Economic Research Forum (ERF)

Microcredit: choosing between inclusion and impact?

375
The microfinance industry continues to grow rapidly in the MENA region. This column reports research from across the world showing that giving people access to microcredit does not lead to significant declines in poverty. But while microcredit is not yet a powerful anti-poverty strategy, the evidence shows that it is a useful financial tool.

In a nutshell

Evidence from around the world indicates that microcredit does not help to lift poor households out of poverty.

Microcredit does allow low-income households to cope better with risk and to enjoy greater flexibility in how they earn and spend money.

Somewhat paradoxically, to increase microcredit’s ability to reduce poverty, providers may need to be more selective by focusing more on relatively prosperous households with prior business experience.

Recent years have seen an intense debate between microfinance proponents and detractors on whether microcredit can lift people out of poverty. What has been absent from this debate is solid evidence. To fill this gap, a number of research teams across the world started randomised evaluations (large field experiments) to measure rigorously the impact of access to microcredit on borrowers and their households.

Studies were set up in Bosnia and Herzegovina, Ethiopia, India, Mexico, Mongolia, Morocco and the Philippines. Research took place in both urban and rural areas and evaluated both individual-liability and joint-liability (group) loans. Some of the participating microfinance institutions were for-profit organisations while others were non-profits.

Together these studies provide a rigorous body of evidence on the impact of microcredit in a wide variety of settings. The research results (Banerjee et al, 2015b) paint a remarkably consistent picture, which contains four main lessons.

Four lessons on microcredit

Impact on poverty

Across all seven studies, microcredit does not lead to substantial increases in borrowers’ income. It does therefore not help to lift poor households out of poverty. A more formal analysis of the evidence collected in these studies confirms that for a large majority of people, access to microcredit has little impact on household income (Meager, 2016).

A possible explanation is that while microcredit clients overwhelmingly report using loans at least partially for business purposes, many of them also report using part of their loans for consumption.

Another possible explanation is that not all borrowers are natural entrepreneurs. Of those that use microcredit to open or expand a small business, some borrowers are more successful than others. Indeed, the evidence suggests that particular sub-populations – especially relatively well-to-do households that already operate a small-scale business before they access microcredit – appear to be better suited to using microcredit in a profitable way (Angelucci et al, 2015; Meager, 2016).

In contrast, ‘reluctant entrepreneurs’ (Banerjee et al, 2015a), who do not have prior business experience, typically show little impact in terms of business scale and performance.

Impact on wellbeing

Access to microcredit also does not appear to have tangible impacts on borrowers’ wellbeing or the wellbeing of others in their households. For example, three of four studies find no effect on female decision-making power and independence. In six studies, microcredit access does not increase children’s schooling.

Impact on flexibility

On the upside, households with access to microcredit enjoy greater freedom in deciding how they earn and spend money. In Bosnia and Herzegovina, and Morocco, microcredit allows people to change their mix of employment activities, reducing earnings from wage labour and increasing income from self-employment activities.

In the Philippines, it also helps households to insure themselves against income shocks and to manage risk. In Mexico, households with access to microcredit do not need to sell off assets when hit by an income shock.

No harmful effects

Importantly, there is no evidence of systematic harmful effects of access to microcredit. For example, overall stress levels among borrowers are no different from the comparison group in Bosnia and Herzegovina or the Philippines, although male borrowers experience significantly higher levels of stress in the Philippines.

Implications for the microfinance industr

Better and more varied product design

Small changes to product design may influence how people use and benefit from microcredit. For example, the typical microloan repayment begins two weeks after loan disbursement and payment is usually required on an inflexible weekly basis.

This can be an effective strategy to limit default, but it may also limit borrowers’ income growth. In India, granting (some) borrowers a grace period – so that they can build a business before they need to start repaying – leads to higher short-run business investment and long-run profits, but it also increases default rates (Field et al, 2013).

In addition, monthly or seasonal repayment schedules that better reflect borrowers’ income flows can help borrowers to make better use of their loans. Microfinance institutions like Enda Arabe in Tunisia and FINCA in Armenia offer loan products where repayment schedules are matched with expected cash flows (which depend on the seasonality of agricultural products).

Further research is needed to evaluate the impact of such flexible loan products in terms of repayment rates and poverty outcomes.

Moreover, microcredit’s liability structure may be an important determinant of loan take-up and impact. Evidence from Mongolia (Attanasio et al, 2016) indicates that in high-risk environments, individuals take up joint-liability rather than individual-liability loans because joint-liability loans can help them to share risk.

While the continuing trend in the microfinance industry towards liability individualisation may benefit less risk-averse (wealthy) borrowers, it may also gradually exclude poorer and more risk-averse borrowers from the market for financial services.

Better market and product segmentation

Microfinance institutions and their clients may also benefit from more market segmentation. Lenders may consider offering larger, more flexible products to clients who are most likely to perform well, and smaller, less flexible loans to less promising borrowers.

Banerjee et al (2015b) suggest that the recent findings on micro-client heterogeneity should make lenders rethink the extremely non-selective nature of their lending. More effort may be needed to focus on the minority of potentially high-growth entrepreneurs and service these households with larger loans.

A next step would be for microfinance institutions to pilot better ways to help high-performing micro-entrepreneurs become eligible for lending to small and medium-sized enterprises (SMEs). Today, successful and growing clients that need more funding may get stuck: too large for microfinance, but not yet viable clients at traditional lending institutions.

Microfinance institutions could set up arrangements with local banks to transfer such successful clients (for a fee) to a bank so that they can continue their growth trajectory. Likewise, banks with both microfinance and SME departments should ensure that fast-growing micro clients can graduate easily to SME status.

Further reading

Angelucci, Manuela, Dean Karlan and Jonathan Zinman (2015) ‘Microcredit Impacts: Evidence from a Randomized Microcredit Program Placement Experiment by Compartamos Banco’, American Economic Journal: Applied Economics 7(1): 151-82.

Attanasio, Orazio, Britta Augsburg and Ralph De Haas (2016) ‘Microcredit Contracts, Risk Diversification and Loan Take-up’, EBRD Working Paper No. 189.

Banerjee, Abhijit, Emily Breza, Esther Duflo and Cynthia Kinnan (2015a) ‘Do Credit Constraints Limit Entrepreneurship? Heterogeneity in the Returns to Microfinance’, mimeo.

Banerjee, Abhijit, Dean Karlan and Jonathan Zinman (2015b) ‘Six Randomized Evaluations of Microcredit: Introduction and Further Steps’, American Economic Journal: Applied Economics 7(1): 1-21.

EBRD (2016) Transition for All: Equal Opportunities in an Unequal World – Transition Report 2016-17, European Bank for Reconstruction and Development.

Field, Erica, Rohini Pande, John Papp and Natalia Rigol (2013) ‘Does the Classic Microfinance Model Discourage Entrepreneurship among the Poor? Experimental Evidence from India’, American Economic Review 103(6): 2196-2226.

Meager, Rachael (2016) ‘Aggregating Distributional Treatment Effects: A Bayesian Hierarchical Analysis of the Microcredit Literature’, job market paper, MIT.

Most read

Fair competition is needed to empower women economically in the Arab world

The participation rates of women in the labour market in Arab countries are the lowest in the world. This column argues that remedying the under-representation of women in the labour force is a social and economic imperative for the region. There are three dimensions for action to realise the potential of Arab women: amending laws and regulations; instilling fair competition in markets; and promoting the digital economy.

Recession without impact: why Lebanese elites delay reform

The survival of Lebanon’s political elites is highly dependent on the wellbeing of the economy. Why then do they delay necessary reform to avoid crisis? This column examines the role of politically connected firms in delaying much-needed economic stabilisation policies.

Competition laws: a key role for economic growth in MENA

Competition policy lacks the attention it deserves in the countries of the Middle East and North Africa (MENA), a region characterised by monopolies and lack of market contestability. As this column explains, there are many questions about the extent of anti-competitive barriers facing new market entrants in the region. What’s more, MENA’s weak overall performance on competition is likely to be hindering economic growth and the path towards structural transformation.

Formidable challenges facing the Middle East require a sea change in economic policies

Weakening global growth, endemic conflicts and increased tensions within the Middle East and North Africa (MENA) – as well as emerging challenges such as climate change and rapid demographic shifts – are likely to have an adverse impact on the region’s economic, social and political stability in the coming years. This column outlines the policy responses that are needed to avert disaster.

Domestic demand and competition: a new development paradigm for MENA

A lack of competition in domestic and regional markets is holding back development in the Middle East and North Africa. This column argues that the region and the international community must ensure that barriers to market entry and exit are eliminated, and that independent regulatory bodies at the national and regional levels help to promote domestic demand as the main engine for sustainable and inclusive growth.

The future of Egypt’s population: opportunities and challenges

Egypt’s potential labour supply depends on the growth and changing composition of its working-age population. This column reports the latest data on labour supply and fertility rates, concluding that the country has a window of opportunity with reduced demographic pressures to try to address longstanding structural challenges for the labour market.

Effects of urbanisation on productivity and wages: evidence from Turkey

Are the substantial productivity gains associated with larger cities in developed countries similar for developing countries? This column provides evidence on urbanised economies in the non-Western world by focusing on Turkey, a country that has experienced fast urbanisation and a high rate of growth of the urban population.

How import dependence could lead to corruption in MENA

Export-led development strategies have had little success in MENA countries; what’s more, instruments of earlier import-substitution strategies – such as state-owned enterprises, high tariffs and subsidies – have survived. As this column explains, these legacies have created crony-capitalist industries that have limited the level of competition in many sectors of the economy and furthered the region’s dependence on imports.

Social security for young workers in Arab countries

Social security coverage of young workers in Arab countries is low – in part because many are employed in informal jobs; and in part because they do not see the value of the system. This column reports survey evidence on young workers’ attitudes towards participation in both social security and politics. It also explores policy reforms that might make access to social security universal for young workers.

Gender discrimination in small business lending: evidence from Turkey

Discrimination in access to financial services can prevent women from exploiting their entrepreneurial potential. This column reports on a ‘lab-in-the-field’ experiment to test for the presence of gender discrimination in small business lending in Turkey.