Armageddon or Adolescence? Making Sense of Microfinance’s Recent Travails

This paper reviews the triumphs and troubles of the microfinance industry. It then sets forth a frame for assessing the impact of microfinance, one that helps put the recent challenges in perspective. It offers some thoughts, in light of these difficulties, about key tasks going forward. It concludes that microcredit stimulates small-scale business activity, but the best available evidence fails to show it reducing poverty. Its ability to empower people, especially women, is also ambiguous since while it can give women more economic power, in some cases it has burdened them with the fear of default and loss of face in public group setting.

The main achievement of the microfinance movement has been the founding of businesses and business-like non-profits that are delivering these services to millions of people on a sustainable basis. The core problem facing the industry is that just as a stable banking system is more than a bunch of banks, a microfinance industry is more likely to be safe and resilient if it contains not just microfinance institutions, but credit bureaus, consumer protection laws, effective regulators, and more. Many of these other institutions are weak or absent in poor nations.

Key findings:

Microfinance has been growing for 35 years and now reaches upwards of 100 million people. Most of them are served by institutions that are nearly or completely self-sufficient in financial terms; these microfinance institutions (MFIs) do not depend greatly on outside subsidies, and so their fates do not ride on the latest headlines in the New York Times or Die Welt. Thus all the recent bad press will probably not extinguish the microfinance industry. And just as recent crises in the mainstream financial system do not spell Armageddon for that system, the recent wounds to the microfinance industry—the bubbles and political backlashes—are unlikely to bring down the global microfinance industry. Because of the vicissitudes of poverty, poor people need financial services more than the rich. Their financial options will always be inferior—that’s part of being poor—and microfinance offers additional options with distinctive strengths and weaknesses. The microfinance industry has demonstrated an ability to build enduring institutions to deliver a variety of inherently useful services on a large scale.

The recent travails are signs that something is wrong in the industry. What is wrong is, ironically, what was once so right about the industry: it largely bypassed governments in favour of an experimental, bottom-up approach to institution building. The industry got so good at building institutions and injecting funds into them that it often forgot that a durable financial system consists of more than retail institutions and their investors. The narrow focus became a widening problem as microfinance grew. The result in some countries is a microfinancial ecosystem that lacks diversity, being dominated by vigorous retail MFIs subject to inadequate external (and, in some cases, internal) controls.

Recommendation:

To mature, the industry and its supporters should recognize the imbalance it has created. Where possible, they should work to strengthen institutions of moderation such as credit bureaus and regulators. Accepting that such institutions will often be weak, they should err on the side of investing less. In microfinance funding, less is sometimes more.

Summary