Microfinance helps or not?

Well, there has been a lot of debate recently on the issue- whether microfinance helps or not?

Two studies, both by Poverty Action Lab researchers have been in heavy controversy since they have been published. First – The miracle of microfinance? Evidence from a randomized evaluation by Abhijit Banerjee,  Esther Duflo,  Rachel Glennerster and Cynthia Kinnan (May, 2009). Second by Expanding Microenterprise Credit Access: Using Randomized Supply Decisions to Estimate the Impacts in Manila by Dean Karlan (July, 2009). First based in India, second in Philipines. Both studies show limited impact of microfinance on people’s lives.

I have been reading oft and on about it, but never could read through the results.

This Wharton news piece summarises the debate neatly. What is the issue at hand?

For three decades, microfinance institutions have given out small loans to the world’s poor — mostly women — and amassed hundreds if not thousands of case studies showing that the loans help alleviate poverty, improve health, increase education and promote women’s empowerment. Skeptics, however, have argued there is not enough hard data to prove that microfinance transforms lives on a large scale, and they have called for more rigorous analysis.

Now two new studies have raised doubts about long-held beliefs in microfinance. The studies — which used randomized controlled trial methodologies — did find that microloans helped poor entrepreneurs boost profits in their businesses. However, the studies found little impact on health, education, average consumption, women’s decision making or self-reported well being.

The findings

One problem with previous research, microfinance’s critics respond, is self-selection — that is, studies only survey clients who successfully take out loans. The new studies differ from the past in that both attempt to measure the impact of microfinance by comparing two groups: one with access to microcredit and one without.

In the first study, researchers from the Massachusetts Institute of Technology (MIT) worked with a microfinance lender in India to look at 104 slums in Hyderabad. Half of the slums were randomly selected to receive a loan branch, while the other half were not. Fifteen to 18 months later, researchers interviewed 6,850 households in the community — about 65 per slum — in an attempt to gauge changes in economic and personal well-being.

The second study, by Dean Karlan of Yale University and Jonathan Zinman of Dartmouth College, used a similar method to analyze microfinance in the Philippines, but instead of communities they looked at individual borrowers, tracking a total of 1,601 marginally credit-worthy loan applicants in Manila. Half were randomly offered a loan; half were denied. Researchers interviewed the sample group 11 to 22 months later to see if anything had changed. In both cases, results were mixed.

Hmmm.. The newspiece goes on to discuss views of economists on the 2 papers. The results seem to have surprised them but most are still hopeful. The benefits of the loan should be seen over a longer term. The next round of research should be more positive. Moreover, finance is just one part. It has to be combined with healthcare facilities, agriculture facilities etc to see proper impact on poverty. However, there are critiques as well who say the results need to be taken seriously and may be we are overdoing microfinance.

Abhijeet Banerjee, throws further light to the issue:

Reassuringly, we see no evidence of people falling into a debt trap. A lot of people do borrow without starting a business, but many of them simply use the money to pay down another, more expensive, loan. Of the rest, some use it to deal with an urgent need (an illness, a wedding) that they would have had to borrow for in any case; others simply buy something they needed for their homes but would never have enough money to buy (a roof or a television). To pay for the loan, they cut back on some of their daily indulgences (a cup of tea here, a pan there), which, remarkably, is exactly what they had said that they wanted to cut before the experiment started.

All this is good news. Yet the reactions to these results in the media have been rather negative — one hears rumblings that microcredit might be the latest ‘God that Failed’. Perhaps this is inevitable: so little has gone right with anti-poverty programmes in the last 50 years that it is hard not to hope for a miracle cure, and some of the boosters of microcredit indeed suggested that we finally have one. It has been argued, for example, that by putting more spending power in the hands of poor families and, perhaps more importantly, in the hands of women, microcredit can expand investment in child health and education, empower women and reduce discrimination against them. There was even the suggestion that by making people feel that their lives could be better and giving women independent access to capital, microcredit could fight the Aids epidemic.

He adds these results should not invite regulators spoiling the game:

This is no surprise for Padmaja Reddy, the founder and CEO of Spandana, who has always insisted that real transformation of people’s lives takes a long time — the next round of data collection is scheduled to start three years after the original loans were given, and there we might see something, she says — but it could still be a problem for her, if, for example, the Indian regulators, who have always been a little suspicious of microcredit, use the evidence as an excuse to start interfering more.

I agree to the long-term impact as it is all too complex. People take time to sort out their finances. But don’t agree to the regulation bit.

Again, I don’t know why financial regulation is always seen in this light. Why can’t financial regulation lead to better results? There is a proliferation in microfinance lending and with advent of for-profit microfin firms, it is changing bigtime. In such a case, shouldn’t we be prepared for some problems/issues in future? This crisis (and umpteen ones before it) tells you whichever sector of finance looks promising be weary of it. I am not saying restrict microfinance but it has to be watched. You never know what hits you and how.

How can we make financial regulation efficient? That to me is a very important question which remains unanswered. Financial regulators are seen as slow, not understanding the dynamics of finance etc. How can all this change? We live in a highly regulated world, why can’t we do the same for financial sector?

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5 Responses to “Microfinance helps or not?”

  1. Microfinance helps or not? « Mostly Economics Economic Finance news Says:

    […] Read the original:  Microfinance helps or not? « Mostly Economics […]

  2. Microfinance helps or not? « Mostly Economics | Finance Magazines Says:

    […] original here:  Microfinance helps or not? « Mostly Economics Share and […]

  3. Jack Commission Says:

    Do you accept guest posts? I would love to write couple articles here.

  4. Microfinance: Translating Research into Practice « Mostly Economics Says:

    […] Translating Research into Practice By Amol Agrawal I had written a while ago on the new controversy in microfinance research. Recent research shows that microfinance has […]

  5. Further explanation for whether microfinance works? « Mostly Economics Says:

    […] explanation for whether microfinance works? By Amol Agrawal I had written a while ago on the new controversy in microfinance research. Recent research shows that microfinance has […]

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