We’ve thought and written a lot about microfinance lately. As of now, here’s where we stand.
What microfinance is and isn’t
First, it’s important to recognize that most of what you’ve heard about microfinance is false. It isn’t primarily about funding business expansion.. It isn’t a “proven solution” to poverty. And it doesn’t leverage your donation far more than other options.
Rather, we think of microfinance as a way to help people with low, volatile incomes manage their financial lives, an idea that is well argued in the recent Portfolios of the Poor study. This study implies that microfinance is really about providing one more option for borrowing rather than the only way to borrow, and that the borrowing is continual rather than “one crucial loan to escape poverty” – more like a credit card than a business investment. (This would explain why “graduation” from microlending programs appears rare).
What to look for
Does microfinance do good? It depends on a lot of things.
- If loans are constantly and heavily subsidized, they can be thought of as similar to giving out cash, in which case our primary concern is that benefits reach the right people.
- On the other hand, if loans are not subsidized, a microfinance institution’s profits could be taken as a sign that it has paying customers. This in turn could be a sign that it is providing empowerment.
With the latter goal (which seems to be the more common one), there is a big question about what role donations can and should play. We have expressed serious concerns about mixing donations with for-profit enterprises, with the possible result that donations end up padding profits (concept; example). In addition, we worry that there are too many donations blindly chasing the microfinance “story,” with the result that donations end up disappearing into nebulous activities.
There is also a question about the extent to which loans are truly providing empowerment. There is evidence that borrowing is bad for at least some borrowers.
We have developed a set of critical questions both about microlending and microsavings, to get at the question of whether an institution is helping people. We’ve looked hard for organizations that can answer our questions.
What we’ve found
In trying to answer the above questions, we’ve become fairly pessimistic about the area of charitable microfinance in general.
- The large U.S. charities are rarely clear even about what their value-added is. To the extent that I’ve been able to see their due diligence on partners (most of which is unfortunately confidential), it seems focused on financial performance, with much weaker examination of social impact-related questions.
- Something as simple as the “repayment rate” turns out to be reported, by standard practice, in what we feel is a highly misleading way. We’ve been shocked at how hard it is even to get what we consider the “real repayment rate” out of a microfinance charity.
- We’ve also been surprised by how often people drop out of microlending programs, generally for negative reasons.
- All in all, the picture we have is of a sector that tells stories about helping people but largely measures and rewards financial performance. As a result, microfinance institutions seem to have strong incentives to maximize their scale and their profits, even if doing so isn’t good for the borrowers.
All in all, we would guess that microfinance as a whole has done a great deal of good, but has also probably done some harm. We are more pessimistic specifically about microfinance donations in the current environment. For the reasons outlined above, we believe that giving to an “average” or “typical” microfinance charity – or giving with an illusory “peer to peer” relationship as the extent of your due diligence – is a fairly bad bet. At the very least, it will deliver far less good, and far more potential harm, than the typical microfinance narrative suggests.
Yet we still find the basic idea of providing financial services to people with low and volatile incomes very appealing as a way to help people … if it is done in a way that stresses social impact and uses donations responsibly.
We believe that microsavings is a particularly promising area, although we haven’t found a microsavings charity we can be confident in.
We believe that the Small Enterprise Foundation is a microlending institution that is truly and appropriately focused on achieving positive social impact. We’ll be writing more about it.