Microfinance Can Change the World
We are claiming April as the month of Microfinance.
All are welcome to join our community: microfinance professionals, researchers, and enthusiasts; chief executive officers and loan officers; small, medium and large-scale microfinance institutions; microfinance institutions that operate in Bangladesh, Bolivia, Pakistan, South Africa, the United States…anywhere. Voices from the mainstream and voices of dissent are welcome. Diversity in our community will be accompanied by a diversity of experiences, beliefs, and narratives regarding microfinance.
What is Microfinance
About Month of Microfinance
We have a lot of questions. Some are expansive: When does the pursuit of scale come at the expense of clients? Does microfinance help move clients out of poverty? Others are specific: What is a fair interest rate to charge? Which fees are consistent with client-centered microfinance? Answers are good. But, conversation – nuanced conversation – that allows for ambiguities and explores the tensions at the heart of client-centered microfinance is even better.
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The market for microinsurance in Bangladesh has been growing rapidly over the last 10 years, with over 25 million subscribers. Yet it is still met with skepticism among many poor microfinance clients. As of this January, BRAC, in partnership with Guardian Life Insurance Company, joined the market making its Credit Shield Insurance product available nationwide to a further 5 million of its clients across the country.
Its first microinsurance product, BRAC initially started piloting Credit Shield Insurance in November 2014. After years of testing, we finally have a solution that is simple, accessible, affordable and, unlike most other microinsurance products on the market, voluntary for our clients and their families, while being sustainable for the institution.
Clients benefit in three ways. First, Credit Shield Insurance, which is available to anyone that has a loan with BRAC, covers the outstanding loan balance in full in the event of death of a client or her/his insured family member. Second, the nominee (the client or the surviving family member) receives an instant cash benefit to cover hospital and funeral expenses. Third, clients’ savings with BRAC are reimbursed with full benefits to the family. And all these benefits come at a nominal, one time (per loan) premium.
While Credit Shield Insurance is now a success for BRAC, getting here hasn’t been easy. Below we reflect on three key takeaways from our experience getting microinsurance right in Bangladesh.
1) Keep learning as you scale
While piloting is vital, the learning doesn’t end there. Often the most important lessons are experienced when taking a product out of pilot phase, to scale.
As we prepared to scale, we discovered the need to alter a few product features. This revision was necessary for two critical reasons. First, in a few cases there was a deviation between product features and the actual needs of the client’s household at the time of death. Second, although the business model was found cost-effective in the short run, it was not appropriate for large-scale expansion in the long run.
We learned that our clients really need to free up cash immediately after the death of a family member to cover hospital and funeral expenses. Often families that use cash available to them (for example, from micro-loans) will later look to repay any outstanding loans either by taking high interest loans from informal lenders or by selling assets. We therefore doubled the amount of funeral benefit to BDT 10,000 (USD 125) for our lower-income group loan clients, and quadrupled the benefit to BDT 20,000 (USD 250) for our individual, small enterprise loan clients.
Though we increased the immediate cash benefit, we wanted to keep the previous premium rate as low as possible. We had determined that clients could afford to pay 0.7 percent as a one-time premium for dual coverage (covering the client and another household earner), which is approximately BDT 210 (USD 2.60) for the average loan size of BDT 30,000 (USD 375).
To manage the offering at this price we decided to drop the feature of refunding paid loan installments to balance. This feature was also less critical for our clients who most valued access to immediate cash, a loan waiver, and fast settlement of claims.
Features of Credit Shield Microinsurance Pilot & Scaled Credit Shield Microinsurance.
For example, during our pilot we discovered 28 percent of deaths occurred within 30 days of enrollment. In most cases, these insured clients or spouses had pre-existing life threatening diseases like kidney failure, cancer or fatal heart diseases which they did not disclose. Offering to cover the entire loan amount (by waiving the remaining outstanding loan balance and refunding all paid installments) may have encouraged greater moral hazard among clients whereby they would enroll because of and without reporting a pre-existing illness – adding costs that were too high. Considering these ground realities, the revised features are now more practical, lower-cost and sustainable for expansion.Even with enrollment being voluntary, we experienced an average of 60 percent uptake during the piloting phase. However, uptake needed to be 80 percent in order to be sustainable. Additionally, as there is no assessment of health during enrollment, clients with ill health may get enrolled, potentially causing negative impacts through adverse selection.
2) Invest in building clients’ understanding
Given the novelty of microinsurance within the Bangladesh microfinance market many clients still failed to see the value of the product. To address this, we invested considerable time into on-boarding our clients through three phases.
At the field level, our team explained Credit Shield Insurance through group meetings and one-to-one communication for SME clients. Frontline workers used storytelling to help clients visualize the threats of not having microinsurance, using real life examples from members of the group or local community.
At the branch level, our Customer Service Assistant (CSA) and branch managers conducted separate sessions on the benefits of Credit Shield Insurance, terms and conditions, and common misconceptions surrounding microinsurance, often related to concerns of fraud. At both the field and branch levels, use of pictorial materials such as banners, pamphlets and posters was also instrumental in raising awareness of the product.
Finally, we also communicated with clients via phone. BRAC’s call center has a team dedicated to providing additional information to clients that are not enrolled.
3) Prioritize convenience and usability
Since the pilot, we have reduced the claim processing time from 10 to just three days, transforming a manual claim management system to an automated system. Now the claim documents are directly sent from the local branch to the insurance provider through an app, saving at least seven days compared to sending physical documents through often unreliable local courier systems. Additionally, the practice of funeral benefit disbursement on the date of death is helping clients meet their immediate emergencies. By making the product work easily and efficiently for clients we are shifting the preconceived negative mindset towards insurance and gradually building a culture of trust and transparency.
Moving forward BRAC hopes to offer some add-ons and provisions to address critical issues, such as permanent disability and accident coverage, alongside our current Credit Shield policy.
Over time we hope to create fertile ground within the market for additional, sophisticated, long-term microinsurance solutions like health, crop, and property insurance. But a precondition for a thriving microinsurance market is fostering an insurance culture first – just like how MFIs once established a strong credit and savings culture. To work towards this, we are planning a national awareness campaign in partnership with government institutions.
Microinsurance, including Credit Shield Insurance, will not take off over night. But if there is just one thing we have learned it is that the effort is worth it. As an increasing number of clients choose to opt in we are steadily contributing to the increased protection and resilience of millions of households in Bangladesh.
By Tanvir Rahman Dhaly (Head of Business Development, Microfinance, at BRAC) and Panuel Rozario Prince (Deputy Manager, Microfinance, at BRAC)
Julia Kurnia is the founder of Zidisha, the first online community to enable direct person-to-person lending to entrepreneurs in developing countries without local intermediary banks. We had our first Q&A with her last year. You can find her on facebook and twitter.
- What makes a person-to-person lending platform so unique in the microfinance world?
Person-to-person lending platforms like Zopa, Prosper and Lending Club have reduced the cost of loans in wealthy countries for many years. Zidisha was the first to apply the direct person-to-person lending model to microfinance loans in developing countries.
Unlike traditional microfinance services, we don’t have branch offices or loan officers. Instead, we provide an online crowdfunding platform that connects internet-capable microfinance borrowers directly with individual lenders worldwide.
Traditional microloans, even those funded by charitable lenders through microlending websites that work with local partner organizations, pass to borrowers at interest rates averaging over 30%. This is due to the high cost of personnel and branch infrastructure, relative to the small amounts of the loans.
The direct person-to-person lending model makes it possible to reduce the cost of microloans substantially. Zidisha borrowers pay only a service fee of 5 percent for the loans (which are interest-free). The lower cost means borrowers keep more of the profits from their loan investments.
- How does Zidisha balance using 5 percent service fees to be sustainable and being client-centered? Have you ever been tempted to raise the fee?
Since we don’t have physical offices or staff in borrower countries, our costs are far lower than those of traditional microfinance services. Our main costs are money transfer fees, SMS messaging, and website development, and these are fully covered by the 5 percent service fee income.
We’re a nonprofit organization, and our mission is to help disadvantaged entrepreneurs in developing countries access affordable investment capital. An important value for us is to keep a very low overhead cost ratio, and pass on the savings to our members. This constraint has often been an advantage, as it has forced us to develop innovative ways to keep costs low, such as automation and decentralizing to the community tasks traditionally done by loan officers.
Though we’ve never raised the 5 percent service fee, we originally allowed borrowers to offer interest to lenders. We discontinued interest for lenders in 2015. One of the reasons was that it undermined our value proposition of providing very low-cost loans – the main reason many lenders as well as borrowers choose to participate.
- What role does trust play in Zidisha’s borrower to lender relationship?
Trust is the most difficult challenge for a web-based marketplace. Since Zidisha borrowers aren’t vetted by loan officers, and we don’t require collateral, we’ve had to evolve other ways to manage credit risk and ensure responsible participation.
We make use of cutting-edge technologies, like using machine learning to develop fraud detection and credit risk predictive algorithms. However, our most important credit risk control measures are simple and low-tech.
Every first-time borrower must repay a small test loan before they can post a larger loan application for funding by Zidisha lenders. Thereafter, credit limits increase based on each member’s track record of successful repayment. Borrowers who wish to raise larger amounts more quickly may qualify to do so by making a payment into a reserve fund, which we use to refund lenders for any defaults. This makes it possible for lenders to preserve the value of lending funds over time, even without earning interest.
Most new borrowers come to us via word of mouth, and new members who have invites from established borrowers with good repayment records enjoy higher starting credit limits. Established borrowers may continue issuing invites, in limited quantities at a time, as long as their invitees continue to demonstrate good overall repayment performance. Over time, this leads to a system where networks of responsible members grow and become the dominant behavior.
- What kind of relationships have you seen come out of your person-to-person model?
At Zidisha borrowers create their own profiles, sharing their personal story as well as a loan proposal. Lenders and borrowers can post messages and photos. Conversations often focus on the loan project, with the borrower answering lender questions and sharing photos and news of progress made thanks to the loan investment.
However, lenders and borrowers often go further, sharing family photos, describing local holidays and even exchanging recipes. One of the really special things about our community is the friendships that are forged across vast geographic and socioeconomic distances. It’s a way to experience the world through the eyes of someone in very different circumstances – a life-changing experience for both lenders and borrowers.
- Why is it important to give the borrower a high degree of control and flexibility? How does trust play into that?
Another of our values is to respect our members’ judgment, and intervene only as needed to ensure responsible participation and protect the integrity of our lending community. We believe people perform best when allowed to make their own decisions and take responsibility for them. For this reason, we don’t have any restrictions on the use of loans, other than that it be legal and ethical.
We also allow borrowers to design their own repayment schedules, with the only requirement being that a repayment installment must be paid at least once weekly to maintain a good on-time repayment record. Borrowers choose the day of the week on which installments fall due, and how much will fall due each week. During the loan period, borrowers may adjust their weekly installment amounts as needed to accommodate changes in cash flow.
We’ve found that this flexibility does not usually result in excessive loan periods; most borrowers repay as quickly as they can afford, in order to access new loans to further grow their businesses. And it helps ensure that the loans never cause harm by forcing people to choose between procuring basic livelihood and making a scheduled repayment installment.
- How do you think client-centered microfinance has evolved and where do you think it’s going?
When Zidisha was founded seven years ago, it was a niche product, available only to the small minority of low-income individuals in developing countries who had access to the internet. Now, the spread of smartphones is bringing connectivity to far greater numbers of people. Smartphone app-based lending services are proliferating and providing much-needed competition to traditional banking models. This is a regulatory challenge, but also an opportunity to bring affordable financial services to far more people than has ever before been possible.
- Where is Zidisha going in the future?
We recently launched lending programs in Haiti, Rwanda and Mexico, following the spread of mobile phone-based payment technologies. In Mexico, we’re using Bitcoin to transfer money for the first time. We’d like to continue to expand to more countries as payment services develop.
As our lending volume continues to grow, we’re able to predict repayment performance more accurately, and develop better fraud prevention algorithms. We’re investing more in data collection and analysis.
We also launched a smartphone app for borrowers, and an increasing percentage of Zidisha loans are raised via the app instead of our website. Learning how to adapt our website-based model to a smartphone interface is an ongoing challenge, and opportunity.
Let’s make sure one thing is super clear: Seeds is not a charity.
We’re not a charity, we’re not a nonprofit, we’re not an NGO. While we think many of those organizations are rad, we don’t belong in those categories. In fact, we don’t even think those categories always apply — we’re moving towards a world where these rigid definitions are starting to blend together. Seeds is a great example of that: we combine the best of all worlds, but at our core, we’re business. A high growth potential startup, to be exact.
Wait, what? I thought you were a vehicle for social good.
We are! Here’s a quick primer on how Seeds works:
Think of us as a Venmo or PayPal. When customers go to make an in-app purchase in one of our partner apps, users will pay through Seeds, which channels the money to our partner 4G Capital, a microloans institution in Africa that has provided $13.7 million in loans since its inception to entrepreneurs, 81% of which are women.
Here’s why we’re so powerful: Social good is the most effective way to get people to spend existing micro-amounts of money — $3 here, $10 there. As a result, Seeds inspires more spending, simultaneously helping others while solving a big problem for apps — 97% of all app users don’t buy anything, but Seeds users are up to 60% more likely to. Helping others and making money aren’t mutually exclusive. Under our approach, we create wins for everyone across the board, from the user making a socially conscious purchase to the appmaker earning more revenue to the lendee receiving a much-needed loan.
One of our microloan beneficiaries is Mary Maina, a Kenyan woman who’s been able to grow her bakery business from a one-person labor to a three-person operation. The proceeds go to provide, food, school supplies and health care for her three children. Microloans have made a real impact on Mary’s life, and they’re an easy way to channel a purchase you would have made anyway into capital for someone in need.
So it IS charity!
Not quite. A microloan is what it sounds like — a loan. It’s meant to be paid back, and our lendees do so at a rate of 98.5%. The money goes towards building economic capital for people who, for example, may be looking to expand their farm or kick off a weaving business. We’re increasing the amount of capital that’s available to people who have clear ideas of how to improve their economic circumstances. We’re also able to continue re-lending that capital in perpetuity, helping people over and over again.
We wanted a solution that helps people sustainably. While it certainly makes sense to teach a man or woman to fish, that person ultimately needs a fishing pole, lure, tackle, bait — maybe even a boat. Microloans empower would-be fishers, farmers and business owners to procure what they already know they need. Many of our loan recipients say they don’t want charity. They don’t need a hand — they need capital to build out something they know is needed in their community. If Mary had never gotten access to our microloans, she never would have been able to grow her bakery to a thriving business. We provide that much-needed cash to people like Mary.
If Seeds is a for-profit, how do you make money?
The Seeds system is a win-win-win-win. There are four players: The appmaker, the user, the loan recipient and Seeds. Here’s how the system works for all of us:
Appmaker: Seeds increases in-app purchases by up to 60%, and our users spend 4x what normal buyers spend. The opportunity to do social good speaks to users in a big way, and it powers spending.
Users: Users get immense satisfaction and knowledge that they’re empowering motivated individuals in the developing world simply through the spending they do on fun — maybe it’s a meditation package on Aura or gems in Habitica — at either rate, they’re buying something they likely would have bought anyway, and contributing to social good in the process.
Loan recipients: Loan recipients get the cash infusion they need (sometimes all they need is $4!) to start a business, expand an enterprise or otherwise build an economic engine to sustain themselves and their families.
Seeds: Seeds takes a transaction fee for successfully inspiring a non-spender to start buying, and we share in the interest generated on the microloans.
Charities can be great, but Seeds isn’t one. If you want to make a difference through your everyday purchases, try an app that has Seeds embedded in it — Habitica, an awesome productivity app, Mini Golf Stars 2, a fun golf game, and Aura, the best meditation app for stress and anxiety, are three of our favorites. We’re excited about the potential to funnel millions of dollars to entrepreneurs both around the world and here at home, and can’t wait for you to be a part of our journey!
In 2014 BRAC launched its microfinance operations in Myanmar – one of the last countries in the world to open up its economy and simultaneously the country with one of the poorest and most unbanked populations. Within three years BRAC has grown to serve over 40,000 women. Read about its journey in a country full of opportunities and challenges.
BRAC comes to Myanmar
Since 2010, Myanmar has been undergoing a series of political and economic reforms; experiencing rapid economic growth as a result. BRAC decided to come to Myanmar at a time when Myanmar’s nascent microfinance (MF) sector was seeing early growth, with a handful of international and local NGOs starting to focus on financial inclusion. A FinScope survey in May 2013 showed that less than 5 percent of Myanmar’s adults had a bank account. The supply of financial services for micro and small businesses reached less than 10 percent of potential customers leaving most of Myanmar’s demand for credit unmet. This was in part because many of the existing microfinance providers were yet to balance sustainability with broad outreach.
BRAC launched its microfinance operations in Myanmar in 2014 as a financially sustainable company. Consequently, all operations had to be self-financed as we could not rely on grants, demanding us to be as business-minded as possible in achieving our social mission of financial inclusion of the poor. BRAC’s general focus for microloans and voluntary savings products is poor women from mostly rural areas involved in various income-generating activities.
Changing financial lives client by client
One of the women BRAC works with is Daw Zar Oo. She might not be the typical entrepreneur but has managed to change her life around and ease some of the financial stress that previously occupied the minds of her and her husband. Daw Zar Oo is operating a small grocery shop, a small-scale broom production as well as paddy farming in the village Koot Kone in Oaktwin Township. Like many people in Myanmar, she is trying to sustain a living in a rural area, with limited infrastructure and beyond the reach of the more profitable markets of the larger cities in central Myanmar. Unlike many other rice farmers, Daw Zar Oo can afford not to sell her rice directly after harvest, when prices are lowest. Instead, she stores the rice in a traditional container made out of bamboo and cow dung and sells it during the year once prices are higher. Going from incredibly high informal loans from loan sharks, Daw Zar Oo was happy to discover the possibility of joining a microfinance group with her friends and neighbors, through BRAC. Perhaps on the face of it seems like a minor change, borrowing the loan from BRAC has enabled Daw Zar Oo to buy stock for her store. This is helping her to prepare for business throughout the different seasons of Myanmar, instead of relying only on the Monsoon and Summer paddy as is very common for the typical Myanmar farmer. BRAC’s loan also enables Daw Zar Oo to smooth income and consumption over the year and create some breathing room for the family to see the market potential in their own surroundings.
Overcoming challenges by applying institutional learning
From the start, BRAC benefited enormously from the years of experience and learning acquired from its operations in seven countries across Asia and sub-Saharan Africa, enabling it to adjust best practices to the Myanmar-specific context. Naturally, there have been some minor and major challenges and operational constraints along the journey. In the first years, Myanmar witnessed political instability and in more recent times ethnic and religious tensions. While access to finance is very limited throughout Myanmar, microfinance as a tool for development does not suitably serve those living in displacement and in areas with ongoing conflict. Mindful of this, BRAC is learning how our vast experiences from humanitarian disasters; in water, sanitation and hygiene; and administering community health programs can be applied as BRAC gets to know the different areas of Myanmar better. For now, the microfinance program which is collateral free and in a group loan modality, demands a certain level of stability to assist small entrepreneurs like Daw Zar Oo to sell her produce and groceries. We have also learned to take an organic approach to expansion, whereby the program tests the ground from one village to the next before laying down roots. Hereby, we take an incremental yet overall more efficient approach to growth as compared to countries where we decided to open offices in a sporadic way and in remote places from the very beginning.
Myanmar also lacks infrastructure, clarity on immigration rules, restricted mobility and limited skilled human resources. All these factors pose operational constraints for microfinance institutions and NGOs by decreasing their efficiency or increasing their costs. In addition, the current regulatory environment in Myanmar means that the funding risk is relatively high in comparison to other countries (investing is deemed too risky by investors) and is to a large extent independent of BRAC’s actions, development and performance.
In spite of these challenges, BRAC has experienced steady growth as it pursued a clear strategy to continue expanding and to diversify into other development programs and new financial products. To promote financial inclusion among the disproportionately unbanked BRAC aims for its client reach to be at least 90 percent women, of which 70 percent will be in rural areas. By the end of 2021, BRAC expects to reach approximately 170,000 microfinance borrowers in 80 branches and serve a further 3,000 borrowers through its Small Enterprise Programme (SEP) which offers larger ticket individual loans to small business owners.
While financial inclusion is vital in Myanmar, BRAC acknowledges that microcredit alone will not be enough to eradicate poverty, believing strongly in a holistic approach to lift the poor out of poverty. BRAC Myanmar is mindful that microfinance is not suitable for everyone and is currently exploring solutions to bring new groups into its platform. By delivering a combination of financial and non-financial services, BRAC will be able to have greater reach in Myanmar both in terms of geography and poverty reduction outcomes. For example, the 40,000 women that BRAC currently serves can benefit from diversified financial products as well as improved health and agricultural awareness. Access to certain services is expected to generate demand for others. For example, awareness building is expected to generate demand for market linkages, which BRAC Myanmar hopes to meet by developing social enterprises in the industries our clients work in.
Despite some challenges, BRAC has been able to establish operations and a strong foundation to expand both in terms of branches as well as in terms of services. Key to this throughout our development has been the application of BRAC’s institutional knowledge, drawn from past international experience, and steady incremental growth nationally.
By Sten Te Vogt (MSc student in Financial Economics from Erasmus School of Economics in Rotterdam) and Annaklara Eriksson (Lead Knowledge Management and Proposal Development, BRAC)
THE HIDDEN IMPACT OF MICROCREDIT: THREE UNDER-RECOGNIZED WAYS THE INDUSTRY CAN HELP EMERGING MARKETS
In my last post, I argued that there is a case for social investment in microcredit under the status quo, since delivering microcredit is, on average, so cheap. That discussion presumed evaluating microcredit on the terms that the industry was built on: raising the income, investment and consumption of clients. It’s on those measures that the findings of the various randomized impact evaluations have been disappointing, at least in contrast to the rhetoric that was so prevalent during the microcredit boom years.
But just because household income and consumption measures were the basis of the original microcredit theory of change doesn’t mean that, 30 years on, we can’t learn from experience and consider other ways that microcredit may have had, and continues to have, an impact. Since emotions run strong on these topics, I feel that I have to begin with a couple of pre-emptive points of clarification: a) It makes no sense to criticize the impact evaluations of microcredit, or the discussion and presentation of those evaluations, for not taking alternative channels of impact into account – these alternative channels were not the chief ways that microcredit was supposedly having an impact; and b) It’s very important to keep the word “may” in the prior sentence; these channels have not been evaluated. I am not making a claim of impact, just speculating on other plausible effects of the microcredit industry that bear considering and perhaps integrating into thinking about the cost-effectiveness of further investment in microcredit.
One of these other channels is institution building, or the creation of a significant number of reasonably well-run and governed institutions in many contexts that lack them. David Roodman lands on this channel of impact in his book (you can see a reasonable overview of the impact through institution building in this post and the various links if your copy of “Due Diligence” isn’t to hand). This isn’t a particularly new perspective, as Roodman points out, but I still think it hasn’t gotten nearly enough attention. Anyone paying attention to the world these days is getting regular reminders of the importance of institutions, how hard they are to build and how easy to tear down. If current events aren’t sufficient, you can check out Acemoglu and Robinson’s “Why Nations Fail.” You’d have a difficult time making an argument that MFIs are more extractive or less inclusive than most of the institutions in the contexts in which they operate.
The institution-building channel, though, obscures another channel that is similar but operates more at the individual level. Development economists have long recognized that lower-income countries lack mid-size companies and other organizations. More recently, economists have come to see the importance of the “technology of management.” (If you’re interested in this idea, here’s a paper that thoroughly explains and documents the idea of management as technology and one that looks at the dearth of and impact of effective management practices in small firms in developing countries.) Effectively managing even moderately complex organizations is a learned skill – and there are few ways to learn the skill in an economy that lacks dynamic mid-size formal organizations. If you consider “investability” as a reasonable proxy for “well-run” organizations, under conservative assumptions, the 500-plus microfinance institutions in that category have collectively trained more than 50,000 people in the technology of management. And that training has been delivered at zero cost from social investors’ perspective given that most of that training happens simply by being in the job. The number of managers trained will continue to grow and those managers will spread through the economies of the countries they work in, amplifying the effect of their training (and transferring their knowledge to others). If you ignored the entire customer side of microcredit, and considered the industry solely as a “job training” or “management training” intervention, it’s plausible the industry could be one of the most cost-effective such programs attempted.
A third way that MFIs may have a long-term impact is in strengthening civil society. Well-functioning countries and economies rely on demanding citizens and customers who expect to be respected and well-treated. For many borrowers, a microfinance institution is one of the first formal organizations that has treated them fairly and with respect. In other words, microfinance institutions (at least those that put customer protection and customer service principles into action) have been training borrowers to be better customers and citizens by showing them how they can and should expect to be treated by other institutions. This isn’t a novel perspective on impact either, by the way. You can see this perspective in some of the stories in “Portfolios of the Poor” where households talk about how much they value the rules-based nature of MFIs, and in many of the anthropological/sociological studies of microcredit. But it can be traced at least all the way back to the Jewish scholar Maimonides, who reasoned that going into business with the poor was superior to most forms of giving because it treated them as equals and changed the outlook of the recipient (and the giver).
None of these channels of impact are likely to yield measurable or noticeable impact in the short or even medium term. But they are worth considering as plausible additional ways that investing in microfinance institutions can have an impact, and if you find any of them at least somewhat plausible, they bolster “The Case for Social Investment in Microcredit.”
By Timothy Ogden (Managing Director, Financial Access Initiative at NYU-Wagner)
I believe there’s a strong case for social investment in microcredit, but that the best case is built on new theories of change. Historically the standard microcredit theory of change has been that many (if not most) households are eager to start their own microenterprise but are stymied by a lack of access to credit, and if credit constraints are relaxed they will be able to make profitable investments and rapidly improve their standard of living. My read of the evidence is that rather than being frustrated entrepreneurs, most people are frustrated employees (and that’s true the world over, not just in developing countries); the number of people with the proper mix of aspirations, skills and opportunities to generate meaningful profits from microenterprise is limited.
For microcredit to show an impact in terms of revenues, profits or incomes, it likely has to do much more to both target loans to the limited set of people with the requisite attributes (check out this post from Bruce Wydick) and change the contract terms so that the loans are more conducive to business investment.
But there are also other theories of change worth considering; for instance, the value of microcredit for consumption smoothing given rampant volatility in incomes and expenses. To formulate a new theory of change for microcredit, it’s useful to consider an analogy to medicine: Is microcredit a vaccine or an antibiotic? Both vaccines and antibiotics are vital tools in the fight against disease but they operate very differently, and require different delivery models and processes to have maximum effect.
Start by thinking about the nature of credit constraints in the context that you care about. One perspective is that credit constraints are pervasive – many members of the community miss opportunities to invest, or suffer from a lack of ability to buffer downturns, because they do not have access to affordable credit when needed. If you believe credit constraints are pervasive, it’s also worth considering whether credit constraints are “contagious.”
As we know, most households are enmeshed in a complex social network where families borrow from and lend to each other (or make gifts) constantly (see, of course, “Portfolios of the Poor” and the classic mobile money remittances study by Jack and Suri, for instance). These financial relationships are a vital buffer against the worst of times. But they can also limit the ability of any household in the network to accumulate enough to make productive investments, and can provide a disincentive to such investments because of the increased claims that come from the social network when such investments are made (Google “Rotten Kin Theorem”). The lack of access can therefore spread through a community and perpetually limit the entire community’s ability to invest (check out this new paper that explores this possibility through the lens of informal loans for productive investment, or the lack thereof, within a network).
If the story of pervasive and contagious credit constraints makes sense to you, it would follow that making microcredit easily available to prevent “outbreaks” of credit constraints and limit the overall effect of credit constraints on the whole community is the right strategy. If so, it would be difficult or impossible to identify who would be “infected” with a credit constraint at what point, and wouldn’t make sense to try. Better would be “vaccinating” the whole community by making credit widely available. Note that in a vaccine frame it can be very difficult to identify the value of being vaccinated at the individual level – when herd immunity is achieved the value of vaccination to an individual will appear to be zero.
On the other hand, you may believe that credit constraints are not significant to large parts of a community, perhaps because few in the community have opportunities to invest at a rate of return above the cost of credit. Or you may believe that microcredit does not sufficiently relieve the constraint except when delivered at the right dose and at the right moment. If so, microcredit is more like an antibiotic than a vaccine. Making it easily available to an entire population without diagnosing the constraint and delivering the correct dosage might be worse than doing nothing.
Think of the village markets where every stall is selling essentially the same products – making it easier for more undifferentiated vendors to enter that market is close to a zero-sum game. In such instances, microcredit would operate like an antibiotic where drug resistance can develop. Not only will it will be difficult to identify the impact of microcredit if it is widely available, but wide availability may itself limit the gains even for those for whom it is most helpful. If you find this story plausible, the most important investment in microcredit would be better diagnostic and targeting tools, even at the expense of reducing availability.
Both the vaccine and the antibiotic stories are plausible and concordant with current evidence. It’s also possible that whether microcredit should be thought of as a vaccine or antibiotic varies from context to context. Thinking through the vaccine or antibiotic frame can help social investors clarify their theory of change and guide what areas of microcredit innovation to invest in.
The bottom line is that investment in microcredit innovation is both worthwhile and necessary (see the paper for more) – but rather than just supplying more funds to the industry, social investors need to go back to the drawing board, figure out their theory of change and invest appropriately in that theory of change.
By Timothy Ogden (Managing Director, Financial Access Initiative at NYU-Wagner)