature other reason. of that help may differ substantially from the widespread story line about microloans funding By contrast, diary households found formal investment in microenterprises that lift their microfinance a much more reliable tool. The owners out of poverty. But is Portfolios just importance of this reliability is obvious when another set of anecdotes, or does it paint a one considers that their main use of financial picture that is generally true for vast numbers of instruments is to cope with the unreliability of microfinance clients around the world? their income and their lives. As the authors of Portfolios concluded, Does microfinance improve their lives? Poor people say yes Whether or not the microfinance movement was right to stress loans for microenterprises, There are strong reasons to believe that clients or has been too slow to embrace savings and around the world value financial services as other services, its greatest contribution is, to coping tools the same way that the financial us, beyond dispute. It represents a huge step diary households described in Portfolios do. in the process of bringing reliability to the The evidence comes mainly from the observed financial lives of poor households. behavior of hundreds of millions of clients who It is hard to exaggerate the importance demonstrate how important microfinance is to of these developments, which we saw clearly them by voting with their feet.4 when we looked at microfinance through the eyes of the Bangladeshi diarists [who had 1. The experience over three decades has been better access to microfinance than households that when providers make microfinance in the other study countries]. Irrespective of available to clients who havent had it before, how microcredit loans were used, borrowers there is hardly ever a need to advertise. appreciated the fact that, relative to almost Customers arrive in droves, propelled by all their other financial partners, microfinance word of mouth. providers were reliable. That is, loan officers 4 This section relies on observed behavior, not RCTs or other econometric studies. But there is no intent to suggest that such studies are unnecessary. The behavior of clients presents a strong case that microfinance is providing, at a minimum, highly valued coping benefits. That case is persuasive but not conclusive, and it should be further tested and quantified by econometric and qualitative studies.

4 4 2. People not only take out loans, but they 5. Of course, repeated use does not by itself repay them with high reliability. Why do prove that a service is benefitting users. they do this, when the lender holds no No one would make this argument about collateral? The strongest incentive to repay repeated use of heroin, for instance. People is usually not group pressure, but rather the do not always borrow wisely. With microloans borrowers desire to keep access to a highly or any other loans, some borrowers will valued service, one whose future availability inevitably over-indebt themselves and be they can count on as long as they keep their worse off as a result. As long as the number end of the bargain.5 MIX Market offers 10- who do so stays relatively small, it is better year time-series data on many hundreds of to live with the over-indebtedness than to microfinance institutions (MFIs), including deny the loan product to the great majority most of the ones where the bulk of the who are helped by the borrowing. But customers are concentrated. Annual loan could it be that large numbers of repeat loss rates have generally averaged at or microborrowers are caught in a debt trap, below 2.5 percent of portfolio during the able to pay off one loan only by taking out whole period. This represents extremely another? Probably not. When significant high repayment: for example, to achieve numbers of customers are taking on more that loan loss rate, an MFI that makes six- debt than they can handle, it is highly likely month loans repayable weekly has to collect that many of them will eventually default on about 99.3 cents of every dollar it lends out.6 their loans, and the lenders collection rate During Indonesias financial and economic will plunge. To the contrary, MIX Market meltdown in the late 1990s, loan repayment data show that, among the MFIs that plummeted almost everywhere, except for account for the vast majority of borrowers, microcredit loans, where repayment stayed most maintain very high collection rates over very high.7 In especially tough times, it seems the long term. While it does not settle the that low-income borrowers were particularly matter conclusively, this general pattern of anxious to preserve their continued access high repayment over the long term justifies to microcredit and other financial services a strong presumption that microfinance is they might need to cope with shocks that not over-indebting large proportions of its might be coming. clients. At the same time, this presumption needs to be tested by further research. 3. Clients find microfinance services so valuable that they are typically willing to pay high Moving the goalposts? interest rates on loans, and accept minimal or no return on savings. If it eventually turns out that microfinance is not moving people out of poverty as its 4. Clients return again and again for proponents have claimed, are its other benefits microfinance services. Even in institutions worth bothering with? When we hear that that have high desertion rates, most of the evidence about microfinance raising poor their business is from repeat customers. peoples incomes is unclear, and that many 5 Group guarantees are seldom enforced, and default is not much higher in individual microlending than in group microlending. Both kinds of microlending depend on an implicit contract that if a borrower repays faithfully, the microfinance provider will give her another loan (or other services) when she wants it. This is borne out in practice: whenever anything happens to shake clients confidence in the providers ability to honor its implicit promise, loan repayment plummets precipitously. Cf. Chapter 5 of Armendariz de Aghion and Morduch (2005). 6 For an explanation of this surprising result, see Rosenberg (1999, pp. 45). 7 E.g., Seibel (2005).

5 5 (sometimes most) clients use microloans and For instance, BancoSol in Bolivia represents a savings to smooth consumption rather than to few million dollars of donor subsidies in the mid- grow enterprises, we tend to be disappointed, 1990s that turned into a loan portfolio of over and to view consumption smoothing as a mere $200 million and services for over 300,000 active palliative. If thats all it is, why bother? we ask. savers and borrowers by the end of 2008, funded almost entirely from commercial sources. This is But we react this way only because our own not an isolated exception. Among microfinance minimum consumption levels are seldom if ever providers reporting to MIX Market, the ones threatened. As we see in financial diaries and in that are profitable and need no further subsidies the observed behavior of hundreds of millions already account for 71 percent of all the clients, of microfinance clients around the world, poor and MFIs that are close to profitability account people think this palliative is enormously for another 22 percent.9 important in helping them deal with their circumstances. Small one-time subsidies leverage large multiples of unsubsidized funds Based on what we know now, it seems unlikely that a year of microlending helps poor people producing sustainable delivery year after year as much as a year of girls primary education (for of highly valued services instance). The true advantage of microfinance that help hundreds of millions of people is not that each dose is more powerful, keep their consumption stable, finance major but rather that each dose costs much less expenses, and cope with shocks in subsidies. Social programs like primary education and health care usually require large despite incomes that are low, irregular, and continuing subsidies, using up scarce tax dollars unreliable. year after year. Microfinance is different: when it is done right, relatively small up-front subsidies All and all, isnt this a pretty impressive value lead to permanent institutions that can continue proposition, even if we eventually find out that providing services year after year with no further microfinance doesnt raise incomes the way subsidy needed, and can expand those services some of its proponents have claimed? to reach many millions of low-income clients.8 8 Not all microfinance funders do it right. Some agencies fail to produce much sustainable return from their microfinance subsidies because they routinely ignore well-established principles of sound practice , e.g., CGAPs Good Practice Guidelines for Funders of Microfinance (2006). 9 Calculated by Adrian Gonzalez from MIX data. The analysis excludes five state banks that are not trying to reach financial sustainability.

6 6 References Karlan, Dean, and Jonathan Zinman. 2009. Expanding Microenterprise Credit Access: Banerjee, Abhijit , Esther Duflo, Rachel Using Randomized Supply Decisions to Estimate Glennerster, and Cynthia Kinnan. 2009. The the Impacts in Manila. New Haven, Conn.: miracle of microfinance? Evidence from a Innovations for Poverty Action, July. randomized evaluation. Cambridge, Mass.: MIT Poverty Action Lab, May. Karlan, Dean, and Jonathan Zinman. 2008. Expanding Credit Access: Using Randomized CGAP. 2006. Good Practice Guidelines for Supply Decisions to Estimate the Impacts. New Funders of Microfinance. Washington, D.C.: Haven, Conn.: Innovations for Poverty Action, CGAP. January. Collins, Daryl, Jonathan Morduch, Stuart Roodman, David, and Jonathan Morduch. 2009. Rutherford, and Orlanda Ruthven. 2009. The Impact of Microcredit on the Poor in Portfolios of the Poor: How the Worlds Poor Bangladesh: Revisiting the Evidence. Working Live on $2 a Day. Princeton, N.J.: Princeton Paper No. 174. Washington, D.C.: Center for University Press. Global Development de Aghion, Beatriz Armendariz, and Jonathan Rosenberg, Richard. 1999. Measuring Morduch. 2005. The Economics of Microfinance. Microcredit Delinquency. Occasional Paper 3. Cambridge, Mass.: MIT Press. Washington, D.C.: CGAP. Dupas, Pascaline, and Jonathan Rutherford, Stuart. 2000. The Poor and Their Robinson. 2009. Savings Constraints and Money. New Delhi: Oxford University Press/ Microenterprise Development: Evidence from India. a Field Experiment. Working Paper #14693. Cambridge, Mass.: National Bureau of Economic Rutherford, Stuart, and Sukhwinder Arora. 2009. Research, January. The Poor and Their Money: Microfinance from a Twenty-First Century Consumers Perspective. Goldberg, Nathanael. 2005. Measuring the Oxford: Oxford Policy Management. Impact of Microfinance: Taking Stock of What We Know. Washington, D.C.: Grameen Seibel, Hans Dieter. 2005. The Microbanking Foundation. Division of Bank Rakyat Indonesia: A Flagship of Rural Microfinance in Asia. In Harper and Arora, eds., Small Customers, Big Market: Commercial Banks in Micro-Finance. Rugby, UK: ITDG Publications, Rugby.

7 7 Annex. Recent Randomized from a pool who were initially rejected but who Studies of the Impact of fell just below the cut-off. Applicants who were Access to Finance reconsidered (many, but not all, of these were then given a loan) were more likely to keep Dupas and Robinson (2008) conducted a their jobs, have incomes significantly higher randomized field experiment in Kenya where (possibly because they had kept their jobs), have they gave interest-free savings accounts in a local households that were less likely to experience village bank to a random sample of poor daily hunger, and have a more positive outlook on the income earners (primarily microentrepreneurs). future. On the other hand, they also reported The accounts paid no interest and charged more depression and stress than those from the withdrawal fees, so they offered a de facto pool who were rejected and not reconsidered. negative interest rate, but they were the only Over a longer time horizon, reconsidered formal savings option available in the area. applicants had a higher probability of having Dupas and Robinson found wide variation in a credit score but showed no difference in the the intensity of account usage. Some refused score itself, suggesting that the intervention the accounts, and many signed up but didnt may have brought people into the credit system use them. Nearly 50 percent of those with and probably did not get them over-indebted. accounts used them more than once but only a few used them intensively. Account ownership Their loans were consumer loans, not typical was associated with substantial increases in microloans. Applicants were not very poor (i.e., investment and increased daily expenditures income averaged about $300 a month). The for women, but no measurable impact for men. loans were not linked to any business activity Possibly more important, the women who didnt and were administered by a for-profit consumer receive accounts were forced to draw down lender. Interest rates were considerably higher working capital or stop working in response to than what is typical in microfinance. Thus, the health shocks (like malaria). Presumably, savers results may not generalize to many microfinance were less able than nonsavers to be able to contexts. Additionally, the subjects were new afford prompt treatment. borrowers observed for 612 months, so its not clear how continued access to credit would Unfortunately, this study has a few shortcomings impact their lives in the long run. that may limit confidence that its findings will apply in other contexts. First, the study has Karlan and Zinman (2009) randomly prompted a small sample (185 entrepreneurs), and only loan officers at a microfinance lender in the a small number of these used the accounts Philippines to approve loan applicants from a intensively. Additionally, it was limited to a single pool that had been ranked marginal by credit site near one market in Kenya and to a single scoring software. The loans were ostensibly bank branch, so it may not be representative of intended for microenterprise development other settings. rather than consumption. The loan officers had the final say, and they turned down some Karlan and Zinman (2008) randomly prompted of the applicants they had been prompted to loan officers of a South African consumer lender approve. Applicants who got an approve to reconsider and approve applicants for a loan prompt increased their formal borrowing but

8 not their total borrowing (implying reduced Banerjee, Duflo, Glennerster, and Kinnan reliance on informal options). Somewhat (2009) conduct a randomized evaluation on No. 59 January 2010 surprisingly, increased access to microcredit led the community-level impact of new branches to less investment in the targeted business, to of a microfinance bank. Half of 104 slums in substitution away from labor and into education, urban Hyderabad, India, were randomly and to substitution away from insurance (both selected for the opening of an MFI branch. At Please share this explicit/formal, and implicit/informal) even the beginning of the study, there was almost Focus Note with your as overall access to risk-sharing mechanisms no microlending in the sample areas, but 69 colleagues or request increased. Karlan and Zinman conclude, At percent of the households had at least one extra copies of this paper or others in least in a second-generation setting [individual outstanding loan from a moneylender or family this series. lending at a for profit-MFI], microcredit seems member. The authors found that the areas to work broadly through risk management and with branches featured more new business CGAP welcomes investment at the household level, rather than openings, higher purchases of durable goods your comments on this paper. directly through the targeted businesses. and especially business-related durables, and Finally, the results suggest that treatment effects higher profits in existing businesses (despite All CGAP publications were stronger for groups that are not typically presumably greater competition from the new are available on the targeted by microcredit initiatives: male and businesses). Households were scored on how CGAP Web site at higher income borrowers. likely they seemed to start a business. Those who scored high increased durable purchases CGAP The microentrepreneurs in the study are and decreased purchases of luxury items, both 1818 H Street, NW MSN P3-300 wealthier than average for their area, so the of which are consistent with having started a Washington, DC extent to which these results will extend to business. Those who scored less likely to start a 20433 USA the very poor is unknown. Additionally, since business increased consumption of nondurables. borrowers profits are self-reported from The main effects are consistent with borrower Tel: 202-473-9594 Fax: 202-522-3744 memory, there is some riskprobably not a households starting businesses, but the authors large onethat entrepreneurs who borrowed cant tell whether the loans are actually used Email: had a bias toward exaggerating their actual to start businesses, so these effects may come [email protected] profits. Finally, while Karlan and Zinman report through indirect channels. CGAP, 2010 that the loans show greater impact on the pool of male borrowers than female ones, they dont The authors find no impact on health, compare other characteristics that might vary by education, or womens outcomes. However, the gender. For instance, if men are more educated study was conducted only 1518 months after on average, education might account for the the advent of the branches, and the questions difference in effect rather than gender itself. used to measure these outcomes were not very comprehensive. The author of this Focus Note is Richard Rosenberg, CGAP adviser. Latortue, Kate McKee, and Ousa Sananikone for their valuable The author thanks David Roodman, Jonathan Morduch, Dean comments and corrections. Jake Kendall produced the Annex. Karlan, Mark Schreiner, Stuart Rutherford, Meritxell Martinez, Alexia The suggested citation for this Focus Note is as follows: Rosenberg, Richard. 2010. Does Microcredit Really Help Poor People? Focus Note 59. Washington, D.C.: CGAP.

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