# Estimating the cost-effectiveness of microfinance charity

Note: I’ve responded to the most recent batch of comments.

A lot of work has been put into estimating the “bang for your buck” in health initiatives. In the area of microfinance, though, things appear very murky.

Microfinance advocates say things like “As our clients repay the loans, the money is loaned again and again to help many more entrepreneurs. It’s giving that keeps going.” Skeptics reply that much of the cost of lending is in operating institutions, not simply loan capital. We should be able to agree that the cost-effectiveness of microlending is not literally infinite, but what’s the right ballpark? Does the impact per dollar dwarf that of health?

We can take a very rough – and very generous to microfinance – cut by looking at some global estimates by CGAP. Notes before we get to the numbers:

• We are trying to get a number that we can put alongside existing estimates of health cost-effectiveness, just to see whether the microfinance sector as a whole has a clear and large advantage in cost-effectiveness. The estimate will be extremely rough and will not apply to any given microfinance charity, but rather to the area of microfinance as a whole.
• Our estimate is essentially a “best-case scenario” for what microfinance cost-effectiveness would be if (a) there were a direct link between donations and people served (b) microfinance could reach an enormous “target population” at the same level of donation funding that’s being provided now.

CGAP looks at both dollars invested in microfinance (PDF) and people served. According to these links,

• $11.7 billion of funding went to microfinance in 2008, of which 19% – or ~$2.2 billion – was grants (not loans, not investments, not guarantees).
• There are currently between 130 and 190 million microfinance borrowers worldwide.
• CGAP implies a “target number” of borrowers: “Given that almost 3bn people live on less than two dollars a day, clearly the battle to bring financial access to as many people as possible is a very long way from being won.” I have major issues with this target – for one thing, I’m not sure that people living under $2/day should all be targets, or are the only targets, of MFIs. A couple of ways to look at the “costs per MFI client”: • A lot of money is spent on microfinance.$2 billion in grants is about 10% as much as the total official development aid of the U.S. government (according to the 2008 Index of Global Philanthropy (PDF)).
• We’re currently spending $12-$17 in grants alone for every MFI borrower. Of course, the grants could be paying for a lot more than borrowing (including savings), and could be made with the aim of expanding future services rather than maintaining existing ones.
• If you believe that microfinance will eventually reach the entire CGAP “target population” (or a population that size, which would be around half the population of the world) and that the current level of grants will be maintained (say, growing only at the rate that the size of the target population grows), then at the point where microfinance is reaching its entire “target population,” the grants per person reached will be about $0.75. While this figure could be overstating the costs per person served if grants eventually create self-sustaining institutions and become unnecessary, I think it is far more likely that it understates the cost because (a) those who can most practically be reached in a profitable/sustainable way are likely to be those already reached, and the hardest people to reach are more likely to require continued subsidies; (b) there is a huge amount of other investment in microfinance, and we have very little sense of the role that grants play in enabling the expansion of services; (c) 3 billion clients is an extremely ambitious goal – around 20x the number of people actually being reached today, and around half the world’s current population. A couple of ways to think about the comparison with health: I would answer both of these questions mostly with a shrug. Certainly, under this extremely generous estimate of what microfinance could cost, it is “competitive” with the best health programs. But this is assuming that all of that money going to microfinance is going to eventually succeed in reaching half the world, and also making the even bigger assumption that grants are the key factor. We think it’s very possible that much of microfinance’s reach has very little, or even literally nothing, to do with charitable support. (The less generous cost-effectiveness estimate of$12-$17 is fairly clearly not competitive with the best health programs: compare 12-17 person-years of financial services vs. 1 life saved, or 1 person-year of financial services vs. 3-5 person-years of extra school attendance due to improved health.) Bottom line: we don’t see cost-effectiveness or “multiplying the impact of your dollar” as a strong argument for funding microfinance over health, on a general sector-level basis. This is the case even under the most generous model of the microfinance figures we’ve come up with. ### Comments • Phil S. on December 11, 2009 at 1:22 pm said: While I share your sense that microfinance is likely below well chosen health initiatives on the “bang for the buck” scale, I think your analysis above is kinda muddy. It’s a little hard to follow how you made the leap from$12-$17 in grants, now, per MF recepient, to 75 cents in some nebulous future. Also, in the second to the last paragraph (beginning “But this is”), you talk about$12-17, then 12-17 person-years of financial services. Perhaps you are taking a cost per life saved, dividing by $12 and$17 for an upper and lower range, and it coincidentally comes out to 12-17. In this coincidental case, you should make your math clearer. Or perhaps you’ve made a mistake in math or a mistake in explanation, it’s just kinda muddy to me.

This is an important topic, but I think it deserves a clearer analysis than this.

• Phil,

• The amount being given in grants now divided by the # people being served now = $12-$17. This may underestimate the cost-effectiveness of grants if they’re about to result in dramatic expansion of services. The amount being given in grants now divided by the total target population = $0.75 and should represent a sort of “upper bound” on cost-effectiveness. Does that clarify? • Yes, it is a coincidence. We are using$200 as the cost to save a life. $200/$12 =~ 17 and $200/$17 =~ 12 so 1 life saved costs about the same as 12-17 person-years of financial services.
• I don’t want to get into the argument of health vs microfinance but to me there seems to be a flaw in the level at which you are comparing these interventions.

The cost-benefit of deworming drugs (for example) comes a result of the improved health of the recipient not at the cost of the drug per individual. Similarly the benefit we should be looking for in the case of microfinance isn’t the unit cost of providing financial services – it is the impact this has on those households that receive loans i.e. the (hopefully) increased surplus household income after repaying the loan which then could be used by the family for food, health and education.

• Phil S. on December 11, 2009 at 3:09 pm said:

I went looking for this in some of the other micro-finance based info on the site and blog, but didn’t find it – maybe you can help:

One of my concerns about MF is the interest rate charged to the borrowers. If this rate is very high (say, 15%+), then it seems likely that many borrowers would be unable to earn that from business investment. If, in fact, many/most borrowers are using the loans for more consumption-type purposes, then the issue is compounded – they are agreeing to pay, say, $230 next year for$200 today, but if their income doesn’t change, then all MF does is makes them $30 poorer over the course of a couple years. i.e. Could MF institutions be the third world equivalent (roughly) of payday loan places, pawn shops, and high interest credit cards in the first world? While I think these things have their place here, I think that many of those who use them end up worse off than if such options weren’t available, and certainly, the idea that I, as a donor, would want to make a charitable gift to enable Al’s Pawn Shope or Quick Cash Payday Loans to expand their reach is not very appealing. Yeah, these concerns may be beyond the scope of what you’re trying to address in this blog post, but it’s just odd to me that we as a society generally condemn high interest loans to the poor in the U.S., but apparently seek to expand the practice in the third world (if indeed the typical loan is fairly high interest). • Ian, in an ideal world, I would agree. But we have too little information about the impact of financial services to make a direct comparison. The comparisons I gave are the ones I think are easiest to wrap your head around while still having some degree of validity to the numbers themselves. There is still an apples-to-oranges component, which is why there is a lot of ambiguity in a comparison like “250 person-years of financial services vs. 1 life saved.” • Phil, we have expressed a very similar concern. The only really strong way I’m aware of to address this concern would be via rigorous impact studies, i.e., evidence that participation in microfinance causally improves one’s standard of living. The other questions we propose for evaluating a microfinance charity could mostly be answered positively even in a payday-loan-type situation. Different donors will react to this concern differently. • Phil S., MF is not the third world equivalent of payday loan places. Many developing countries have informal moneylenders as well, and those are the equivalent of payday lenders, not MF institutions. Holden, I agree with many of the points in this analysis, especially your assessment that the entirety of the 3 billion people living under$2/day should NOT be the “target population” of microfinance (as Phil S. says, I agree that people who can’t afford loans shouldn’t become indebted).

However, I would like to see some more thought put into the objective in your final analysis of “providing someone with a year’s worth of financial services.” Do you really think that’s where the impact of microfinance ends? So far we have no evidence of the long-term effects of financial access, and two pieces of evidence demonstrating that there are no short-term effects in the Philippines and mixed effects in India, it seems. We also have an amazing piece of intensive research, the book Portfolios of the Poor, which meticulously tracks financial behavior and exposes issues associated with lacking basic financial services, while also exposing some of the failures of MF services as is.

Though I agree that the “multiplier” effect of capital spent on microfinance might be small or nonexistent, I challenge you to think more about the effect of financial services on someone’s life. It is a tad unfair to compare financial services with something health-related like vaccines or deworming, which has a clear-cut link to being “life-saving.”

• Elise, I agree that the comparison is problematic. It’s the best one I can think of given the limited available info, for purposes of answering the question, “Is microfinance clearly superior to the best health programs in terms of bang-for-the-buck?” Also see my response to Ian T. on this thread.

• Ryan Calkins on December 12, 2009 at 8:19 am said:

Holden,
Great post, especially for getting the microfinance and larger development community to think about opportunity costs.

Coming from the microfinance field, you would expect me to defend the importance of microfinance over and above other forms of development–or at least in conjunction with them. I’m not inclined to do that, however, as I think health care, education, political rights for the disenfranchised, and other basic needs have a higher value than access to financial services. However, in some cases, microfinance provides a means or a conduit to provide these other, more important services. The recent announcement by PATH, Global Partnerships, and Pro Mujer to provide access to health services through existing microfinance networks is just one example of many.

• heating film on December 18, 2009 at 4:10 am said:

What is the different between micro credit and micro finance?

• We (try to remember to) use the terms as follows:

• “Microfinance” is a general term for financial services that are provided on small amounts of assets, small transactions, etc. It includes loans, savings and insurance. Discussions of it usually focus on loans, although microsavings is arguably more promising.
• “Microcredit” refers to loans only.
• Ariah Fine on December 22, 2009 at 10:26 pm said:

I’m just a layperson here and that was a bit over my head. I think it’s a critique of micro-finance, but I wasn’t so sure.

Out of curiousity, what’s your take on an organization like Kiva.org

• Ariah, this post isn’t really a critique of microfinance – more a critique of a specific argument that people often give for microfinance, which is that it “multiplies the effect of your donation.”

Our quick take on Kiva is included in this post on “celebrated charities”. And here’s our full set of posts on Kiva.

• Sam Lee on January 1, 2010 at 7:44 pm said:

Two thumbs up on Ryan’s comments about microfinance institutions’ potential value added (at least in some cases) lie not only on financial services, but also on the network to reach population in need.

Phil S, on the issue of interests rate, one way to take look at it is that the specific interest rates are less important than that people voluntarily take the loans with the known interest rates, which, on aggregate, serve as a reasonable indicator that the services achieve some purposes, or people wouldn’t take the loans. However, what Holden mentioned that at times the loan officers are too “pushing the loans out” could be a real danger and should be kept in mind.

• Eric Friedman on January 20, 2010 at 11:32 pm said:

The calculations in the original post assume that donations do not create truly sustainable microfinance institutions. A truly sustainable microfinance institution—-the blue sky vision of microfinance—-can operate in perpetuity without donor capital (or at least without additional donor capital after setting it up). That is, a finite amount of donor capital could fund financial services for a finite number of people over an infinite period of time.

If you want to compare this to the cost of one-time health interventions, you’d need to consider the probability that this blue sky vision is possible. The premise of your math is that it is not possible, as you assume donor capital is needed in perpetuity. If your premise is right-—even for the best microfinance institutions—-then microfinance is not as sustainable as it is commonly advertised to be. But if the blue sky vision is reasonably attainable, then it the long-term cost of microfinance is lower and it is more difficult to compare microfinance to one-time health interventions.

• Holden on January 27, 2010 at 1:56 pm said:

Eric, you’re correct that we could be understating the cost-effectiveness of microfinance if these grants lead to perpetually self-sustaining institutions, leading ultimately to a substantial drop in microfinance grants. However, it doesn’t seem wise to assume that the “average” microfinance grant is headed this way. In fact, we would guess that most of the most financially viable opportunities have been capitalized on by now, and the people still not being reached are the ones who may never be reachable in a self-sustaining way.

This post is about the cost-effectiveness of the microfinance sector as a whole. We’re arguing against funding large U.S. microfinance charities, or effectively funding microfinance institutions through Kiva, on the basis that microfinance is so inherently cost-effective as to make finding outstanding organizations unnecessary. If you find an outstanding microfinance institution, your donation could end up far more cost-effective (and one way is by leading to creation of a self-sustaining institution).