What is microfinance and why should we support it?
There is a myth in the U.S. that it only takes hard work and an entrepreneurial spirit to “make it” in life. Of course, in a developed economy this is often true, though the importance of luck cannot be overstated. Traveling in the Third World, you will quickly discover the fallacy of this myth. In the States, we often say that someone “started with nothing,” but our “nothing” and Third World “nothing” are miles apart. Without education, without infrastructure, without government programs, success is virtually impossible. This is where microfinance comes in.
Microfinance entails providing financial services to those that traditionally are of no interest to banks. A full-service microfinance program offers loans, savings, insurance and training to these forgotten ones.
The field of Microfinance has received a lot of attention since Muhammad Yunus received a Nobel Prize in 2006 for his work with the Grameen Bank that he founded in Bangladesh. Certainly Bangladesh qualifies as one of the countries where having “nothing” is an extraordinary hardship. The overwhelming majority of the loans (96%) from the Grameen Bank are to women. See the excellent entry in Wikipedia of the history of the Bank, and of course Yunus's book Banker to the Poor.
In general, loans are not given to individuals. Loans to groups or collectives are deemed more effective. One reason is that the amounts are so small, that an individual loan would hardly be worth the paper it was written on. Groups also have the advantage of peer pressure and support. Since each group member has a financial stake in the productivity of the other members, there is incentive to work collaboratively.
Microfinance programs have had mixed results, and there are those who completely dismiss the movement. Article taking this negative view was published in the Stanford Social Innovation Review Click for Article. The author Aneel Karnani argues that a top down approach would be more effective: investing in getting manufacturing companies to move into impoverished countries. We've seen successes in a number of countries where industry moves in to take advantage of plentiful, lowcost labor. This can have the effect of increasing the number of wage earners, which in turn can jumpstart economic development. True, an influx of manufacturing can have a beneficial impact. And, clearly, anyone who sees microloans as a solution to poverty rather than just a useful tool is naïve. There have been studies that show verifiable benefits from micro loan programs.
At ELI, we try to support the microfinance movement by providing interns and volunteers to organizations that we feel are doing good work in the field. It has the two-fold benefit of providing manpower to these organizations and of educating our participants about work that is being done. The hope being that they will return home more knowledgeable about poverty and methods for combatting it.
Although Muhammad Yunus founded the Grameen Bank and ran it for many years, his reliance on the government of Bangladesh for much of his funding left him open to an eventual ouster. This occured in 2011. The government claimed that there were violations of the law that governed the bank. From what was reported in the New York Times at that time, there may have been deviations from best practices. The Times also points out that microfinance institutions were under close scrutiny around the world because of predatory lending and exhorbitant rates. See the Times article for more.
Follow-up
In spite of all of the negative news about microfinance programs, apparently real progress in the fight against poverty can be attributed to their activities. This has been pointed out in an article in The Diplomat: "Micro-credit loans, in themselves, have been somewhat controversial, but a 20-year longitudinal World Bank study entitled “Dynamic effects of microcredit in Bangladesh” released in 2014 authoritatively points in the direction of micro-credit being immensely effective at reducing poverty by increasing household spending, labor supply, and women’s labor force participation rate." Here's the World Bank Report.
ELI doesn't work in Bangladesh, but any discussion of microfinance institutions (MFIs) must relate back to the successes and failures that can be seen there. The more you look into the issues in the field, the more you realize that caution must be excercised when working with MFIs. You might want to look at the Village Bank program in Uganda. You'll find it on our Uganda microfinance page.
By Kevin O'Neill
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