Myths of microfinance

We feel that much discussion of microfinance is clouded by commonly held, appealing myths that have little or no basis in reality. Our 2009 blog post, 6 myths about microfinance charity that donors can do without, discusses and debunks myths including "microfinance has been shown to reduce poverty," "microfinance has been shown to work best when targeting women," and "microfinance donations get lent out again and again, and thus leveraged far more than other donations."

How can microfinance help people?

Microfinance is often presented as a way to help people escape poverty by giving them the capital to start or expand small businesses. However, the reality of how people use loans appears more complex. It appears that loans are often used for consumption purposes: food, visits to the doctor, etc. This isn’t a bad thing - the poorest people in the world face considerable financial uncertainty, and loans may empower them to manage their own lives.1

Does microfinance help people?

It depends on many factors. (The links below will direct you to longer discussions of each issue on our blog.)

• If loans are constantly and heavily subsidized, they can be thought of as similar to giving out cash, in which case our primary concern is that benefits reach the right people.
• On the other hand, if loans are not subsidized, a microfinance institution's profits could be taken as a sign that it has paying customers. This in turn could be a sign that it is providing empowerment.

With the latter goal (which seems to be the more common one), there is a big question about what role donations can and should play. We have expressed serious concerns about mixing donations with for-profit enterprises, with the possible result that donations end up padding profits (concept; example). In addition, we worry that there are too many donations blindly chasing the microfinance "story," with the result that donations end up disappearing into nebulous activities.

There is also a question about the extent to which loans are truly providing empowerment. There is evidence that borrowing is bad for at least some borrowers.

We have developed a set of critical questions both about microlending and microsavings, to get at the question of whether an institution is helping people. We've looked hard for organizations that can answer our questions.

Microfinance charities

In trying to answer the above questions, we've become fairly pessimistic about the area of charitable microfinance in general.

• The large U.S. charities are rarely clear even about what their value-added is. To the extent that we were able to obtain and review their due diligence on partners (most of which is unfortunately confidential), it seems focused on financial performance, with much weaker examination of social impact-related questions.
• Something as simple as the "repayment rate" turns out to be reported, by standard practice, in what we feel is a highly misleading way. Even after repeated conversations with many individual organizations, it was surprisingly difficult to even obtain basic information allowing us to calculate a "real repayment rate" for a microfinance charity.
• We've also been surprised by how often people drop out of microlending programs, generally for negative reasons.
• All in all, the picture we have is of a sector that tells stories about helping people but largely measures and rewards financial performance. As a result, microfinance institutions seem to have strong incentives to maximize their scale and their profits, even if doing so isn't good for the borrowers.

Where should you give?

We would guess that microfinance as a whole has done a great deal of good, but has also probably done some harm. We are more pessimistic specifically about microfinance donations in the current environment. For the reasons outlined above, we believe that giving to an "average" or "typical" microfinance charity – or giving with an illusory "peer to peer" relationship as the extent of your due diligence – is a fairly bad bet. At the very least, it will deliver far less good, and far more potential harm, than the typical microfinance narrative suggests.

Yet we still find the basic idea of providing financial services to people with low and volatile incomes very appealing as a way to help people - if it is done in a way that stresses social impact and uses donations responsibly.

We believe that microsavings is a particularly promising area, although we haven't found a microsavings charity we can be confident in.

We recommend:

• Small Enterprise Foundation, a microfinance institution in South Africa. For more, see our full review of SEF.

1. 1.
   • "Will the real microlending please stand up?" - a summary of this idea, 2 years old (more evidence has become available since)
   • Post on evidence of impact for microfinance - most encouraging effects came from programs not focused on business investment.
   • Conversation with David Roodman about microfinance.
   • More information on how loans are used.
   • Collins, Daryl, et al. 2009. Portfolios of the Poor: a study on how extremely low-income people use financial services (formal and informal). Princeton: Princeton University Press. http://www.amazon.com/Portfolios-Poor-How-Worlds-Live/dp/0691141487.