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24 March 2010

Banking on the poor

Microfinance, despite criticisms, remains a powerful tool for alleviating poverty.

By Meenal Vamburkar

When Muhammad Yunus won the Nobel Peace Prize in 2006 for his work in microfinance, the relatively new concept garnered a great deal of positive press and was touted as an innovative way to eradicate poverty. The general consensus was that by empowering the poor with microcredit lending, microfinance initiatives (MFIs) could be tremendously beneficial for many people living in impoverished regions.

Yunus founded Grameen Bank in 1983 in Bangladesh as a financial house that made small loans to the poor without necessary collateral. His idea was that the poor have wasted skills and, with a little financial help, they can use those skills to help themselves.

Since then, microfinance operations have exploded across the globe, from India and Bangladesh, to various countries in Africa. There are more than 665 million client accounts being served by banks who lend to the poor.

Yet for all its celebrated benefits, microfinance was criticised from the very beginning. Following Yunus’s Nobel Peace Prize, Salil Tripathi wrote a piece in the 17 October 2006 Guardian, stating emphatically: “Microcredit won’t make poverty history“. Tripathi wrote:

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Microfinance is often targeted at women, empowering them in societies with deeply entrenched views of gender roles. But don’t expect economic indicators to improve, incomes to rise or poverty levels to fall substantially.

One of the main critiques is that microlending does not actually lift up those living in extreme poverty; many doubt its real financial benefits. But this poses another problem: how to measure the impact of MFIs. The Consultative Group to Assist the Poor (CGAP) addresses this issue on its website, acknowledging the difficulties:

Unfortunately, scientific testing of the impact of microfinance is surprisingly difficult. If we find that people who got microloans are doing better than those who didn’t, does this mean that the loans caused the improvement? Maybe not. There are several other plausible explanations — for instance, that the people who apply for and get the loans may have more drive and ambition, in which case they would probably tend to do better than others whether or not they get the loan.

Up until recently, most of the few studies that addressed this challenge seriously found that microcredit produced important economic and social benefits. But there has always been controversy about the validity of these studies. A recent analysis of the most widely cited one raises grave doubts about its methodology and conclusions. These doubts probably apply to some of the other early studies as well.

CGAP makes an excellent point: those who get loans are likely to be more ambitious to begin with. This does make it difficult to measure impact, but there is a bright side as well.

If fundamentally driven and hard-working people are the ones getting the loan money, the bank is providing them with the means to apply their work ethic so that they can help themselves better their situation. It is, as they say, helping people help themselves — ultimately the goal of MFIs.

 

The benefits go beyond cash

Admittedly, this is an idealistic scenario. While most microcredit loans go to women, there are many instances of women simply passing their loans on to their husbands. In these cases, the money is most likely not used as efficiently as possible, and the quality of life may not significantly improve.

The benefits of MFIs, however, go beyond financial improvement. The “I can help myself” notion of empowerment is sometimes not taken seriously, but is more important than it may seem. One of the worst aspects of poverty is the helplessness it imposes on the people living in such conditions.

If a small loan can help get a family on its feet and make members feel like they do have some control over improving their lives, that does have a positive effect on that family’s quality of life. But again, these are consequences that cannot be measured adequately.

Like with any good idea, the true success lies in its execution. Microfinance will work and change lives when it is done right — and only when it is done right. With its vast popularity, there are increasing worries that the industry will become too commercialised, and have a detrimental effect on its overall aims.

However, there are also encouraging trends. MFIs are increasingly diversified, branching into micro-insurance, microsaving and even micro money transfers. Many providers are also specialising in specific services, or even providing non-financial services such as sharing “marketing infrastructure”.

As these trends emerge, they are giving microfinance hope for sustainability. Innovation is increasingly important to remain sustainable, and microcredit loans have been popping up in unexpected places. In last Sunday’s Observer, there was a piece on Faisel Rahman, who founded Fair Finance, a microlending bank in the East End of London. Having seen its success in Bangladesh, Rahman wondered if the idea could work in Hackney, London.

At first sight, such lending might seem a bit odd for the UK, but why not? There is nothing restricting microlending to developing or underdeveloped countries.

Another innovation is microfinance’s move to the web: Kiva.org, in particular. Through Kiva, anyone can lend as little as $25 to an entrepreneur somewhere else in the world. Its mission, according to its website, is “to connect people, through lending, for the sake of alleviating poverty”.

Lenders — ordinary people — can browse through entrepreneurs’ profiles, pick one and lend using PayPal or their credit card. Over time, the loan is repaid. This is a fresh approach to lending and as of November 2009, Kiva had facilitated over $100m in loans.

The concept of microlending has great potential, and has already helped many people across the globe improve their lives. There are many risks and criticisms — many of them valid — but, when implemented the right way, microfinance is a powerful tool to help alleviate poverty. Alone, it cannot eradicate poverty, but good execution and innovation will sustain it for longer than many predict.