Tim Taylor on the Status of Microfinance

Microfinance, the provision of small loans to poor individuals, got a lot of buzz in 2005-2006 and one of its pioneers, Muhammad Yunus, received a Noble Prize for his work with the Grameen Bank in 2006.

However, it appears that some of the shine is off the apple. Research by Abhijit Banerjee, Esther Duflo, Rachel Glennerster, and Cynthia Kinnan found mixed results from micro-credit efforts in Hyderabad, India. In discussing the research with Deseret News, Kinnan noted that fewer households than expected took out loans and, among those that did, their monthly consumption did not increase and neither their businesses' profits. They also found no evidence that the microcredit had an impact on the education, health or role of women in the households that took out loans. While microcredit loans did have potentially positive effects on household spending, such as increasing the purchase of durable goods and decreasing spending on temptation goods, the loans did not seem to have the dramatic effects claimed by microcredit proponents.

At the Conversable Economist blog, Tim Taylor looks at recent research by David Roodman (you can see Roodman's orginal work here). The story that Taylor pulls out of Roodman's research is that, whether or not microcredit lifts people out of poverty, it gives the impoverished more control over their lives by providing otherwise unavailable access to credit. Thus, microcredit institutions are increasingly filling a void  in their nation's banking system.

Indeed, according to Roodman's data,  microcredit loans have expanded greatly since 2006 in both the number of loans outstanding (from 55 million in 2006 to 80 million loans in 2001) and the total amount of money lent (from $25 billion to $80 billion in the same period). Being able to get capital from donors or from below market interest rate loans has allowed microlenders to become largely self-sufficient  and to begin attracting money from the private sector.

The fly in the ointment appears to be that these institutions are operating in an un- or under-regulated environment. While they have been building up institutional capabilities from the bottom up, the banking industries in these countries are still deficient in top down systemic institutions. Taylor provides the following quote from Roodman:

• "The microfinance industry has demonstrated an ability to build enduring institutions to deliver a variety of inherently useful services on a large scale. Nevertheless, the recent travails are signs that something is wrong in the industry. What is wrong is, ironically, what was once so right about the industry: it largely bypassed governments in favor of an experimental, bottom-up approach to institution building. The industry got so good at building institutions and injecting funds into them that it often forgot that a durable financial system consists of more than retail institutions and their investors. The narrow focus became a widening problem as microfinance grew. ... To mature, the industry and its supporters should recognize the imbalance it has created. Where possible, they should work to strengthen institutions of moderation such as credit bureaus and regulators. Accepting that such institutions will often be weak, they should err on the side of investing less. In microfinance funding, less is sometimes more."

So once again, we come back to the importance of institutions in developing nations (for that matter any nation).