Learning from failures in microfinance: what unsuccessful cases tell us about how group-based programs work

            American Journal of Economics and Sociology, The, Jan, 1999

            By Michael J.V. Wollcock

“Money, says the proverb, makes money. When you have got a little, it is often easy to get more. The great difficulty is to get that little.” –Adam Smith

To me this quote really summarizes the goal of Microfinance. So many people really just need a small stock of money to get themselves going- to get out of the cycle of having money lords holding loans over their heads, or to buy themselves a small amount of capital to start their own business.  Micro-loans are helpful to the poor because they “give them a hand up, not a handout” (Sampson, 1989). This process of giving those in need small loans so they can make more money with it has been quite successful over the years- as many of my entries have noted, but what about the failures and areas where the method of microfinance has struggled?

The article goes on to argue that despite clear developmental progress as a results of MF, there are “several methodological weaknesses in the literature documenting their impact and replication that should give pause to uncritical, wholesale endorsement.” I don’t doubt that microfinance institutions are reporting on a bias of support for their methods and it is important to know both the successes and failures of any project in order to move forward. It is especially important for the US to know what did not work in third world countries as we develop the best model for our own country, which has a very different make up than third world countries.

The main arguments of the article include the following:

-how to we know these results wouldn’t have occurred anyway?

-to what extent are outcomes attributable to noncredit and/or nonprogram variables?

-does it matter that villages and borrowers are nonrandomly selected?

In my opinion, selection bias is important when offering loans to those who are credit-less, especially if you are trying to build a successful base. Until a bank has developed success and a reputation, they must select the best and safest borrowers to guarentee returns. As the banks capital and abilities grow they can help more and more borrowers who may be riskier investments. If a microfinance bank begins by loaning to anyone and everyone who is creditless and wants a loan, they will lose too much money to continue their work. I understand that the point of microfinance is to help those without credit, but within that group there are still borrowers more qualified than others. A credit-less qualified borrow might be one that has a specific skill to market (ie. the ability to produce a desirable good) and a little capital to get that business started would appear to have good returns.

            The article also believes that there is a systematic bias to only report favorable outcomes, but is that not true of all businesses trying to promote their services? The article discusses specific case studies of microfinance failure that will be helpful for me to read through while thinking about an ideal model for the US, in particular the refugee women. 

Why Microfinance Alleviates Poverty (not just a temporary relief solution)
    With many dying and poverty worsening every day, it is important that action be taken now. Micro-finance offers equal opportunity to the world’s poorest people and countries, working as a realistic solution to alleviating global poverty. Micro-lending makes the previously impossible option of self-employment a reality. With increased opportunities, higher incomes are available. Self-employment is a realistic solution to raising living standards above poverty level because there is endless room for growth. Self-employment is especially sensible method of employment in underdeveloped countries where many have skills to create their own goods and there are rarely licenses or insurance needed to begin such an operation. In a country like the US, expensive licenses and insurance are often impossible hurdles to starting your own business because significant capital is necessary to get started. In underdeveloped countries (like Bangladesh) a micro-loan is all a woman needs to buy the initial capital to create and begin selling baskets (for example).

Repayment of Loans

One of the major criticisms against the field of micro-finance concerns the repayment of loans. Muhammad Yunus admits to the risk of such investments, “’[borrowers] don’t have collateral, they don’t have guarantees, they don’t have lawyers, nothing. How risky can you get? Still, our money comes back,’” (Parker, 1). Currently Grameen Bank holds a repayment rate of 98%, which is impressive even for a traditional bank (Parker, 1). World wide, “developing countries MFIs report unusually high repayment rates of 95% to 98%, which is higher than the rate for student loans and credit cards in the United States” (Hawser, 25). Yunus contends that these borrowers have no incentive not to repay their loans (they would be sacrificing their only chance) and in turn trusts them with credit. Additional security, provided through the group-loaning method, helps to maintain this impressive repayment rate. Robert Annibale, the global director of  the Citigroup Micro-finance Group comments on the process, “‘most micro-financing of Grameen-inspired MFIs is done through lending to groups of five to 20 women co-guaranteeing one another…so if one of the women has a problem meeting a repayment, other women in the group often help her to make that repayment’” (Hawser, 26).

Micro-lending that targets poverty has enabled higher income generation through a multitude of economic activities. Offering credit to the unemployed poor, works as a powerful method to breaking the cycle of poverty. Stuck within deathly cycles, these people were squashed under the forces of those they worked for or borrowed from. When one has no other choice but to work a full day for a just handful of rice, that is what must be done. Micro-lending offers another option, enabling people to become independent. Micro-loans provide access to credit and finance, training and skills, which lead both lead to better job opportunities, higher incomes, and a decent standard of living (Geodesudbury.com). Micro-lending makes the previously impossible option of self-employment a reality. With increased opportunities, higher incomes are available. Higher incomes do not only benefit the previously unemployed poor, but the country as well. Micro-lending can expand a country’s financial sector, but adding new companies and products. Variety and increased volume are both beneficial, especially to developing countries that may rely heavily on one export. With this expansion of business, the individual’s and country’s economic power grows.

When money is loaned out it is eventually put back into another bank and is ready to be loaned out again. The effect of a loan in the economy is described through the equation, 1/ R (“R” is the reserve ratio) multiplied by the money supply ((1/R) x MS). Therefore, even these micro-loans have a greater effect on the economy. Although these loans are small, the do have a significant impact on the national economy as their positive effects ripple throughout, income, employment, aggregate supply, GDP and living standards.
The only way for a country to expand its output in the long run is for it to expand its aggregate supply. Aggregate supply is accounted for by, natural resources, labor, technology, capital and education. If any one of these factors is increased, overall output and therefore GDP can be increased. Micro-loans can help to increase many of these five factors within aggregate supply. Giving the unemployed poor an opportunity to take part in the economy is a great step in itself. This increases the amount of labor available in a country shifting the AS curve outward. With loaned money, capital resources can be increased as the poor buy materials to begin their own businesses. Many of these businesses need other laborers, who will be taught a new skill. These increases in capital, education and labor productivity also shift the AS curve outward. The potential output of the country is increased by this shift in aggregate supply. Micro-loans help to utilize those previously unused resources in a country such as the unemployed poor and force them to effect the economy in a positive manner.

When offered credit, the poor are often able to employ themselves and raise not only their own incomes, but the GDP of their country as well. Micro-loans also increase the aggregate supply of a country, ultimately increasing the countries production potential. Most importantly, micro-loans help the poor to improve their own lives and increase their dangerous living standards. Through its provision of credit, micro-finance empowers the poor, alleviating the strongest symptoms of poverty and helping stagnant countries to prosper.
 

Through a rigorous loan process, loans focus on aiding the poorest of the poor (who would never be considered as potential borrowers by traditional financial services), those who are unemployed and barely scraping by. Typically, first loans are equivalent to about $5-$15 American. It is difficult for many to fathom the magnitude that this small amount of money can have. The CEO of Grameen foundation explains, “if 110 million people increased their per capita income by $3 a day, every day, that starts to become more meaningful on an aggregate level” (Hawser, 24). No collateral, credit history, or other legal paperwork is required for micro-borrowers to receive loans and the smallest amounts completely alter lives through the opportunity they provide. Many are able to break payment cycles they are stuck under, start their own businesses or even simply put a roof on their own home (Geodesudbury.com). Micro-loans open a world of opportunities for the poor who would otherwise be likely to die of poverty.
    Whether or not loans will be repaid is a chief concern and criticism in the field of Micro-lending. Yunus and Grameen Bank developed a system, to ensure the payback of loans from borrowers. All loans are granted to people in groups of five. If one person in the group fails to pay back his or her loan, the entire group is let down. The group dynamic allows borrowers to have support and encouragement from their community, helping to ensure loan repayment (Yunus). Yunus admits his loans to be risky, “’[borrowers] don’t have collateral, they don’t have guarantees, they don’t have lawyers, nothing. How risky can you get? Still, our money comes back,’” yet is confident in the process (Parker, 1).