Does microfinance really help poor people?

In Peru there is an excess, not a shortage, of credit for low-income people.Photograph: Rodrigo Abd/AP..

                                                                                         Tomado de: Guardian Professional, 8 October 2014

First it was microcredit. Then microfinance. Now financial inclusion. Despite new names, 30 years later there are $100bn (£62bn) in current loans outstanding and the idea of providing financial services to the poor – particularly loans – attracts a cult-like following. Financial inclusion dominates the social investment sector, arguably crowding out other more traditional interventions such as healthcare and education.

I believe that there’s a lack of credible academic evidence proving any poverty-alleviating effects of financial inclusion. “On current evidence, the best estimate of the average impact of microcredit on the poverty of clients is zero”, says mathematician and development economist David Roodman.

Also, in a systematic literature review by the UK’s Department for International Development (DfID), University of East Anglia-based Maren Duvendack concluded the enthusiasm for microfinance had been built upon “foundations of sand”. The microfinance sectors of entire countries have collapsed, a spate of borrower suicides in Andhra Pradesh, India, raised uncomfortable ethical questions, and yet the hype continues. Why?

To clear up some terminology: financial inclusion encompasses a broad range of services, yet in my experience, the focus remains on offering loans (and to a lesser extent remittances), which is where the profit lies. The principal source of revenue for the sector is interest on loans, which is rarely publicised on websites. Rates exceeding 100% per year, even over 200%, are disturbingly common, particularly in Zambia and Mexico. The sector refuses to define what constitutes extortionate rates, or encourage basic requirements for sensible loan use.

Finally, the sector glosses over the fact that much credit is spent on consumption. Over-indebtedness is a chronic problem in some countries, particularly Mexico and Peru , where the problem is not a shortage of credit, but an excess.

Regulation is required, but to date the sector’s main effort, the Smart Campaign offers a watered-down, ineffective set of voluntary principles. Their recent certification of Banco Compartamos, one of the most vilified institutions in the sector, which distributed a €154m (£121m) dividend to its shareholders in 2013, on the back of charging triple-digit interest rates to Mexicans, led even Muhammad Yunus, founder of the Grameen Bank, Bangladesh, to suggest that “self-regulation doesn’t really work”.

The challenge with self-regulation can be explained by potential conflicts of interest. As the Smart Campaign is owned and staffed by Accion, the principal shareholder of Compartamos, how can it be expected to draft up guidelines where it punishes itself?

But it needn’t be like this. There are individuals in low-income communities who could benefit from fairly priced, well-designed loans. Savings, micro-insurance and remittances offer valuable services for a far broader range of clients too, but offer lower margins. We need to move away from recycling capital into yet more basket-weaving and fruit-selling enterprises that will only perpetuate the informal economies of developing countries.

Instead, capital should be increasingly directed towards small and medium enterprises (SMEs) capable of generating employment, paying taxes, and moving into the formal realm, an aim backed by the Inter-American Development Bank in their 2010 analysis of productivity in the Americas.

Countries such as Ecuador have demonstrated that a vibrant microfinance sector serving the full range of citizens with broad services and fair prices is both possible and modestly profitable. But such successes arise from proactive formal regulation at the national level, rather than “letting the market work” under the veneer of voluntarily self-regulation. This includes a reasonable interest-rate cap (30.5%); enforced client protection; obligatory use of a centralised credit bureau; complete pricing transparency; formal complaints mechanisms for clients; beefed-up risk management; and deposit protection.

Genuinely independent regulators need to be empowered along with the ongoing expansion of financial inclusion. Aid agencies such as DfID instead of fuelling financial inclusion at this stage, could fund a genuinely independent self-regulator capable of using carrots as well as sticks and support and train local regulators. They should ensure investment funds channelling funds towards financial inclusion are subject to the same oversight as those investing in other sectors and could implement centralised credit bureaus and related measures to prevent over-indebtedness. An excellent example was DfID’s support of Plus in Bosnia, which helps over-indebted microfinance clients to re-structure their loans.

Ultimately though, the current system is not protecting the people it’s designed to empower. Microfinance has clearly deviated from its original goal, it’s given rise to “its own breed of loan sharks,” as Yunus says. The question is will the new financial inclusion mantra be any different?