Open Forum

New Delhi, 8 March 2017

Microfinance Credibility

NEED TO TAKE FRESH LOOK

By Moin Qazi

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 afford­able 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.

Based on Stuart Rutherford’s classic paradigm, microfinance practitioners identify basically three financial needs of the poor: Life cycle needs. Life cycle events that impose financial burdens include: births, deaths, education marriages, home-making, old age, widowhood and the need to leave something behind for one’s heirs; Emergencies. Impersonal emergencies are caused by floods, cyclones, and fires etc., while personal emergencies include illnesses, accidents, bereavement, divorce and desertion; Opportunities. Financial and life-style opportunities can require large sums of money for starting or acquiring productive assets (including land and housing), or running businesses, or buying life enhancing consumer durables (fan, television.).

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. An illness left unattended can lead to serious complications. Money is usually borrowed from a nationalised bank, a cooperative bank, a microfinance institution or a money-lender, in that order of preference. Banks have long back turned off their spigots after social banking left a cruel legacy of mountains of sour loans which had to be plowed like rotten potatoes.

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.

In their recent book, From Dependence to Dignity, Chalmers' Brian Fikkert and Russell Mask explain how microfinance consumption loans can play a critical role in the lives of poor. “Although stabilising a family’s consumption seems less exciting than increasing it, the effects may be more profound than first meets the eye. For when a household is brought back from the edge of a cliff—the vulnerability line—the effects can be dramatic.”

The value of microfinance for low income families is also evidenced by their strong demand for it, their willingness to pay the full cost of these services, and high loan repayment rates that are motivated mainly by their trust in them.

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. Not all microdebt produces beneficial results, especially for those engaged in low-return activities in saturated markets that are poorly developed and which are prone to regular environmental and economic shocks.

Most microfinance clients have no training, education, or role models in business, and therefore are unlikely to cultivate successful microenterprises on their own. They are not entrepreneurs in the traditional sense. If their communities had jobs and if their family situations permitted it, they would be employed. 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. There are many who fail. No one will ever tell you their fate. The cheering news we hear of several of microfinance’s borrowers are truly exhilarating but equally chilling are episodes of the harrowing plight of those who have been painfully trapped in inescapable debt.

Microfinance is a good development tool, but it had been inadvertently overhyped. And the hype has undermined the good that microfinance can achieve. Microfinance is actually a tool in a broader development toolbox, but in certain conditions, it happens to be the most powerful tool. It has all to do with how we are using it and how we are defining the outcomes. 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. --- INFA

(Copyright, India News and Feature Alliance)