‘Little’ help from our friends

Koli Mitra puts the much-applauded microcredit and microlending schemes, championed by the likes of the Grameen Bank in Bangladesh under the scanner and tries to analyse its pitfalls, as well as its benefits.

About the featured image: Bangladeshi women count money for repayment to a microcredit bank at Dowtia village, near Dhaka. Once living hand to mouth, now the women earn an adequate amount to support their families by running small projects of cattle breeding or poultry farming with loans from BRAC, the biggest of a legion of non-government organisations that has pioneered microfinance as a means of helping the poor to help themselves. Picture taken on January 20, 2004. Credits: REUTERS/Rafiqur Rahman

In 2011, Dr. Muhammad Yunus of the Grameen Bank fame wrote in an opinion piece in the New York Times, “I never imagined that one day microcredit would give rise to its own breed of loan sharks.” There are some critics who would say he shouldn’t be surprised.

Microcredit or microlending has been widely praised over the last couple of decades as an efficient and sustainable way to eradicate widespread poverty. It is supposed to be a classic market-based solution and yet animated by the philanthropic impulse. A real ‘win-win’ option.

In 2006, when the Nobel committee named Dr. Yunus as the recipient of the 2007 Nobel Peace Prize, Jeffery Tucker of the Mises Institute complained “Everyone Left, Right, and Center appear to love him. His microcredit scheme seems to mix the best socialist ideals with free market means, and then the rhetoric alone carries the day.” Interestingly, though, Dr. Yunus and his microcredit system have also received scathing criticism from the ‘Left, Right, and Center’ almost since the beginning of his career – or at least from the time he came into the global limelight. So, the praise has not been so much ‘universal’ as Tucker and others have claimed. Rather, it has been ideologically varied, just like the disapproval has been ideologically varied.


From the Left, there was always the criticism that the superficial appeal of microcredit as an easy cure for poverty had the effect of weakening the more time-tested and robust – and also more expensive and difficult – antipoverty strategies like job creation, education, infrastructure, public healthcare, unemployment insurance, food and housing assistance – basically labour development and social welfare safety net programs for which already cash strapped people are NOT expected to ‘repay’ anyone or be thrust into an entrepreneurial role for which they are ill equipped.

A few years ago, Prof. Aneel Karnani of the University of Michigan Ross School of Business wrote in the Stanford Social Innovation Review, that, if the goal of microfinance is to end poverty, then it “misses its mark” by a long shot. He asserted that for the vast majority of people in dire economic circumstances, the real key to getting out of those circumstances is employment in large, industrial enterprises, NOT taking on the burden of running fledgling ‘micro’ enterprises for which they are utterly unprepared. He says, “Although some microcredit clients have created visionary businesses, the vast majority are caught in subsistence activities. They usually have no specialised skills, and so, must compete with all the other self-employed poor people in entry-level trades.” He believes that society’s “resources and energies” should be invested in large, labour-intensive industries and also provide basic services that improve the employability and productivity of the poor like education and training, because “this is what is alleviating poverty in China, Korea, Taiwan, and other developing countries.” The United Nations Development Programme (UNDP) seems to agree with Prof. Karnani on the centrality of stable employment for reducing poverty. The UNDP found that, “Employment is a key link between economic growth and poverty reduction. Productive and remunerative employment can help ensure that poor people share in the benefits of economic growth.”

Another recurring problem with microcredit is the echo of what Dr. Yunus himself lamented: the rise of a new class of loan sharks. For over a decade, the New Delhi based economic journalist Sudhirendar Sharma has been sounding the alarm about the fact that, whatever the rhetoric or the theory, the empirical evidence shows that microcredit is not helping anyone escape the cycle of poverty; instead, it is drawing the poor into a vicious cycle of debt and deepening their financial troubles. His warnings proved to be well-grounded when a spate of suicides in Andhra Pradesh revealed a shocking world of small-time borrowers getting buried under a mounting burden of debt at astronomical interest rates and harassment by collection agents – just the kind of harsh scenario from which Dr. Yunus wanted to free people by giving them a benevolent, legitimate source to borrow from.

There is a growing consensus among the Left leaning (at least Left leaning on this issue), that much of the problem stems from the phenomenon of “mission drift” – specifically, the gradual shift away from the microfinance’s primary goal of alleviating poverty and toward the goal of selling financial services to the poor for profit.  According to Italian economist Valerio Carboni, “Nowadays microfinance encompasses a wide range of financial services, from micro-insurance to mobile banking, and seems to have lost its original vocation; instead of helping the poorest, the question has been turned upside down and it is now how to make money out of them.”  In a InterPress Service article, ‘Banksters Hijack Microfinance’, Julio Godoy writes, citing Carboni, “Microfinance is no longer contributing to self-reliant development processes based on domestic resource mobilisation and local institution building, but has instead become ‘in some cases a significant blockage for the development of the poorest by dragging them into speculative market dynamics and generating a renewed dependency on international financing and actors’.”

In a Business Week article ‘The Ugly Side of Microlending’, Keith Epstein and Geri Smith exposed a vast and complex system of predatory lending, intimidation, and cartel-like behavior by powerful banking and retail monopolies.  In another article, Epstein and Smith noted that the IPO for another Mexican microfinance institution (MFI) earned close to half a billion dollars, provoking “a passionate protest from nonprofit traditionalists around the world.” Veteran development experts have argued for years that commercialised microlending inevitably means favouring investors ahead of vulnerable borrowers. ‘They’re moneylenders. They’re not microcredit” says Muhammad Yunus. But, this hybrid of philanthropic and capitalist appeal might be exactly why microfinance is such a popular idea. Cambridge university professor Ha Joon Chang explains that it is a “strange alliance” between a financial sector “which does nasty things to make money, and people who genuinely wanted to help the poor but were against the collective approach.”  He says this blending lets “some [public] institutions claim they care about the poor without having to spend on social welfare.”

The microfinance industry whistleblower Hugh Sinclair has caused a sensation with his stunning revelations through a series of interviews, an ‘open blog’ and the tell-all book, Confessions of a Microfinance Heretic: How Microlending Lost Its Way and Betrayed the Poor. He has said that “recent studies show that microfinance was simply another profit making scheme for global private finance corporations, such as the Deutsche Bank, Citigroup, and Standard Chartered, who started pouring money into microcredit initiatives.”

In Confessions, Sinclair reveals how, since the mid-2000s, MFIs essentially stopped being nonprofit service organisations. They began charging usurious interest rates (sometimes as much as 200%) and using aggressive debt collection tactics – including harassing and threatening the borrowers. Sinclair, who has more than ten years of experience as an industry insider, paints a picture of an under-regulated, opaque, and unaccountable system, where loans are pushed on poorly understood (and poorly disclosed) terms, and often not even nominally for the purpose of supporting any income-generating activity, but for purchasing big ticket consumer goods or refinancing another pre-existing debt. The ‘microenterprises’ these borrowers are engaged in are nothing more than very low-end subsistence level self-employment such as selling apples or cigarettes on the street, sometimes with the help of coerced or semi-coerced child labour.  In an interview earlier this year, Sinclair said that the microfinance sector is not even willing to discuss the problem of child labour as a part of their purported efforts at client protection. He says that “the argument is: we do not lend to children, we lend to their parents. Those are our clients. It is the client-protection principle and it extends to the client only. What they do to their children has nothing to do with us.”


In other words, the grand mission of poverty elimination and giving people a better shot at a decent life, as envisioned by Dr. Yunus, is not what the sector is about anymore. But has it ever really been about that? Some progressive critics have always suspected that microcredit schemes are exploitative and they didn’t exempt Dr. Yunus and his Grameen Bank from that charge. As early as 1996, economic journalist Gina Neff had argued that the “Grameen model… translates as moving the responsibility for antipoverty programs to [the] poor people themselves” and, to make matters worse, they are made to take that responsibility “using borrowed money.” She pointed out that, while claiming to lend to “the poorest of the poor” the Grameen Bank requires “that its borrowers own their homes – not unlike the assumption that shoeless women have bootstraps [by which to pull themselves up]. Evidently Bangladeshi homeless women don’t count as the poorest of the poor.”

The attacks from the Right, remarkably, have a good deal in common with the attacks from the Left, in terms of how to read the effects – or lack thereof – of three decades of microlending as a poverty-fighting mechanism. They all seem to agree (a) that there has not been significant reduction in poverty; (b) that most of the ‘microenterprises’ supported by MFI loans are really nothing more than the practice of unskilled, self-employed labour or trade or subsistence activity (c) that most people are not equipped to be ‘entrepreneurs’ whether by skill or temperament (or even choice) regardless of whether they have access to credit; (d) that much of the microloan money is used to repay a prior debt or to meet an exigency such as illness or to finance consumption (whether it be necessities such as food or some industrial or luxury consumer goods that are ordinarily beyond the borrower’s reach); (e) that there has been too little emphasis on savings and thrift in the way the borrowers’ financial plan is supposed to work; (f) that a lot of MFIs are heavily subsidised by grants and donations (there’s a disagreement on whether this is a good thing or bad); (g) that there has been over-lending and over-borrowing; (h) that interest rates are very high; (i) that the industry lacks transparency; and (j) that there has been a significant move away from the nonprofit, charitable MFI toward the commercial, for-profit lending institution that dominates the industry. The difference between the two types of critique, though, lies in causation analysis and allocation of blame.

In the conservative economic analysis, for example, high interest rates reflect the market’s natural, rational pricing of the high risk of lending to the poor, the commercialisation of microlending is a good development, and it is the prevalence of donor-subsidised MFIs that is harming the poor by distorting the market and leading to all kinds of inefficiencies. Unlike the progressives mentioned above, who advocate strong public investments in helping the poor defeat poverty, many conservatives would advise governments of countries with a lot of MFIs (like Bangladesh and India, but now, increasingly, also certain depressed areas of the United States and other industrially developed countries) to opt “for a freer market through radical privatisation and free trade” as Jeffrey Tucker has written.

Owen Barder, a development economist thinks “access for the poor to financial services is definitely a good thing. Access to credit can help households to increase their consumption, reduce risk and increase food security, reduce malnutrition, and empower women.” But he believes that this access should be furnished by the private sector operating with the normal commercial motives, because subsidies from “donors, philanthropists or governments” distort the market and reduce competition, which in turn prevents the “evolution of the financial services industry” which he believes would benefit the poor more in the long run.  But he also says that the fact that the poor have had little or no access to credit in the traditional banking system is “not a market failure.” He says that, if “the returns are not high enough to compensate for the risk, then the market is doing exactly what it should by excluding the poor from access to credit.”

I find this line of thought a little perplexing. If the market won’t provide credit to the poor, and governments and philanthropists shouldn’t provide it, then where is this thing that’s “definitely a good thing” supposed to come from? I suppose Dr. Barder would counter that (now, almost a decade after he wrote the piece I’m quoting) that the market ended up wanting to lend to the poor; but contrary to his assertion; this “evolution” (to use his term) was not facilitated by market competition. The credit market entirely ignored the poor for – well, forever – until the nonprofit sector and Yunus demonstrated that the poor can be creditable. Even more to the point, Barder’s original assertion was that even if the market forces excluded the poor from obtaining lines of credit, the public and nonprofit sectors should NOT step up to fill that gap, because that gap reflected the rationality (or “non-failure”) of the market.

Again and again, the economists on the Right have taken up the issue from the point of typical, classical-liberal analysis of things like ‘efficiency’ and ‘competition’ and other free-market ideas firmly rooted in priorities that have little to do with the kind of individualised help that nonprofit MFIs are supposed to provide. The late, eminent economist Gary Becker insisted “Economic growth requires secure property rights, encouragement of private enterprise, openness to international trade, stimulation of education, limited and sensible regulations, and reasonably honest government. Microfinance makes only a small direct contribution to any of those variables”. But the question before him was not whether microfinance fosters ‘economic growth’; the question that he himself started out purporting to address was whether it lifts people out of poverty. And anyone who knows anything about economics knows those are two very different things. Dr. Becker certainly was aware of it. But to him, poverty on an individual level was simply not the right issue to be addressing, since, the Chicago School of economic thought (of which Dr. Becker was a distinguished exponent) holds that the tide of economic growth eventually, somehow, manages to trickle down to those struggling with poverty. In my humble opinion, that view has been amply contradicted by the last few years of post recession economic ‘recovery’ which saw sizable growth coupled with ever-deepening long-term poverty.

A Cato Institute paper, written by Thomas Dichter argues that the whole microcredit philosophy has the “sequence of growth and credit” backwards. He does a historical analysis to show that economic development in the West always saw growth first, followed by savings, followed by informal credit arrangements (for emergencies and for consumption), then followed, finally, by formal consumer credit marketed directly to small borrowers… and still, primarily, if not solely, for consumption, rather than investment in start up businesses.  I think Dichter has the history absolutely right. But what his analysis misses is the goal of nonprofit microfinance. He is analysing how an ‘industry’ develops that effectively and profitably sells credit to small borrowers, but the idea of the Grameen model is to address the existing needs of the small borrowers, not to ‘market’ a product to them.

Tellingly, Dichter described the earliest motivation for commercial microlending as an a outgrowth of increased industrial productivity and technical innovation and also the Progressive movement which “led people to focus on the needs of the ‘little man’… but the ‘little man’ was not expected to start a little business.” He was expected to earn wages by doing industrial labour and then consume industrial products “and to borrow money to buy the things he didn’t absolutely “need” (emphasis added by me). Dichter goes on to add, “In short, the little man, for whom mass credit was designed, was a product of the rise of wage labour, a product of the first fruits of industrialisation, which was in effect the West’s form of economic development. His role was not as a direct producer of economic growth but as a consumer of its fruits.”

I couldn’t agree more on the historical interpretation. I do disagree, however, that we should endeavour to repeat that history, which has only locked generations of ‘the little man’ in crushing cycles of debt and poverty by wresting his scarce, extremely hard-earned money in exchange for useless consumer trinkets and gadgets. Somewhat disturbingly, the predatory banking and retail conglomerate that Epstein and Smith exposed in the article discussed above, is cited approvingly by Dichter as a positive market development.

That said, much of the critique – from all political camps – that does focus on the results of microfinance vis-a-vis its impact on poverty, is important to consider, as they bring attention to genuine problems. And it’s not just the private financial institutions that are problematic. Some are public institutions that have begun to act like for profit businesses. As Valerio Carboni pointed out, the European Investment Bank is increasingly looking at microfinance schemes as ‘investment projects’ and are ‘following the market’ instead of being in touch with the needs of the poorest, whom microfinance was supposed to help. Also, to compensate for the lack of collateral or income sources to secure loans, core MFIs, including the Grameen Bank have used draconian ‘social pressure’ systems to ‘encourage’ repayment and even elicit other kinds of collective social behavior (having to do with diet and personal hygiene habits and choosing whom to socialise with) that seems rather overreaching for a bank, to say the least. Sadly, I have never heard a progressive, liberal critique of this practice. In fact, this has been touted as a selling feature of the Grameen model under the laudable-sounding name of “social capital.”

Several studies – by governments, nonprofit think tanks of all political and academic stripes, as well as participants in the microfinance sector – have shown little if any long term impact on poverty. Most studies are inconclusive at best. “We’re strikingly devoid of evidence that microcredit can be an effective route out of poverty”, according to Dean Karlan, a Yale economics professor and expert on microfinance. New York University economist Jonathan J. Morduch echoes that sentiment: “The evidence is pretty dicey.”

By contrast, there is a growing body of evidence that borrowers are not using the loans to invest in income-generating activities, but to meet short term cash-flow needs and sometimes to buy non-essential consumer goods and other consumption purposes –a trend which may be beneficial to them in the short term, but doesn’t really align with the actual goals of the credit line. There have been serious questions raised about the accuracy of the extremely high repayment rates reported by many lending institutions, even ones that charge high rates of interest. Some of the MFIs have been accused of arbitrage-like activity (borrowing in the market or from governments at low interest rates and then lending the money at higher rates to the micro-clients). There is a perennial lack of transparency and regulatory oversight, making it difficult for policymakers and neutral observers to accurately assess what’s happening.

But, for all its failures, microfinance – at least when provided by lending institutions that are truly nonprofit, not just in name, but the conduct of their business – offers a number of benefits that are valuable. Although originally conceived of as a financier of small enterprises, it is clear that the ‘survival skills’ people have to develop by default when they live precarious lives simply can’t be translated into  ‘entrepreneurship’ just by adding a little – VERY little – money. However, if indigent borrowers are using these loans to meet emergencies, basic, nutritional or medical needs, etc., that is still fulfilling a vital requirement and significantly improving the borrowers’ lives. While this doesn’t ‘cure’ poverty, it certainly contributes to better health and a more manageable household financial picture, which then enables the borrower to focus on finding and performing other income producing work. This has indeed been a pattern that emerges from many of the same studies that show microfinance doesn’t directly cure long-term poverty.  Earlier this year, the United Nations released a study that found that borrowers, especially women, have seen significant increases in personal expenditure, household assets, [participation in] the labour supply and children’s education, for example.  Also released this year, a study by the Center for Microfinance in Hyderabad (in partnership with ICICI Bank and Spandana Foundation) found a reduction in expenditure on temptation goods (tobacco, alcohol, etc.) and more toward expenditure for investment in durable goods for the home and business for households with an existing business (although only a modest increase in starting a new business).  So, what if all these people didn’t magically transform into entrepreneurs? The point is their lives got better in some small but real and measurable way. Call it “mission-drift” – of a more benign nature.

And the best news of all is that truly nonprofit MFIs are doing quite well. Kiva (better known as Kiva.org) does not make profit a part of its mission. It operates on grants and interest-free loans; and it also provides interest free loans to its clients. It runs smoothly. It is not in debt. Its clients are not over-indebted because they never owe more than they borrowed. Its repayment rate is nearly 100%. Of course, institutions like Kiva have been criticised by some business analysts for not making a profit. But that’s precisely the point. They are not in business to make a profit. They are in business to ease the financial burdens of people during times of need. But it’s not really charity either… because the money gets paid back (without having to pay an interest). I suppose you could say these institutions operate more like a friend lending a helping hand.

Passionate rationalist. Bleeding-heart moderate. Geek. Afflicted with a "language fetish". Koli practiced law on Wall Street until her lifelong love affair with writing demanded its rightful place as her primary occupation.

2 Comments

  • Reply November 12, 2015

    Hugh Sinclair

    This is an excellent, thorough article. If only all such discourse on the microfinance sector was as well written. Posted by a self-confessed geek lawyer, this is the kind of article that actually moves the conversation forwards.

    However, the final paragraph undermines the entire text. I initially assumed the author was somehow related to Kiva, but apparently not. I thus assume this was an upbeat but ill-informed comment attached inadvertently to an otherwise intelligent article.

    Kiva does not offer interest-free loans, and in fact it’s interest rates are disturbingly high, as it channels the funds through precisely the same microfinance institutions (MFIs) as other investors – the novelty is the crowd-funding raising of capital. Indeed, even Kiva acknowledge this, and yet they refuse to publish the actual interest rates of their loans. One wonders why? Kiva’s repayment rates are high, suspiciously so. Indeed, they are higher than the repayment rates of the underlying MFIs that actually make the loans. The deal is simple: Kiva provides interest-free loans to the MFIs, and the MFIs can charge whatever they like to the poor without any need to report these rates either to Kiva or to the naive users of the platform, and pocket the profit. The MFIs absorb the occasional defaults to maintain the high repayment rates in exchange for interest-free credit. Kiva reports the high repayment rates which maintains the flow of interest-free credit from its users. Simple.

    Is there any assurance on Kiva that loans are not directed towards consumption? Is there any assurance that the loans are not used in enterprises that utilize child labour? Indeed, is there any assurance that the underlying micro-enterprises funded are even legal? Why would the impact upon poverty of loans funded through Kiva be any different to loans raised through other mechanisms, i.e. zero? Kiva has been caught lending substantial sums through deeply fraudulent banks, such as LAPO, which I discuss in detail in my own book, which the author of this blog post references above (but presumably has not read). And indeed, Kiva may operate as an NGO, but this hardly guarantees it is somehow ethical or effective as a result – it makes no profit because it is simply a grossly inefficient means to do microfinance loans – compare their operating costs versus almost any other mechanism to lend to the poor.

    The underlying question is simply “who are Kiva’s clients?”. The poor face abundant sources of loans from an ever increasing number of MFIs, some of which happen to channel money from Kiva. Over-indebtedness rather than scarcity of access to credit is increasingly the problem. But Kiva serves two important functions, and I would argue that understanding these helps define who the real clients of Kiva are.

    First, it perks up the reputation of the ailing microfinance sector in the minds of the laymen and laywomen. This is a great service to the sector at large. But secondly, Kiva users are not “microfinance experts”, but casual armchair lenders who want to do something apparently useful with their $25. They are duped by Kiva, the fancy website, the win-win message, the simplistic but persuasive two-minute videos about Pedro the farmer who transformed his coffee plantation thanks to buying a tractor funded by Kiva (no interest rate stated, and coffee plantations don’t need tractors – it’s a bush and you don’t plough bushes, details aside). Kiva users get a heart-warming sense of satisfaction, and get their money back a few months later – who cares if it actually works? They don’t require evidence of impact, and Kiva provides none, but lives of the donations that the Kivans leave for Kiva. These are the real clients of Kiva. The poor clients are mere vehicles, idealized photo-stories of debatable validity, poor people who have already received a loan from some MFI and Kivans judge which they will effectively buy from the MFI, based on a photo, a heart-warming story, but suspiciously little other information about the actual loan.

    Kiva is a scam. Kiva users are blissfully unaware of this, innocent victims who suffer from naivety but are otherwise well-intentioned. The fact that the US financial sector regulator allows such abuse of it’s own citizens by an unregulated financial intermediary dressed up as an NGO is an indictment on the US financial sector regulators more than the users. The fact that Ms. Mitra failed to pick up on this in an otherwise excellent article is a mystery. I would suggest she reads two key articles before commenting further on Kiva:

    http://nextbillion.net/nexthought-monday-the-kiva-fairytale/
    http://governancexborders.com/2013/12/10/kivanomics-101-or-dkyc/

  • Reply November 13, 2015

    Phil Mader

    Hugh (above) alerted me to this article, I guess because Kiva is a pet peeve of his. I agree with Hugh that Kiva is not an example of “good” microfinance; but since it uses dishonest methods not to trick (wealthy) people out of their money but simply to grant them illusions about the impacts they are achieving, it is more a sham than a scam.

    Your article summarises well some of the debates that have been going on around microfinance but on two small factual points (which have larger ramifications) I wanted to suggest corrections. One, Hugh’s book “Confessions of a Microfinance Heretic” (which should really be read by anyone with more than a passing interest in the topic) does indeed describe how non-profit NGOs became profit-seeking ruthless microfinanciers, but what you leave out is his depiction of the non-profit sector, which is damning as well: rampant inefficiency, exploitative interest rates, absurd practices, but with more of a bleeding-heart (and often religious) mission. Two, you suggest the “Left” critique focuses on mission drift, whereby well-intentioned microfinance practitioners have lost sight of the original goal of helping the poor. This is not the Left critique, it is the standard narrative of many in the sector, which has some elements of truth in it but is also strategically deployed by the likes of Yunus in protecting the reputation of the idea which won him (and not countless others, who had it at the same time) a prize. The Left critique is instead to question whether debt can liberate.

    I can’t fault you for missing my book “The Political Economy of Microfinance: Financializing Poverty” as it wasn’t out at the time, but I think reading it would have enriched the article with two insights. First, the “new moneylenders” argument is both right and wrong. Wrong, because MFIs, despite recurring reports of nasty practices, have little in common with traditional moneylenders; they are more modern, efficient, more impersonal, and perhaps somewhat cheaper. On the other hand they are in a way taking over the role of the old moneylender, keeping people in sustained debt so long as it is profitable, rather than reducing their debt (which would be unprofitable). So the actual phenomenon with microfinance is that global finance (thanks in part to donors and pioneering NGOs) has identified the global underclass as a new profitable frontier to cultivate returns at. Second, bafflingly, your article gets around mentioning the 2010 crisis in Andhra more than in passing. Andhra in fact which was the denouement of what happens when financial capital “overfarms” the poor as a frontier for profits; the productive base collapses, and with does the financial superstructure built upon it. But notably Andhra was THE globally touted success case of microfinance, right until the collapse; microfinance at its best, it turns out, is its own worst enemy. In that connection it is also interesting to see the evidence for the poor already tightening their belts in the study in Hyderabad, which you interpret in a positive light, but should better be read as evidence of the hardships imposed by borrowing from MFIs.

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