Historical Perspectives in Microfinance

Author: Sam Mendelson.

We think of microfinance as being ‘invented’ in Bangladesh in the 1970s. To be sure, Grameen was the genesis of modern microcredit, the provision of small, unsecured loans to mostly women, for enterprise development. But microfinance – defined more broadly as financial services to the poor – goes back as far as money and commerce. Paul Thomes of Aachen University, Fatoumata Camara, from WSBI (the World Savings and Retail Banks Institute, and N. Srinivasan, an India consultant with decades of experience in the industry) ran a session entitled History Perspectives in Microfinance – to present the context of microfinance services over the centuries.

Historian Paul Thomes noted that microfinance, broadly defined, has had a cyclic nature for a long time. Old models of cooperatives and savings models, led to profit driven models, euphoria, disappointment, a push for optimization, and then a return to simplicity. Have we, he asked rhetorically, come full circle?

What we need is a ‘plausibility assessment’ in the historical perspective. Thomes compared European microfinance in the 18th and 19th Century, to 20th/21st Century financial services in developing countries.

There is, he said, a surprising amount in common. There are core challenges shared: limited access to finance, the need for inclusion of large social groups. There are common general challenges: fast growing populations, rural exodus (or urbanization), structural change from agrarian to industrial or service-based societies, collapsing social institutions, pauperism, lack of quality infrastructure, and from the individual perspective, poverty, lack of finance, and lack of security.

Fatoumata Camara, from WSBI, gave a tour d’horizon of informal financial services through history. How did microfinance evolve? It’s not new. Savings and credit groups have operated for centuries. African countries have their Susus and Tontines, there are chit funds in India, Arisan in Indonesia, Cheetu in Sri Lanka – all examples of traditional models for taking savings and providing loans within communities.

As she observed, WSBI is uniquely placed to speak on retail banking – formal and informal – around the world, representing 7000 banks in 90 countries, with 570m customers represented. WSBI believes in presenting the historical context for financial services as a central repository of lessons learned from the past. As Fatoumata recounted, the Irish loan fund system in the 1720s was arguably the first formalized modern loan system to the poor. The entities transformed to financial intermediaries in 1823, a loan fund board was created in the 1840s, and about 300 funds were soon making small short term loans.

People’s banks, cooperatives, and credit unions among the rural poor expanded throughout the 1800s, and the first ‘Communical’ fund was created in Germany, the first ‘thrift society’ in 1778, a communal savings fund in 1801, and the merging to the Rural Urban Networks of Credit Associations in 1889.

The spread of cooperative models around the world continued through the early 1990s, especially in Latin America, with the double objective of improving the commercialization of the rural sector. There was a strong focus on agricultural credit to small farmers in the 1950s-70s, with targeted cooperatives in Latin American receiving concessional loans to on-lend to farmers. But performance was disappointing, and loan repayment poor.

By 1970s, a major shift was underway with the emergence of solidarity lending, joint-liability credit within groups for income generating activities. This is when we think of ‘modern’ microfinance (microcredit, in reality) being born, something oft-repeated since Muhammad Yunus’ Nobel Prize in 2006.

In the 1980s, a new school of thought emerged dominant: the ‘financial systems approach’. Within this, credit is not a productive input necessary for agricultural development, but rather is just one type of financial service that should be freely priced in order to guarantee its permanent supply and eliminate rationing.

The 1990s saw recognition of microfinance as a strategy (perhaps the strategy) for poverty alleviation, with lofty claims made for its efficacy in this. Services began to widen beyond microcredit to savings and other products, such as insurance and money transfer/remittances. In short, microcredit evolved into microfinance, and in the 2000s with technology such as biometrics, smart cards, remittance platforms, and m-banking becoming more widespread, financial ‘inclusion’ – or inclusive finance’ became the dominant theory.

So what are the lessons from this historical tour? Poor people have excellent repayment, they are willing and able to repay. Credit allowed microfinance institutions to cover their costs, with high repayments and high interest rates allowing MFIs to look to long term sustainability and reach large numbers.

But there is much that remains ‘traditional’ in contemporary microfinance in certain markets. In Africa, historical and traditional schemes based on legitimacy, knowledge, values and enforcement have endured, alongside growing formalization of financial services: SACCOs in the East of the continent; COOPECs in the West, for example.

Poor people, Fatoumata Camara believes, intuitively prefer savings to loans – although the appetite for credit in underserved markets around the world might suggest otherwise. The lessons from microfinance’s history, though, are the importance of program integration and linkages, she said. Microfinance may have evolved a lot to what it is today, but there are trends and lessons from the past, which endure.

N. Srinivasan provided a historical context even broader in scope, going back to the beginnings of finance itself. “What is microfinance’s origin? When did finance as an enterprise begin? Was it ever ‘micro’? Taking the audience through Responsible Finance in history, Srinivasan reminded that as early a the 4th Century BC, Dharmashastra in India decreed that lending on interest was one of 34 major sins, comparable to teaching for a salary or not taking care of one’s parents. Someone who lent for interest, or profit, would be reborn five times as a low life form. It wasn’t clear whether this would include an investment banker.The Book of Moses, the Bible, and the Koran also forbade lending on interest, or ‘usury’ as it came to be known.

Gradually, it moved from sin to enterprise. From total prohibition, some lending on interest was permitted – although the Church would not allow a Christian burial to those who did. The Catholics, perhaps because of the long historical association of Jews with finance (we've all read the Merchant of Venice, I presume), took a long time to come around, and the right to lend with interest was declared heresy by Pope Clement V in 1311. It was not until 1545 that an Act in England gave legitimacy to lending for interest.

The history of microfinance is a long one, and shelves of books have been written on the subject. This session didn’t purport to summarise the literature, but rather to elucidate some of the themes which have emerged over time. “History doesn’t repeat itself, but it rhymes” said Twain. And “those who don’t learn from the past are doomed to repeat it”, said Santayana. It would do us well, at this critical time in microfinance, to remember both truisms.