- Microfinance is the practice of providing loans and other financial services (such as savings accounts or insurance) to poor individuals (largely) in the developing world.
- Assessing the impact of microfinance charities is difficult, partly because microfinance is commonly portrayed in misleading ways. (See also our discussion of "6 myths of microfinance.")
- We would guess that microfinance as a whole has done a great deal of good, but has also probably done some harm. In the past, we have reviewed many microfinance organizations including most of the largest ones.
- Our current view is that microfinance is not among the best options for donors looking to accomplish as much good as possible.
- For donors intent on supporting a microfinance organization, we suggest the Small Enterprise Foundation, which stood out most in our previous investigations of microfinance and which we have visited. For those interested in learning more about microfinance, we recommend the book Due Diligence.
Published: May 2012
How do charities help?
Microfinance organizations generally provide financial services - particularly loans, savings, and insurance - to people who are unable to obtain these services via traditional banking.
Microfinance is different from how it is usually presented. We feel that much discussion of microfinance - particularly microlending - 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."
One point we feel most donors are particularly misled on is the question of how people use, and benefit from, micro-loans. Microlending 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 appears more complex: it appears that loans are often used for food, visits to the doctor, and other consumption. 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
For those interested in learning more about microfinance, we recommend the book Due Diligence.
What are the challenges of finding a great microfinance charity?
There does not appear to be strong direct evidence that microfinance improves clients' incomes (or other measurable aspects of well-being), and the highest-quality studies of microloans in particular do not appear to show strong effects. (See our discussion of these studies on our blog as well as a more recent update by David Roodman of the Center for Global Development, whose work in this area we are very familiar with and believe to be of high quality.2 )
Most microlending institutions do report data on their interest rates and repayment rates, and one take on microfinance is that when clients are taking out loans at relatively high interest rates and paying them back, this itself is evidence that the clients are being empowered (see our discussion with David Roodman). However, in examining microlending organizations, we have generally seen high dropout rates (i.e., many clients seem to pay back their loans but drop out of the program), and have seen some reasons to be concerned that loans can do harm as well as good to the borrowers. (See our discussion on our blog.)
Previously, we examined microfinance organizations using a set of critical questions both about microlending and microsavings. In searching for institutions with strong answers to these questions, we found that:
- The large U.S. microfinance charities were rarely clear about their value-added.
- To the extent that we were able to obtain and review due diligence on partners (most of which is unfortunately confidential), it seemed focused on financial performance, with much weaker examination of social impact-related questions. (See also our discussion of the NIgerian organization LAPO as a case study.)
- There is an argument for focusing on financial performance over social impact, in the hopes of creating self-sustaining microfinance institutions and reaching as many people as possible. However, we have concerns about mixing donations with for-profit enterprises, with the possible result that donations end up padding profits (concept; example). We found that organizations hoping to use donations to start for-profit microfinance institutions are (perhaps for good reasons) rarely willing to share substantive information about their track record.
Another obstacle to finding great microfinance charities is the fact that telling oversimplified stories, and using oversimplified numbers, seems so widespread in the sector. See our posts on the potential difficulty of understanding a microfinance institution's true interest rates and repayment rates.
We have done substantial investigation of microfinance organizations and have not seen it pay off in finding outstanding giving opportunities, so for the time being we have de-prioritized this area (though we may revisit it at a later point).
Giving to microfinance organizations
In a research process conducted from 2009-2011, we identified microfinance organizations to contact, completed in-depth reviews of promising organizations and identified the Small Enterprise Foundation (SEF) as a standout organization. SEF is a microfinance institution operating primarily in the Limpopo province of South Africa. SEF demonstrated a strong focus on collecting the information necessary to assess its social impact, including (a) data on how many clients are dropping out of the program (and why), and (b) data on whether SEF is succeeding in its attempt to target people with very low incomes. We also had a positive impression of SEF when we visited its operations in South Africa (see our site visit notes).
That said, we have concerns about SEF's social impact, particularly regarding its substantial dropout rates, and we have not followed up on its progress since early 2012.
- "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: How the world's poor live on $2 a day. Princeton: Princeton University Press.
Roodman, David. Latest Impact Research: Inching Towards Generalization. http://microfinance.cgap.org/2012/04/11/latest-impact-research-inching-… (accessed May 11, 2012). Archived by WebCite® at http://www.webcitation.org/67aLL8rPI