Microcredit: Neither miracle nor mirage, by Orazio Attanasio, Britta Augsburg, Ralph De Haas, Heike Harmgart, Costas Meghir, Vox EU: Recent years have seen an intense debate between microfinance proponents and detractors on whether microcredit can lift people out of poverty. The microfinance industry has long painted a picture – often backed by inspiring individual success stories – in which households can escape poverty once they receive a microloan. Women are thought to benefit in particular as access to credit allows them to become economically and socially more independent. More recently, doubts have emerged about the ability of microcredit to improve living standards in a structural way. Some point out that many villages where microcredit was first introduced in the 1970s are still as poor today as they were then. Others take offense at the very high interest rates that some microfinance institutions (MFIs) charge.
What has been absent from this heated debate is solid evidence. To fill this gap, a number of research teams across the world started randomized evaluations (large field experiments) to rigorously measure 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 organizations whereas others were non-profits. Nominal annual interest rates varied between 12% (Ethiopia) and 110% (Mexico).
Four main lessons
Together, these studies have produced a rigorous body of evidence on the impact of microcredit in a wide variety of settings. Earlier this year the research results were published in a special issue of the American Economic Journal: Applied Economics (references at the end of this article). They paint a remarkably consistent picture and contain four main lessons:
- Across all seven studies, microcredit did not lead to substantial increases in borrowers’ income. It did not help to lift poor households out of poverty. This holds both when measured over the short term (18 months) and over the longer run (three to six years).
A possible explanation for this finding is that while microcredit clients overwhelmingly reported using loans at least partially for business purposes, many of them also reported to have used 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. Though business investments and expenses increased for borrowers in several countries, researchers did not find any overall effect on borrowers’ profits in Bosnia and Herzegovina, Ethiopia, India, Mexico, and Mongolia. In the evaluation in Bosnia, we only found positive profit impacts among a small segment of all borrowers.
- Access to microcredit also did not appear to have tangible impacts on borrowers’ well-being or the well-being of others in their households.
For instance, three of four studies found no effect on female decision-making power and independence. In Mexico, where the microfinance institutions emphasized empowerment, women did enjoy a small but significant increase in decision-making power. In six studies, microcredit access did not increase children’s schooling.
- On the upside, the data collected by the research teams show that households with access to microcredit enjoyed greater freedom in deciding how they earned and spent money.
In Bosnia and Herzegovina and in Morocco, microcredit allowed people to change their mix of employment activities, reducing earnings from wage labor and increasing income from self-employment activities. In the Philippines, it also helped households insure themselves against income shocks and to manage risk. In Mexico, households with access to microcredit did not need to sell off assets when hit by an income shock.
- Importantly, there is no evidence of systematic harmful impacts of access to microcredit.
For instance, overall stress levels among borrowers were no different from the comparison group in Bosnia and Herzegovina or the Philippines, though male borrowers experienced significantly higher levels of stress in the Philippines.
Implications for the microfinance industry
Small changes to product design may have a big influence on how people use and benefit from microcredit. For instance, repayment begins for the typical microloan 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 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 – led to increased short-run business investment and long-run profits, but also increased 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. For instance, 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. In Mali, researchers found that a credit product designed around agricultural timing had positive impacts and did not lead to increased defaults (Beaman et al. 2014).
Related to the previous point, microfinance institutions and borrowers could benefit from better segmenting the market and offering larger, more flexible products to clients most likely to perform well, and smaller, less flexible loans to less promising borrowers. Better ex ante differentiation is, however, not straightforward and would require better screening methodologies (Fafchamps and Woodruff 2014).
In addition, financial institutions can pilot better ways to help high-performing micro-entrepreneurs become eligible for small and medium enterprises (SME) lending. 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 department should ensure that fast-growing micro clients can easily graduate to SME status.
Lastly, we note that the rapid expansion of lender competition can tempt some clients to borrow from various lenders (double dipping) which may result in over-borrowing and repayment problems. A potential mechanism to prevent such problems is to let lenders share borrower information via a credit registry. These considerations are particularly urgent for countries, such as Tunisia, that are currently opening up their microfinance sector to increased competition.
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Attanasio, O, B Augsburg, R De Haas, E Fitzsimons and H Harmgart (2015), “The Impacts of Microfinance: Evidence from Joint-Liability in Mongolia”, American Economic Journal: Applied Economics 7(1), 90-122.
Augsburg, B, R De Haas, H Harmgart and C Meghir (2015), “The Impacts of Microcredit: Evidence from Bosnia and Herzegovina”, American Economic Journal: Applied Economics 7(1), 183-203.
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