Friday, January 12, 2018

Micro-finance and its flaws

Designed to help alleviate poverty in some of the world’s poorest countries, microfinance initiatives provide loans to entrepreneurs and small businesses, hoping this will help the poor to work themselves out of desperate poverty. Despite around US$34 billion in funding and numerous microfinance initiatives to help entrepreneurs in the world’s poorest countries, informal moneylenders and predatory loan sharks continue to thrive. If microfinance cannot compete with informal lenders, can we be confident that it really works?

 Philanthropic donors and policy-makers are enthusiastic about microfinance initiatives and, understandably, those working in microfinance often have a vested interest in showing that their work is effective. This means that the enthusiasm of microfinance funders is still not grounded in rigorous studies.

Microfinance initiatives can produce unintended consequences. When poorly managed, they provide entrepreneurship opportunities for “middle men”, where borrowers who more easily qualify for loans from microfinance initiatives then lend to poorer borrowers. Consequently the poorest of the poor micro-entrepreneurs benefit less than the comparatively less poor, and this reinforces existing socio-economic hierarchies in these countries.

 Loan officers at formal microfinance organisations have an incentive to focus on quantitative outcomes such as the number of loans provided and rollovers of “safe” loans, rather than on funding the poorest borrowers. Loan officers know that some borrowers use their loans to lend to others; they provide loans to these informal intermediaries because they know that they will reliably pay back their loans.

There exists collusion between intermediaries and loan officers, as well as former microfinance loan officers becoming informal lenders themselves. “It is easy to do”, they said, easier than to “sell noodles or operate a small grocery stall”, and borrowers “do not care whether we have licenses or not”. During preliminary fieldwork in Thailand in August 2017, we found that informal intermediation and relending of loans between borrowers occurs there, too. To stop predatory lenders from taking advantage of poorer borrowers, the microfinance industry needs to develop ways to identify and prevent management failures. It is also important to understand that informal lending doesn’t just involve predatory loan sharks. There is a whole spectrum of informal intermediation, for example, ranging from the benign and casual to the systematic and downright criminal.

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