Helping to alleviate poverty is the key aim of any individual or group involved in development. The classic diagram of the poverty trap is frequently used to explain why it is so difficult to break out of the cycle of poverty.
Low productivity means that there is no money to invest in those things that could increase output. Banks will not lend even the small amounts required to invest in the means to increase productivity because those on such low incomes can provide no security against the loan. The only money available is often from local moneylenders who charge exceptionally high interest rates that only make the situation worse. In the last 30 years there have been some attempts to change the situation and microfinance is a term used to describe how financial services can be made available to poor people. It has received a lot of support from people involved in international development because it has been seen as an important way of helping millions of people out of the poverty trap. However recent criticisms by some politicians and development experts mean that the advantages and disadvantages of microfinance have been the subject of many discussions and caused many arguments.
The first example of an organized microcredit institution is generally accepted as being the Grameen Bank in Bangladesh in 1976. It was founded by Muhammad Yunus who started by making small loans from his own money at low interest rates to the rural poor around the village of Jobra. At the same time BRAC (formerly known as the Bangladesh Rehabilitation Assistance Committee, initiated in 1972, and later as the Bangladesh Rural Advancement Committee) also started providing microcredit to the rural poor and continues to provide microfinance facilities and support for rural development programmes today.
Grameen Bank extended its original microcredit project with the support of the nationalized commercial bank in 1979 and in 1983 it was transformed into an independent bank by government legislation. Although it started as a non-profit organization dependent on government subsidies, it became a corporate bank in 2002. Today it is 90% owned by its borrowers (the rural poor) and 10% by the government. It is estimated that nearly nine million people are borrowers from the Grameen Bank in Bangladesh and 95% of them are women. Yunus received the Nobel Prize in 2006 for his work in alleviating poverty in rural areas but he was controversially removed from his post as head of the Grameen Bank by the Central Bank of Bangladesh in 2011 because of his age (70 years old). The move was widely seen as a political attack by the Bangladesh Prime Minister, Sheikh Hasina, a long-term critic of Yunus and the Grameen Bank who, she claimed, were making money from poor people by charging high interest rates.
The success of the Grameen model has encouraged the growth of many more microfinance institutions in Latin America, Africa and Asia such as Kiva and PRODEM (later Banco Sol). It is the growth of these institutions and the increased involvement of commercial banks with neoliberal principles that has caused a debate about the true value of microcredit as a means of reducing poverty.
Yunus stated his principles when he started the Grameen Bank.
One of the early principles of microcredit was lending to individuals. This has gradually changed because the cost of monitoring loans and enforcing repayments is high and most loans are now made to groups because the costs are lower when they are spread among groups rather than individuals.
Each microcredit provider may have its own model for lending. In India, NABARD (National Bank for Agricultural and Rural Development) funds self-help groups that are made up of 20 or fewer members from the poorest castes and tribes, the majority of them women. Each member is expected to save a small amount a month which goes into a group fund. Members can borrow from the fund for a number of reasons and if the group shows itself capable of managing its funds they can borrow extra funds from a local bank to invest in small business or agricultural activity.
It is a common feature of microcredit institutions that most borrowers are female. Women make up around 75% of all microcredit recipients worldwide. This is not just because women form the majority of poor people in rural areas but also because they are seen as having the biggest influence in attempting to reduce poverty and are more reliable in making repayments. Lending to women has become a core principle for most microcredit organizations – indeed, some lend exclusively to women.
Grameen Bank says that it encourages borrowers eventually to become savers so that their local capital can be converted into new loans. It claims that, since 1995, 90% of its loans have been funded by interest income and deposits collected and that it converts deposits made in villages into loans for those most in need in the villages. It has also diversified its investment programme and made use of technology, as with its Village Phone programme (see box).
Among many different applications of microcredit by the bank, one is the Village Phone programme, through which women entrepreneurs can start a business providing wireless payphone service in rural areas of Bangladesh. This programme earned the bank the 2004 Petersberg Prize worth EUR 100,000, for its contribution of Technology to Development. In the press release announcing the prize, the Development Gateway Foundation noted that through this programme:
‘...Grameen has created a new class of women entrepreneurs who have raised themselves from poverty. Moreover, it has improved the livelihoods of farmers and others who are provided access to critical market information and lifeline communications previously unattainable in some 28,000 villages of Bangladesh. More than 55,000 phones are currently in operation, with more than 80 million people benefiting from access to market information, news from relatives, and more.’
The programme also won the International Telecommunications Union’s World Information Society Award in 2008.
Making microcredit facilities available to the poorest members of society has attracted strong support from neoliberals (because of its emphasis on individual responsibility) and those on the left of the political spectrum (because of its potential to empower women).
‘The basic idea sounds so simple and easy that a toddler could think of it. Why are people poor? Because they have no money. So let us give them money – then they will not be poor any more.’ (Indian economist Jayati Ghosh)
Although it would appear to be self-evident that providing finance for the poorest in society to invest in the means to increase productivity is a good thing for development, there is a problem when it comes to providing evidence of the benefits of microfinance programmes. There are very few evidence-based studies and those that have taken place only offer partial support.
The first randomized studies of microcredit appeared in 2009. MIT economists found that in the slums of the megalopolis of Hyderabad, India, small loans caused more families to start micro-businesses such as sewing saris. Existing businesses saw higher profits. But over the 12 to 18 months the researchers tracked, the data revealed no change in bottom-line indicators of poverty, such as household spending and whether children were attending school. (David Roodman, ‘Microcredit doesn’t end poverty, despite all the hype’, Washington Post, 8 March 2012)
Microcredit has not had a positive impact on gender relationships
A study in Bangladesh (2008) found that, although the majority of loans were made to women, they were often acting as collecting agents for their husbands. Women had to accept responsibility for repaying the loans that men had spent. This is particularly true for larger loans - women have 100% control over loans that are smaller than 1000 Taka but only 46% of control if the loan is bigger than 4,000 Taka. (Source: Lamia Karim, Demystifying Microcredit: The Grameen Bank, NGOs, and Neoliberalism in Bangladesh, a 2008 study of micro-lending)
Interest rates are too high
The cost of servicing loans is higher than for commercial banks because administration charges for small amounts are proportionately higher than for larger amounts of money. Institutions have to charge an interest rate that will cover those costs and continue to lend to future borrowers. The result is that the world’s poorest people pay the world’s highest cost for their loans. Grameen Bank interest rates are typically 20% but in other countries and institutions they can be much higher. The global average interest rate is estimated at 37%, with rates reaching as high as 70% in some markets.
High interest rates are a major criticism and the high demand for the services of microcredit institutions is one of the major causes. The rapidly expanding demand for micro-lending encouraged institutions to look for capital from foreign commercial private equity providers. The non-profit models of the micro-lending institutions were in conflict with the private equity providers. As a result, many of them changed their status to for-profit in 2005, converting their philanthropic nonprofit assets into private for-profit assets.
One such micro-finance program was Compartamos in Mexico, which in 2007 launched an initial public stock offering. According to a New York Times article, it charged its borrowers an annual interest rate of near 90 percent, producing a return on equity of more than 40 percent, nearly three times the 15 percent average for Mexican commercial banks. This made Compartamos highly attractive to private equity investors. The public offering brought in $458 million, of which “private Mexican investors, including the bank’s top executives, pocketed $150 million.” (David Korten, ‘Microcredit: The Good, the Bad, and the Ugly’, Yes Magazine, 9 January 2011)
For some people it is this neoliberal intrusion into micro-lending that has subverted a philanthropic ideal and caused many of the problems identified by critics. Others think that this notion is too simplistic and fails to take account of other basic problems.
Microcredit has driven poor households into a debt trap
One of the impacts of high interest rates has been to force poor households into a debt trap. Households borrowing money have to earn more than the interest accumulating on the loan or face increasing debt. The previously mentioned 2008 study in Bangladesh found that some families were using a microcredit loan from one organization to meet interest obligations from another. Officials working for the microcredit institutions often had their own wages based on repayment rates paid by lenders and sometimes used coercion to collect repayments on loans. In some situations, instead of gaining release from the poverty cycle, families were driven deeper into debt.
Microcredit does not alleviate poverty or improve health and education.
Claims by some supporters of microcredit about the contribution that microcredit can make to alleviating poverty are deemed to be unrealistic by many. One estimate by a researcher in Bangladesh suggested that 5% of the loans given by Grameen Bank resulted in the loanee escaping poverty – a worthwhile contribution to development but not the panacea that some people hoped it would be.
Microcredit rarely transforms lives. Some people do better after getting a small business loan, while some do worse – but very few climb into the middle class. It’s a constructive endeavor, but it has been vastly overhyped. And the hype has undermined the good that the movement can achieve. (David Roodman, Washington Post, 8 March 2012)
People like Roodman believe that microfinance has an important role to play in future development but, like the provision of clean water and access to medical services, it cannot solve the problem of poverty by itself. For people like him, the rapid growth of microfinance institutions around the world has not been helpful. The growth has increased expectations and the demand for capital has resulted in for-profit organizations replacing the original microfinance not-for-profit institutions. The result has been a big increase in interest charged on the loans and an increase in personal debt.
To ensure that the small loans would be profitable for their shareholders, such banks needed to raise interest rates and engage in aggressive marketing and loan collection. The kind of empathy that had once been shown toward borrowers when the lenders were nonprofits disappeared. (Muhammad Yunus 2004)
There are clear parallels here with the global banking crisis. A major cause of that was the selling of mortgages to poorer people in the US who did not have a realistic hope of repaying the mortgage. The initial high return from the interest charged on these mortgages encouraged the banks to think there was no limit to the money they could make and they committed vast amounts of capital. The global financial crisis occurred when it became clear that banks were holding worthless assets in the form of mortgages that would not be repaid.
The transformation of microcredit institutions from a model that serves communities to a model that is ‘sucking blood from the poor in the name of poverty alleviation’ mirrors a similar transformation of the US banking system, which occurred through the process of banking deregulation that began in the United States in the 1970s. (David Korten, Yes Magazine, 9 January 2011)
Roodman calls for a slowdown in the availability of microfinancing and for greater concentration on both start-up investments and training to build a solid framework for growth. Nevertheless, he still believes that microfinance has an important role to play in reducing the number of people living in poverty.
Financial services are like clean water and electricity – they are essential to leading a better life. Imagine if you didn’t have access to bank accounts, insurance or mortgages. Poor people need such services more than anyone, because in developing countries, poverty does not just mean low income, it means volatile income. The poor need to set aside money in times of plenty and draw it out in lean times. Financial services allow you to save for wedding expenses, borrow for funeral costs or insure for health care. (David Roodman, Washington Post, 8 March 2012)
The ‘privatizing of welfare’ argument
There are some people who believe that the biggest problem with microcredit is that it gives neoliberal politicians the opportunity effectively to privatize welfare and avoid government responsibility for providing the help and support that poor people need to escape poverty. Individual responsibility is a good thing but individuals cannot provide the infrastructure that communities need to make themselves wealthier and healthier, such as healthcare, clean water and sanitation, education and political freedom. It is an argument that is repeated many times in development studies. To what extent should people living in poverty be left to do things for themselves?
The arguments about the effectiveness of microfinance in alleviating global poverty will continue. They often reflect the different political values brought to bear on the whole field of world development.
The links below are to helpful articles and websites for further reading;
Blog from The NewYork Times by David Bornstein that provides a good background to the dispute between the Grameen Bank and the Bangladesh government. Contains good recent data.
UNESCO website article that contains mostly uncritical information about the Grameen Bank
Article from the Sydney Morning Herald by Ben Doherty from 2011 about the problems encountered by the microcredit industry
Guardian article by Mark Tran from June 2012 about whether microinsurance provides a more stable future for small-scale farmers
Blog from The Guardian by Les Roopanarine about some success stories for microfinance, 28 March 2012
Interesting article from The Guardian by Jonathan Glennie that comments on the differing views of microfinance held by Milford Bateman and David Roodman, 28 March 2012
Guardian article by Claire Provost analyzing a new book by David Roodman about microfinance, 6 January 2012
Article by David Roodman from The Washington Post explaining the limits of microfinance in helping people out of poverty
Demystifying Micro-Credit, The Grameen Bank, NGOs, and Neoliberalism in Bangladesh, Lamia Karim 2008 study of micro lending
Wikipedia article on microcredit