Has Microlending Lived Up To The Hype?

Microlending – or small loans (less than a few hundred dollars) – has become a popular, buzzed-about method of poverty relief over the last few decades. As of 2013, there were 211 million micro-borrowers worldwide; as of 2018, that number was nearly 240 million.

The concept is pretty simple: By providing small loans to those in developing nations who need them, the lender empowers the borrowers to invest in starting a small business, or an education, or even household improvements – and thus, through the use of those funds, to help remove their families from poverty.

It’s a solid theory, and one that has attracted entrepreneurs, NGOs, investors and philanthropists worldwide to get involved.

So, has it worked?

That, as it turns out, is a somewhat difficult question to answer – because, as recent reports indicate, the answer will vary greatly depending on what criteria for success are applied. As a pure poverty reduction tool, the results are mixed at best – there is very limited evidence that the advent of microlending has moved a statistically significant people from the jaws of poverty.

But – and this is an important “but” – the evidence also indicates that what microlending has done is to greatly advance the cause of financial inclusion worldwide, and given the global poor access to financial services that heretofore simply didn’t exist. It may not have lifted any people out of poverty yet, but the evidence does seem to suggest that it has at least begun laying the groundwork for a road out of poverty for hundreds of millions of people worldwide.

The Poverty Puzzle

The person largely credited as the father of microlending is Muhammad Yunus, an economist who made two fundamental arguments in favor of the practice. The first was that “all human beings are born entrepreneurs” who are inherently motivated to innovate and create new businesses. The second was that with a dependable source of credit, even people in developing nations can tap into that natural entrepreneurship and use it to earn their way out of poverty.

Yunus won the Nobel Peace Prize in 2006 for his work in advancing microlending worldwide. According to Tim Ogden, managing director of the Financial Access Initiative, in addition to founding the Grameen Bank, what Yunus primarily did was to change the narrative about lending to the poor being a necessarily evil thing to do and something that would trap them in debt.

“You’re loaning money to a woman who is earning a dollar a day? How is that not going to trap her in debt? Oh! She’s starting a business and earning more money than I’m charging her,” Ogden explained of the mind shift, which Yunus grew.

In the intervening 12 years, however, two issues have cropped up around microlending and its efficacy.

The first issue is interest rates. Yunus argued from the beginning that for microlending to be an effective tool, rates had to be locked in at a low level, lest microlending turn into a developing world’s form of loan sharking. Instead of pulling people out of poverty, high interest rates would in fact push them deeper into it. Others, however, have argued that standard is essentially crippling, because evaluating creditworthiness is difficult in many parts of the world, and sustainable lending to the poor has to be priced for the elevated levels of risk. That debate is ongoing.

The second issue is about efficacy, and whether microloans are actually working in the way they were intended and having the elevating effects as promised.

By the Numbers

While anecdotes from borrowers worldwide indicate that on the whole microlending has lived up to its billing, the more systematic research on the topic has been a bit less clear.

For example, a 1998 study by Mark Pitt and Shahidur Khandker claimed that borrowers — especially women — were getting out of poverty at significant rates in Bangladesh due to the push from microlending. But a reanalysis of the study data by Jonathan Morduch led to questions about the reliability of the results and the methods used to obtain them.

Not all that much research was done on the subject for the next 15 years or so – but in the last five years, that has changed with a series of randomized controlled trials (RCTs) taken to the subject.

The most recent six microcredit studies, published in 2015, were conducted by economists working independently across six countries. All consistently came to the same result: Average income was not any higher for those people who had received microloans than those who had. The study did note some modest effects – more small businesses, minor spending pattern changes, mostly – but nothing even close to a tool that was successfully moving people from poverty.

“We note a consistent pattern of modestly positive, but not transformative, effects — not the result that many people had hoped for,” the study noted.

But “not the hoped-for result” and “not a good result” are two very different things.

Improved Access for All

Poverty is an incredibly difficult thing to alleviate – if it weren’t, it would no longer exist, since it is not exactly popular with anyone, anywhere.

In a recent discussion about the history of microcredit, Economist Bruce Wydick noted that the expectation that microlending could lift people out of poverty in developing nations in a single generation was probably never a good one to start with. Turnaround takes time, he said, comparing microcredit in poor countries to introducing credit cards in the developed world a half-century ago.

“When they introduced credit cards in the U.S., so that almost everybody had access to a credit line, did that pull millions of people out of poverty? No,” Wydick noted.

What it did do, he said, was give American consumers access to a new way of managing and accessing their funds, which over time very much changed the economic condition of millions of people all over the world.

The value of microlending is similar, he stated, because what it offers to residents of developing world is something that has never existed in most of their economies, which is reliability: People can depend on getting a loan at a certain time, then commit to the small, regular repayments so they can get a further loan.

Those loans – as researchers Daryl Collins, Jonathan Morduch, Stuart Rutherford, and Orlanda Ruthven found in their study Portfolios of the Poor – are critical to consumers’ lives in the developing world, even if they are not actually taking those loans to start SMBs as often as had been predicted. What these people are doing instead, the researchers noted, is using those funds to get out of emergencies, or even to fund day-to-day expenses in tight times.

“Incomes are seldom steady and predictable; needs vary as well: Families need to pay for schools, medicines and food during slow periods … evidence that microfinance loans are used to fund non-business needs (even for education or health) is sometimes used to criticize microfinance, but that misses the point … poor families, like richer families, need broad financial tools. In fact, the poor may need them more urgently.”

Economists Emily Breza and Cynthia Kinnan also found in a study that while microfinance does not have a quickly massive effect on poverty, it almost immediately affects consumer mobility. Those who have taken microloans are more able to travel further from their hometown or village, more likely to solicit further education and better able to command higher wages in the market.

“Microlending moves hand-in-hand with the digitization of funds in the developing world,” the study said. “Simply giving consumers a method to hold and control their funds – without having to physically carry cash with all the attendant risks – has been a terribly important advance.”

So what does all this mean for microlending and its uses?

While it is fair to say that microlending has not singlehandedly lifted those living on less than $2 a day out of poverty, one might wonder if perhaps the expectation of a silver bullet was misplaced. Because it is also fair to say that what microlending has done is create access to financial services in parts of the world where those services were once limited to “places where cash can be received.”

And while that may seem like a small step forward, it probably feels a good deal larger to someone who will eat tonight or attend school tomorrow thanks to a microloan.