Microfinance Not So Miraculous Afterall?

Microfinance (a.k.a., microcredit or microlending) has been highly touted among many development folks and people interested in helping to alleviate poverty in developing countries (and communities in the US). For instance, Opportunity International claims:

Microfinance is the provision of financial services such as loans, savings, insurance, and training to people living in poverty. It is one of the great success stories in the developing world in the last 30 years and is widely recognized as a just and sustainable solution in alleviating global poverty.

There’s just one problem. There is virtually no systematic empirical evidence to support that claim.

The authors of one of the first randomized studies on the effects of microfinance (published in 2010) recently released an updated version of what they claim to be “the first and longest running evaluation of the standard group-lending loan product that has made microfinance known worldwide.” The abstract of the NBER paper (gated version here, ungated version here) summarizes their findings:

This paper reports on the first randomized evaluation of the impact of introducing the standard microcredit group-based lending product in a new market. In 2005, half of 104 slums in Hyderabad, India were randomly selected for opening of a branch of a particular microfinance institution (Spandana) while the remainder were not, although other MFIs were free to enter those slums. Fifteen to 18 months after Spandana began lending in treated areas, households were 8.8 percentage points more likely to have a microcredit loan. They were no more likely to start any new business, although they were more likely to start several at once, and they invested more in their existing businesses. There was no effect on average monthly expenditure per capita. Expenditure on durable goods increased in treated areas, while expenditures on “temptation goods” declined. Three to four years after the initial expansion (after many of the control slums had started getting credit from Spandana and other MFIs ), the probability of borrowing from an MFI in treatment and comparison slums was the same, but on average households in treatment slums had been borrowing for longer and in larger amounts. Consumption was still no different in treatment areas, and the average business was still no more profitable, although we find an increase in profits at the top end. We found no changes in any of the development outcomes that are often believed to be affected by microfinance, including health, education, and women’s empowerment. The results of this study are largely  consistent with those of four other evaluations of similar programs in different contexts


This is not to suggest that microfinance is bad, but it is obviously not the miracle it is often purported to be by its proponents. Some microfinance organiztions recognize microfinance’s limitations. For instance, Kiva explains:

While some studies indicate that microfinance can play a role in the battle against poverty, it is also recognized that is not always the appropriate method, and that it should never be seen as the only tool for ending poverty.

The Consultative Group to Assist the Poor (CGAP) is even more direct in their explanation of microfinance’s effects.

While the concept of capital that will allow poor people to unleash small business opportunities remains valid for some poor clients, not every borrower is a microentrepreneur—take-up rates for credit products are often surprisingly low, and not all economic activities that poor people engage in yield high returns. Microcredit is not transforming informal markets and generating significantly higher incomes on average for enterprises. And yet the industry has focused almost exclusively on the rhetoric of entrepreneurship and has overlooked the many important benefits to households that are using loans to accelerate consumption, absorb shocks, or make household investments, such as investments in durable goods, home improvements, or education for their children.

Long story short: Microfinance does allow households to change their consumption pattern to a limited extent. But it does not stimulate tremendous economic opportunity, empower women in business, or in alleviate poverty in meaningful ways.

If you want to help the poor, providing funding for microfinancing through groups like Kiva may make you feel good about making a difference. Just understand that it’s not near the kind of difference you may have been led to believe.


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