Author: Daniel Rozas

A recent article by the Economist hails a study in Bangladesh by Shahidur Khandker as "the biggest study so far [which] finds that microcredit helps the poor after all."  Within the sector, the article has been widely circulated as proof that, indeed, microfinance does work. Rupert Scofield, CEO of FINCA, found vindication that this study finally resolved the problems of earlier randomized control trial (RCT) studies, which had found that microloans had zero impact on clients:

The recent short-term studies were undertaken in highly saturated markets and focused on clients who diverted some or even all of their loans into consumption. Microcredit works best when the client uses it to fund a business.

But there's the danger of jumping to early conclusions. Before considering the Khandker study, it's worth addressing the way Scofield seeks to explain away the RCTs by referring to "highly saturated markets" and "clients who divert loans to consumption."

First, Scofield errs by suggesting that the RCTs (assuming here he means the Banerjee/Duflo 2009 study in Hyderabad and others) were undertaken in highly saturated markets, thus implying that Bangladesh is somehow less saturated. On the contrary, Bangladesh is the most saturated market of all. Even the Khandker study repeatedly discusses widespread multiple borrowing among the surveyed households. While we all have the image of the microfinance bubble in Andhra Pradesh in 2010, it's worth remembering that at the time of Duflo's study, during 2006-08, it was significantly less saturated, probably less than Bangladesh anytime in the past decade. And Duflo's study is by no means the only one. I am sure that Scofield would not suggest that Karlan's RCT study in Manila in 2006-08 (which found much the same thing as Duflo) was conducted in a market more saturated than Bangladesh.

As for the diversion of loans to consumption, is there anything in Khandker's study to suggest that the households he surveyed did NOT divert their funds to consumption? Why would we assume that these clients are any different from those in India or Philippines? I find no basis for this.

Scofield does have a point about the relatively short timeframe of the RCTs, though I don't find them quite so short, given that they spanned one full loan cycle or more.

So what about the Khandker study itself?  Here, I must once again go to the authority, David Roodman:

The article appears to commit what Dierdre McCloskey and Stephen Ziliak dub the “standard error of regressions,” which is to confuse statistical significance with real-world significance. Statistical significance, as meant here, is the certainty that the impact of microcredit is not zero. Real-world significance is whether the effect is big enough to matter. “A 10% increase in men’s borrowing raises household spending by 0.04%….Borrowing by women pushes up household spending by one and a half times as much.” Let’s see…because of compounding, seven 10% increases would about suffice to about double borrowing. So doubling female borrowing will lift household spending by 7 * 0.04% * 1.5 =  0.42%. To me, that seems small—about a sixth of the impact found in the first study of these families.

Indeed, 0.42%. That's what's being hailed here as proof of success. Let's put this in perspective. Let's say you are a middle-class family earning €50,000/year. Would you want to double your debt in return for an extra €210?

No, probably not.

Neither would Scofield. In the two client examples he gives, we don't see a benefit of 0.42%. Both are standout clients. One has actually gone on to build a million-dollar business. They are the equivalent of those two kids you knew in high school, one of whom went on to become a successful lawyer and another a billionaire hedge fund manager.  And as with the high school curricula, I doubt that FINCA's lending programs are oriented to those two success stories. No, they quite rightly aim to serve the average person, which is what microfinance should be all about. The need for quality financial services – savings, credit, insurance – is enormous. And so far, we've barely made a dent.

I reject microfinance as the story of rags to riches. As financial providers, we're in no position to be selling tickets out of poverty. Rather, we should focus on providing everyday people who are excluded from the financial system with the products they need, and doing so responsibly. When some clients do extraordinarily well, we should celebrate them, not us. When others make mistakes or suffer bad luck, we should try to mitigate their situations as best we can. But above all, we should focus on those in the middle, and try to make their lives just a tad easier and help them lay the foundation for the next generation.

That should be the measure of success. 

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Comments (3)

Hugh Sinclair

I suspect Scofield is regretting writing this post. But what else does he have to go on? He is grasping at any possible straw to justify the existence of his institution, and would we expect him to do otherwise? Any intelligent researcher of microfinance who has bothered to read the evidence and articles is, by now, well aware that this is no magic bullet as originally claimed. However, people such as Scofield have built institutions around a myth. They have staff to pay and banks to operate and have to raise substantial funds, particularly to prop up loss-making banks. If they go to their investors with comments along the lines of "every $50.000 loan will increase income by only $210" (using your example above, they will struggle to persuade people to open their wallets. Rather, they have to present microfinance, with its rather mediocre poverty-alleviating results to date, in the most ludicrously positive light possible, and the only way to do this is to jump on anything remotely positive and make a song and dance about it. They have to scour their clients until they find a super-hero, and present this as the typical. Obviously it would be better if they did in fact have this typical result, and didn't have to deceive their investors, but this is simply not the case, and in the meantime we should not be surprised to see such spin.

Indeed, have a look at any website. Is Kiva any different? Look at the MIVs - they all do this. But so do shampoo manufacturers, car dealers, any business basically. It is standard marketing rhetoric. They hope to persuade us that if we buy their soft drink we will be like the cool hansome guy on the beach, or the tall beautiful woman in the elegant clothes etc. Most of us have the common sense to realise this is not the case, and have become so accustomed to this marketing that the positive effects of such methods is largely subliminal. But in microfinance the likes of Finca have a huge advantage: the "consumers" (i.e. donors/investors) have little means to verify or refute the claims made. They like the message (self-help, teach a man to fish, recycling loans, entrepreneurship etc) and likely don't read the RCTs and academic literature, and are thus an entirely captive market. Finca etc. know this all too well, and exploit it as best they can. You and I look at their websites and find them frankly ridiculous, but you and I are not typical. The typical American or European well-intentioned donor or investor without "inside knowledge" actually believes this rhetoric, and donates/invests. The tragedy is that they are essentially being duped, and these funds are largely channelled into useless activities. I urge anyone remotely considering an investment in microfinance to first demonstrate that the impact is greater than competing activities. Which brings me to my final point:

When we debate whether microfinance works or not - in relation to what? What is the benchmark? The $210 upside you mention above is only meaningful if this is compared to something. Perhaps this is the best possible outcome? But if you examine something like the GAVI bond and say to a potential investor "for $50.000 you can vaccinate 50 kids a year and get your money back at the end with 5% per year interest in the meantime" then the $210 return from the microfinance loan can be placed into perspective. Ever wonder why the microfinance community never does this? The downsides are underplayed, the upsides are held up as typical, but neither are compared to anything. While I find this sort of deception unfortunate, I concede that it is necessary for such institutions. In fact, I feel sorry for them. How satisfying can it be to operate a company such as Finca with such mediocre results? The CEOs and staff of these institutions privately know that what they are doing is largely ineffective, but it pays their bills, the school fees, the annual holiday. I suspect they wish as much as any of us that microfinance did in fact have a widespread transformative impact on poverty. It must be extremely frustrating for these folk, and in some regards, despite the ethical dimension of the deception and the wasted resources that could have been put to better use, perhaps they deserve pity, not criticism?

Daniel Rozas's picture
Daniel Rozas

Hugh- I don't know if Rupert Scofield regrets his blog or not. But certainly, I regret that he wrote it. Yes, putting forth such exceptional cases as proof of microfinance success is a type of deception. I can try to mince words, but there's really no other way to say it. It's perfectly fine to use success stories in ad copy or as overleafs of annual reports, though even in those cases, I'd caution against the urge to focus on the 1-in-1000 clients. However, in arguing that microfinance is successful BECAUSE it produces these exceptional results, we build up irrational expectations and set ourselves up for failure and ridicule. These types of arguments have done enough harm to the sector. The reputation of microfinance is a precious thing, and a CEO of one of its major institutions ought to try a bit harder to safeguard it.

Hugh Sinclair

The irony is that such scrutiny is performed by few, and generally those already aware of the problem. Preaching to the converted. Alas such posts will no doubt convince a few donors or investors to cough up a few dollars, or re-assure those already invested but with limited attention spans or genuine interest in what is happening in the real world - so in fact his method might actually work, reinforcing the message. He spins, some people buy it, he gets paid, fulfills his objective, and Finca limps on another day. It's been like this for decades, and while there is a backlash in certain circles, there is profit to be made lending to poor people, and profit to be made encouraging people to finance such activities, and the merry-go round spins on incessantly. How many of those investing in microfinance have ever read an RCT, or Duvendack? I applaud the work of many academics, and some of the more progressive media outlets in getting closer to the truth, and challenging the accepted wisdom of the miracle cure for poverty. But until this get into the mass market, and the donors and investors to such institutions as Finca start voting with their wallets and holding their intermediaries accountable, not a lot will happen. And until this happens, what is the incentive to actually improve microfinance?

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