The Rise and Fall and Possible Re-Rise of Microfinance
This is the story of one of the world’s greatest solutions to poverty. That solution got corrupted. In some places it may be rebuilding.
That solution is microfinance.
Microfinance is the practice of giving very small loans to poor people. In the old days, banks would never loan money to the poor. It was inefficient from their point of view to do the work of underwriting 5000 loans for $40 apiece when they could just process one application from a normal businessman for $200,000. In practice, the rich got most of the credit. There were modest openings for the middle class and small business. The working class and slum dwellers were left out in the cold.
This situation was changed forever by Muhammad Yunus and the Grameen Bank of Bangladesh. Yunus realized that poor people are perfectly good credit risks. One simply has to limit the size of the loans to a level that poor people can realistically repay.
The consequences of getting a loan can be dramatic. A woman selling sandwiches in front of a factory might have dreams of having a grill so she can make hot sandwiches. That grill might cost $40 – but for her that grill might just as well cost a million dollars. She will never have $40 at her disposal at any one time. Giving her the loan of $40 could be the difference between a lifetime trapped in poverty, and the beginning of a small business that could significantly raise the income of that woman and her family.
The original terms of the Grameen Bank were very pure and very strict. On the pure side, they loaned money only to the authentically poor. Women did not need assets before the Grameen Bank would talk to them.
On the strict side, the Grameen Bank used a lot of peer pressure to make sure women paid back their loans. Loan money was given to a group of women. However, only one woman could use the loan money at the time. The first woman had to pay back her loan for the second woman to be able to access the funds. And so it went for the group until everyone had had their turn. After that, the cycle would repeat, with the first woman being able to borrow from a now bigger pot of money. Repayments were very high under this system. But they were high because the entire rest of the group would be putting a lot of moral and psychological pressure on whoever was using the loan money at the moment. The other women used a lot of arm twisting to guarantee they would have their turn with the money. Recipients of Grameen Bank loans reported a great deal of psychological stress.
However, the loans had the desired anti-poverty effect. Most of the loans got repaid. The microbusinesses of each of the women grew. Over time, many groups of women were lifted out of poverty creating a brighter future for themselves and their families.
The extraordinary success of the Grameen Bank let to a host of imitators. Some of the imitators were as good as the Grameen Bank. Others had problems with repayment.
All credit organizations face the same challenge whether they are loaning millions of dollars to a multinational corporation or they are loaning $60 to a poor woman for a sewing machine. They have to underwrite the loan carefully to know whether or not the debtor can realistically repay the loan. The Grameen Bank was scrupulous about screening women thoroughly before letting them enter a borrowing circle. Some subsequent microfinance programs were just as careful about doing due diligence. Others were not. The sloppy ones began to encounter problems of default.
Another complication emerged when for-profit banks entered the microfinance scene. The Grameen Bank had not been about making a profit. It had simply concerned itself with raising women out of poverty. It enforced repayment standards to keep Grameen from going out of business due to catastrophic losses. But as long as it got most of its money back, it was happy.
When for-profit banks learned that poor people could repay their loans, they wanted a part of the microfinance action. They were less enthused about doing careful underwriting – since paying underwriters costs money. They were much more concerned than were the philanthropic microfinance programs about making money. Their general approach was loan money to the “wealthier” poor. That increasingly meant the lower middle-class. Had other forces not been in play, it would have been entirely likely that microfinance would have been an anti-poverty program in name only, as banks shifted loan programs for the poor away from the actual poor.
What counteracted this tendency?
Microfinance became so glamorous that everyone wanted into the game. Governments threw tons and tons of money into microfinance. NGOs (Nongovernmental Organizations such as charities) were being formed left and right to run microfinance programs. Commercial banks moved into microfinance on a me-too basis because everyone else in banking was doing it.
The flooding of the market was good news for poor people who wanted loans. Anyone could get a loan.
The flooding of the market was bad news for underwriting. People were being given loans very uncritically. Lots and lots of people were in over their heads.
Sloppy banks may not have been good at assessing credit risks before they lent money. They were very, very good at collecting money. When they couldn’t collect the money, they would refinance, loading their over-their-head debtors with even greater amounts of debt.
The speculative fever that led to the overfinancing of the pool was no different than the speculative fever that goes into real estate bubbles or the speculative fever that causes international banks to overlend to the Global South. At some point, bad loans have to crash.
Fortunately, the amount of money that is in microfinance is a small percentage of the money which is in global finance. There is no risk that failed microfinance will bankrupt the international credit system. It does mean however, that many poor people are being wiped out or will be wiped out.
As Maryann Bylander and Nathan Green have noted in settings such as Cambodia, microfinance is now used as a method for cheap real estate acquisition. Property developers who want to redevelop slum neighborhoods work with banks who make aggressive microfinance loans. Unlike the Grameen Bank which required no collateral, the slumdwellers are required to put their homes up as collateral. The loans are then given out freely with minimal underwriting. When the debtor defaults, the banks repossess the home and sells it at a good mark-up to the property developer. The developer gets their property at a substantial discount. The bank gets the proceeds from massive property sales. The poor families involved lose everything and are utterly dispossessed. This is a far cry from the original intent of microfinance which was meant to be a road out of poverty.
However, not all microfinance is as cynical as the programs documented by Bylander and Green. Beck and Radhakrishnan have a more optimistic account of model programs in Guatemala and India. The Guatemala program, Namaste, is a bona fide non-profit. It is funded entirely by philanthropic money exclusively for the purpose of raising people out of poverty. More radically – Namaste is utterly indifferent to whether its loans are repaid or not. Namaste’s own internal definition of success is the level of business success of the women who receive Namaste loans. To see that the loans are put to good use, there is a giant staff that monitors just about everything about the progress of the debtor’s business. Debtors are required to keep extremely detailed records. Those records are examined regularly looking for signs of problems. There is substantial coaching by members of the organization. Furthermore, there is a Grameen-Bank-like structure of peer borrowers that put pressure on the debtors to succeed. The borrower operates in a goldfish bowl – which is a stressful experience. But the businesses grow and prosper under Namaste tutelage.
Sowbagya is another model program in India. Sowbagya is an unapologetically for-profit organization. It gives loans for consumption as well as for investment. Borrowers often use the money for home improvements or for paying school fees. However, the program is enormously popular and generates fierce loyalty among its borrowers. Underwriting is extremely scrupulous. It is quite difficult to get into the Sowbagya program. Sowbagya borrowers are poor, but they are in the upper tier of the poor. More importantly, once a borrower gets in, the organization goes out of its way to ensure that the borrower has no problems repaying the loan. Loan officers are expected to have a caretaking relationship with their clients; they provide services such as helping them surmount legal and bureaucratic obstacles. They set up rescue programs in the face of unexpected crises. They run job fairs for their debtors. They provide financial literacy training. They offer subsidized products such as water-filters which are enormously valued by their customers.
Sowbagya does not particularly produce new businesses that take people out of poverty. However, it illustrates that even in a crowded credit market, underwriting does not have to be sloppy and repayment systems do not need to be savage. Sowbagya also shows that microfinance does not have to be nonprofit in order to treat people decently and provide meaningful financial services.
A global oversupply of microcredit can be highly problematic. There are clearly a lot of microcredit programs out there that are either too poorly underwritten to be effective or – in the bottom tier – too exploitative to be helpful.
But this does not mean microcredit is universally a bad idea. There are outstanding organizations out there. Outstanding organizations are still outstanding organizations. And there probably are places that are still underserved. (I suspect it is hard to find a microcredit program in Yemen.)
The ideals of the Grameen Bank are still noble ideals. The best of the microcredit programs are still worth supporting.
For More Information
The material on Namaste and Sowbagya comes from Erin Beck and Smitha Radhakrishna’s 2017 “Tracing Microfinancial Value Chains” in the journal Sociology of Development. That article starts with a fantastic overview of the history of microfinance and all the debates concerning the subject. The bibliography of that article should provide you with whatever information on microfinance you need to know.
The Bylander and Green material on Cambodia is forthcoming in the June 2021 edition of Sociology of Development. Check that out when it gets published!