The Mystical Lure of Microfinance

>> Authored by Hugh Sinclair

Our fascination with microfinance began last century. The love affair began in the mid 2000’s. First the UN declared 2005 as the year of Microcredit – note this was microcredit, not microfinance. Yunus and the Grameen Bank won the Nobel Peace Prize the following year. Very little empirical evidence supporting the effectiveness of microfinance was presented to support either of these landmark events. Subsequently a series of academic papers have severely challenged the effectiveness of microfinance as a poverty alleviation tool. See Duvendack 2011, Roodman 2012, Zinman/Karlan/Banerjee 2015 etc. Yunus’s suggestion that we would have to go to museums to see what the blight of poverty was like seems laughable now, and only the most fanatical supporters maintain the belief of microfinance as a miracle cure. The sector’s reputation has been hammered by a series of negative reports, documentaries, books and academic papers, and it is widely accepted to have “lost its fairy dust”.

And yet the sector keeps growing. Some remain convinced it is a wonderful poverty alleviation tool, despite having little evidence to support this belief. And how did we ever fall in love with the idea of indebting poor people as a means of escaping poverty in the first place? I propose that this was for mythological and idealistic beliefs we hold dear in the West.

Aid was falling out of favour, deemed as inefficient, ineffective, often corrupt and non-scalable. Along came an alternative. Development was synonymous with food hand-outs, and now the development sector was preaching “teach a man to fish”. Microfinance apparently offered a scalable solution – once the banks had reached break-even, they could grow without endless subsidy, and apparently offer a free lunch to all concerned. Investors could make a return, and the poor could escape poverty by their own hard work. We were harnessing the proverbial entrepreneurship at the bottom of the pyramid.

In the meantime, entrepreneurship itself had become the buzz word. Our super-heroes started up businesses in garages in California and grew into the pioneers of Silicon Valley. MBAs desperately jumped onto the bandwagon, and new technology was the next big thing. The internet provided a superb arena for the next generation of entrepreneurs, heralded in the media as the true heroes of Western capitalist thinking. And microfinance extended this possibility to the poor – they too could be micro-entrepreneurs. Jessica Jackley, founder of Kiva, referred to “mini Bill Gates”, directly referencing this phenomenon.

Governments were cash-strapped, international aid was waning, and microfinance seemed to offer a chance to develop countries, but without draining scarce development budgets, which could presumably be used for more useful things such as vaccinations, hospitals and schools. And then we had the gender angle: microfinance targeted women, the vulnerable but hard-working members of society. The benefits of microfinance would spill over to their families and kids, and institutions such as Women’s World Bank popped up, and microfinance institutions boasted of their female participation rates. These micro-entrepreneurs would first provide for the family, and would then grow into the small and medium enterprises that form the basis of economic development. Imagery such as acorns, sprouting trees etc. were abundant. Yunus referred to the poor as Bonsai people. He even claimed microfinance could reduce crime. Then we have the other bundled services: micro-insurance (healthcare), micro-pensions (retirement), micro-savings (financial security). Who could criticise this? Credit is, after all, a human right, apparently.

The fact that microFINANCE was dominated by microDEBT was ignored. The sector was rebranded as financial inclusion. In response to the rather obvious mission drift in the sector, CGAP changed the “P” to poor, rather than poorest. And this broad belief in debt was highly compatible with western capitalist beliefs: banks are the back-bone of our society, the colour of your credit cards reveals your status. Abundant credit meant everyone could have a new house, car, holiday etc. Investment banks were the ultimate employer, beyond even Silicon Valley. The financial crisis, and endless microfinance scandals and collapses demonstrates the effectiveness of this belief.

And microfinance had ambassadors: Queen Rania of Jordan, the Queen of Spain, Princess (now Queen) Maxima of Holland; Oprah Winfrey loved it, Bono thought it was a marvellous idea. But the supreme representative of the sector was Yunus: a beaming, Western-educated economist from a poor and down-trodden country. This was post 9/11, and here was a mild Muslim promoting a version of the Western capitalist model. No sharia law or prohibitions of interest with Yunus. He had a magical charm, was a great public speaker, and had the exact profile required to promote microfinance. The suit-wearing investment bankers could never be the front-men. They lay in the background doing the IPOs, discreetly pocketing the fruits of the combined labour of the so-called micro-entrepreneurs.

Where was the evidence to support this fanaticism? In short, there was none. Evidence was not needed. Of course microfinance works. It touched all the right buttons in our Western psyche. It just felt right. Critics could be dismissed as heretics. When entire countries collapsed, such as Nicaragua, or during the Andhra Pradesh crisis when women begin committing suicide, the sector shrugged this off as a few outliers – the model still stood unchallenged. To this day Kiva refuses to publish the interest rates on the loans it facilitates, and Kiva users don’t care – 10%, 100% – it makes no difference, the poor benefit because it is microfinance and microfinance works. End of story.

Should we be surprised, in 2015, to read well-respected academics concluding “The [microfinance] studies do not find clear evidence, or even much in the way of suggestive evidence, of reductions in poverty or substantial improvements in living standards. Nor is there robust evidence of improvements in social indicators”? How can we arrive at such a mediocre conclusion from such a hyped sector? We allowed our Western ideologies, our own love-affair with finance, our own obsession with entrepreneurship, to cloud our judgement. Common sense took a back seat. Our subjective desires of what we wanted to be true overshadowed any objective criteria. And many benefitted on the back of this mythology. The lucky few earn massive salaries, huge bonuses, and the proceeds of IPOs can be eye-watering. And it should come as little surprise that these are precisely the same people who maintain this fanatical belief in microfinance, who ignore the academic evidence, who promote self-regulation (overseen by themselves) rather than actual regulation. These same people laugh at the idea of interest rate caps, despite living in countries where interest rate caps are common.

Protection of the poor is apparently unnecessary, as the market mechanisms will ensure this, while client protection in Western countries improves each year. We need more microfinance, to drive down interest rates and improve services, supposedly. The fanatics lick their lips at the prospect of handing out credit cards to the remaining billion or so who have not yet got a bank account, and if they can do this via cellphones even better – the profit margins are higher for them.

Microfinance works because we want it to. Not because it does.

13 Responses to “The Mystical Lure of Microfinance

  • Sinclair’s article here is full of characteristically leading and inaccurate statements, and I found it characteristically low in terms of journalistic ethical standards. It’s a tired and baseless argument from Mr. Sinclair, as described in painstaking detail here: http://nextbillion.net/blogpost.aspx?blogid=3731 This post discredits MMF’s platform and other articles posted here.

    • Hi Katie,

      As a founder of a microcredit organization and a doctoral student studying the impact of this strategy, I can say with confidence that the basis of the argument presented by Hugh is factual (that microcredit does not lift people out of poverty), and in fact well documented in the literature he cites (among other research that has been conducted). The legitimate problems with microcredit, however, are no reason to turn your back on it; in fact, it should be motivation to improve upon an idea that has the power and potential to improve people’s lives. We do that at Zawadisha through a careful approach that leverages the existing leadership in communities, works collaboratively with our members to co-create contextual solutions, and ensures that our impact is real and can be felt at the individual, household, and community level. I’d be happy to share the scholarly literature about microcredit if you’d like to dig deeper yourself — I’m sure that rather than disappoint, it will embolden you to take action. I can be reached at jen (at) zawadisha (dot) org.

  • milford bateman
    2 years ago

    Hugh, excellent posting and kudos to the Month of Microfinance for allowing you to post such a useful response to what the Month of Microfinance people must surely realise, as pretty much everyone else does now, that it is a failed intervention. How long before Month of Microfinance becomes ‘Month of Financial Inclusion’ I wonder?

    I think the one thing you missed one thing though is something on the power of ideology. Microfinance was driven forward because it was packaged up by Yunus and others as the perfect way of ‘bringing capitalism down to the poor’ as one prominent development economist put it. This was why the initial impetus was provided by USAID, the World Bank and some of the other ideologically-driven institutions. Then when a small financial elite realised they could also make tons of money from microfinance and from the poor, the sector expanded exponentially, but it created the conditions for its own demise. So you could have mentioned this for students to debate in place of the transparently false ’empowerment’ rationale put forward by far too many US-based academics. US students deserve better than being taught an elite-driven ideology under cover of ’empowering the poor’ but then so much of US economics teaching is exactly that.

    • Patrick Mfossa
      2 years ago

      Mr. Milford,
      I agree with you that microfinance is more likely to be a means of bringing capitalism to the poor to make it safe for the rich. From the post-cold war development model to these days, microfinance has gradually emerged as one of the most anti-poverty tools in SSA. This can be seen trough the so called Poverty Reduction Strategy Papers prepared with the support of IMF.
      But the gradual debunking of the claims that microfinance is a poverty reduction agent pushed those behind the machine to operate a spectacular shift towards Financial inclusion.
      Well,this isn’t in any way a surprise as Patrice Flynn (2007) pointed it out “lenders will always search for new markets. It is up to the consumer to be cautious when it comes to money” . Those behind the machine will always search for new concepts (microcredit, microfinance, financial inclusion,…) to keep the industry alive. But unfortunately, there is little the consumers can do. I am looking forward to seeing if financial education will help them become cautious!

  • Could “Katie” explain which aspects she finds so “characteristically” tired and inaccurate? If she has any evidnce of microcredit actually impacting the real world I (and the entire academic community) would be fascinated to hear her argument. Her reference to my Kiva post, which was somewhat critical in nature, is interesting. Kivans are a rare breed amongst microfinance fanatics who believe, amongst other myths, that the price of money (i.e. the interest rate) doesn’t matter. That she finds the publication of my post of sub-standard journalistic standard perhaps reflects more of her own views of freedom of speech and balanced debate in such matters. I disagree with Katie, in a number of areas, but suggesting this discredits MMF is a particular oversight of hers. The fact that MMF publishes such a range of opinions is precisely what makes it such a valuable tool in the sector. What a sad world it would be if we were all homogenous Kivans!

  • Mr Bateman, wondering about the reasons behind pushing microcredit will always be speculation. But one remarkably simple question is “what was the evidence upon which the Nobel Prize committee awarded Yunus and Grameen the Peace Prize?” Presumably they have to have some sort of evidence, and yet none has been forthcoming even all these years later. If you read the Nobel Prize anouncement (link below) it is very vague and ill-defined. It speaks in broad generalisations, about microfinance being liberating etc. They say that microcredit is one means to break out of poverty, but there is no evidence cited. Has poverty declined in Bangladesh that can credibly be attributed to microfinance? Does the Nobel Prize committee publish their justification for handing out awards?

    Again, this is speculation, but given the academics have been unable to find much evidence supporting microfinance, this only really leaves ideology and greed as possible explanations for the hype – or are there other reasons? I previously described the sector as a religious cult, and particularly after reading Murakami’s “Underground” I maintain this view. The fanatics simply cannot fathom that their beloved sector is flawed. They search for every shred of positive evidence, however flawed or anecdotal, and dismiss all criticism on whatever grounds they care to select. RCTs are fine when they appear to suggest positive impact, but when they find negative impact they are dismissed as spurious, or too short-term, or whatever. The periodic crises such as Bosnia, Nicaragua etc. are all “exceptions”, and blamed on something, anything else. The fundamental model cannot be challenged, it is written in stone, it simply does not require evidence. And many have built their careers wedded to the sector and cannot necessarily find employment elsewhere, they have school fees to pay and retirment ahead, even if they privately question the wisdom of indebting poor people, is it practical that they will jack it all in? And some of these folk are earning massive 7-digit salaries – hard to walk away from even if the evidence is not particularly supportive of the underlying activity!

    http://www.nobelprize.org/nobel_prizes/peace/laureates/2006/press.html

  • Patrick Mfossa
    2 years ago

    Geographic concentration of the competition between MFIs is one of those arguments put forward to explain the Over-indebtedness crisis that occurred in Nicaragua and Bosnia. Well this is the same competition that was supposed to lead to a significant reduction of interest rates charged to the customers.
    These same customers for whom only the availability of microcredit matters, not its price (according to the public narrative) .
    We were first told those customers were all genuine self-entrepreneurs who just needed access to tiny loans to grow income generating activities. There is now a great awareness that they are most likely consumption-smoothing households than capital-seeking small entrepreneurs.
    No matter who they really are, microfinance empowers them (once more time according to the public narrative). But where are the evidences to support this? Surely somewhere in the 6 recent RCTs conducted by well-respected academics.
    Well, the public narrative on microfinance is full of myths and those highlighted here are part of them. The industry is now a “four players ‘ ping – pong game ” in which the poors are the ball, those behind the myths, the players and most of us, the spectators. But i just hate watching a game where the score seems to be known in advance. Many books have been written in support to this ping – pong game, many bestsellers as well. ” Dead Aid ” of Dambisa Moyo, a high – profile Zambian economist, is one of my favorite. But if Aid is the disease of which its pretend to be the cure, then what she argues to be the solution – microfinance – seems to be even worse. Well after ” Dead Aid “, it seems at if ” Dead Microfinance : Why Microfinance is not working and how there is a better way for the poor ” will be the next best seller if the solution being proposed by its author is ” the rush towards financial inclusion ” ( the new version of our ping – pong game).

    • Patrick,

      Alas your suggested book title is taken! “What’s Wrong with Microfinance” and “Why Microfinance Doesn’t Work” were published some time ago, and I myself published “Confessions of a Microfinance Heretic – how microlending lost its way and betrayed the poor”. Anyone who bothers researching the academic evidence is generally disillusioned, and yet the game continues. So deep-rooted are these ideological beliefs that the MF supporters cannot fathom that their miracle cure is largely useless. Note that I say “largely”, however. There is a sub-set of MF clients who actually put the loans to good use. Not all MFIs are exploitative. And not all micro-enterprises are cannibalistic. While I am largely critical of the sector, where I may differ with other critics is that I think there is a small window of opportunity to use this tool wisely. But, like a medecine, the dosage is important, the price is important, the timing is important, the underlying purpose is important, and dependency is dangerous. Handing medecines out on every street corner is not a good idea. Formal regulation and transparency help to some extent, but the sector itself resists both, as un-regulated and opaque lending is more profitable for the shareholders, many of whom reside in nice offices in Europe and the US, oblivious of the suffering of the poor and enthused by the various medals and certificates they award one another. They often earn massive salaries, and convince themselves that they are doing good. Of course, we know this is largely a lie, and not only to the poor. The other forgotten loser in microfinance are the well-intentioned (but naive) donors who do wish to make a positive difference, and entrust their funds to the financial intermediaries to invest them wisely. Perhaps the true irony is that the regulators in Europe and the US permit this exploitation also, not of the poor, but of their own citizens!

      • Patrick Mfossa
        2 years ago

        Well Mr. Sinclair, i’m aware of the existence of such book. But what i argue is that since none of them did not suggest the rush towards “financial inclusion ” ( the new version of our ping – pong game) as an answer to the failure of microfinance, they are less likely to become bestsellers.

        • Fair point Patrick. So, here’s my challenge: why don’t you write it? Forgive me if I jump to the wrong conclusion, but from your surname and subject of your post on this website, is it fair to assume you are from Africa? If so, I would suggest that a book published by an African citizen would add weight to the debate – much criticism has originated from academics and consultants ultimately from Europe or the US, and can thus be criticised for being biased themselves (athough I would point out that I have lived in so-called “developing” countries since 2000, including in Africa). I cannot guarantee you will have a best-seller, but you have your first sale – I want a signed copy! Why not review the publishers that have previously published critical texts, put together a proposal, and contact them? I would be happy to help if I can, and I suspect more open-minded publishers would find a voice from Africa a refreshing change to the usual authors.

          • Patrick Mfossa
            2 years ago

            r. Sinclair, i have been thinking a lot about writing a proposal in this regards. I suggest we should discuss in box (patmfossa@yahoo.fr)

  • milford bateman
    2 years ago

    Hugh
    Yes, many people have wondered how the Nobel Committee could award the prize to Muhammad Yunus and the microcredit when there was no evidence then, and certainly since, that it was actually doing what it was supposed to. It all comes down to politics, as Patrick Bond points out here in an excellent deconstruction of the reasons why the Nobel was offered to Yunus:

    http://joh.sagepub.com/content/37/2/229.full.pdf+html

    My own thoughts on the whole saga of microcredit and why Muhammad Yunus’s thinking was completely wrong are here:

    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2385190

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  • Radio Silence » Confessions of a Microfinance Heretic | Blog :

    […] LSE – worth a read. And while this blog has been relatively quiet recently, I did a post on the Month of Microfinance entitled “The Mystical Lure of Microfinance”, where I try to stand back and explain why it is […]

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