Need for fresh look at microfin credibility

Microfinance has generated considerable enthusiasm, not just in the development community but also at political levels. The idea that small loans enable millions of poor people to pull themselves up by their bootstraps has captivated liberals and conservatives alike. Inevitably, there has been a lot of over-advertising about the role of microfinance in improving the lives of the low income households.

To refresh what microfinance actually is, it refers to financial services – most commonly loans – delivered in small denominations to poor clients who lack the collateral, credit history, or other assets to enter the formal financial system. Microfinance’s credibility was based partly on the assumption that very small businesses have high profit rates and the bottom economic and social pyramid is awash with business opportunities wanting only for afford¬able capital. But evidence has been very scarce.

There has also been a growing awareness among microfinance institutions that credit is certainly not transformative. Although certain people will be able to use microfinance to transform and build their businesses, that is not the case with the majority of the people who receive a loan. Most are going to use it to smooth out their consumption. It will not build a steady business because a lot of them face several barriers.

But it does some other things that are important to poor people, helping them to cope with immediate poverty. Despite severe skepticism, we must concede that microfinance has relevance to low income households as they keep juggling tools for managing their several financial needs. There is clear evidence that these small loans have become a mainstay of the poor and enabled them to manage sudden emergencies which, if not addressed, can have long term implications for them.

Poor households, in particular the rural poor, are exposed to unsteady flows of income. The reasons are many, including sickness or death in the family or seasonal unemployment related to the agricultural labor cycle, or weather shocks among many others. Given the variability and vulnerability of their income, these families value formal microfinance over banking or money lending or any other informal finance because it is more reliable, even if it is often not as friendly as their other tools may be for managing their cash flow. Banks offer cheaper credit but are mired in thickets of red tape.

Access to small loans for tiny businesses by itself won’t miraculously enable poor to take their business to a new level. A modest cash injection cannot generate a stable income, or create a profitable cycle of trade and income particularly when the daily struggle of most of these people has to do with making a living, feeding their families, educating their children and staving off ill-health The notion that microcredit has potential to spark sustained economic growth is misplaced.

The direct evidence of microfinance’s impact is less than overwhelming. In several cases, microfinance activities can damage the prospects of poor people. Micro financiers had created the myth that poor people always manage to repay their loans because of their ability to exploit business opportunities. It is wiser that we call microcredit as ‘microdebt.’ This can help us be more realistic about the different ways in which loans can impact on the livelihoods of the poor.

Microdebt does create opportunities for people to utilise ‘lumps’ of money for improving incomes and reducing vulnerability. But it doesn’t necessarily mean investing in businesses that could lead to sustained income growth. Most microfinance clients have no training, education, or role models in business, and therefore are unlikely to cultivate successful microenterprises on their own. Many micro-enterprises fail due to lack of local demand, fierce competition or inadequate technical skills of entrepreneurs. According to the World Bank, microfinance actually best serves those who have higher skill levels, and better market networks.

Not everyone is an entrepreneur. Just because someone is likely to pay back a loan doesn’t necessarily mean that he or she is a good target for credit. Instead, micro lenders need to revamp their work for better impact, changing who they target and experimenting with different loan designs.
One reason microcredit soared so high in public esteem was the power of the stories its promoters told. Many of these anecdotes were powerfully fantasised. But we cannot generalise them.

Poor people who take loans use them in different ways and with different outcomes. By luck or by pluck, some do well, and it is their success that microcredit promoters mostly recount. Microfinance is a good development tool, but it had been inadvertently overhyped. It is wiser we learn how positive the effects of microfinance can be, for both financial inclusion and livelihood promotion, if handled correctly. Let us not, in our over haste, throw the baby out with the bath water.

By Moin Qazi