Microcredit is money lending reinvented for a social purpose, and it has taken the development world by storm. People praise it for being able to keep interest rates low and by removing some unsavory elements of traditional lending such as India’s use of hooligans to collect payments or the multiplier effect which negatively impacts both lender and borrower. It has certainly had some success but how much and its overall impact is the subject of some debate.
Typically micro-loans involve loans to a group of borrowers who are liable for each other’s loans and hence have a reason to make sure each other pay. Some organizations expect borrowers to know each other when they come to pay, others hold weekly meetings. The very act of bringing the borrowers together helps to build a group mentality and makes them more willing to help out a group member who faces difficulty. Unlike traditional moneylenders their policy is to never use physical violence, but the power of shame seems powerful enough.
Where MFI differ from other loans is that they remove almost all flexibility. Moneylenders allow borrowers to decide how they repay their debt…some pay once a week, some twice a month some just pay the interest until the are able to put more money down. MFI’s has to repay a fixed amount every week at a time and place designated by the group. The biggest advantage to this is that the collector has a much easier time getting all his/her payments. The loan officer simply has to look and see if they have enough from this particular group and then move on to the next. This allows the loan officer to collect from 100 to 200 groups a day and not wait around to see if the might get paid. Furthermore, the officer doesn’t need to be particularly educated or trained, both of which help keep costs down. Keeping costs down reduces the risk of the multiplier effect and makes lending to the poor possible.
It’s a good plan but whether or not it works depends on your definition of “work.” Defenders of MFI say it transforms lives. The Consultative Group to Assist the Poor (CGAP), an organization that promotes micro-credit at the World Bank states, ” there is mounting evidence to show that MFI can help reach the MDG’s.”
Despite their claims there’s actually very little evidence to support the impact of MFI’s largely due to their own reluctance to gather data. Most of their data is anecdotal arguing, “as long as clients keep coming back, the loans must be helping them.” Maybe….but how much?
Others argue that because MFI’s are financially sustainable evaluating them is unnecessary. This disingenuous because most MFI’s are sponsored by donors and the generosity of their staff based on the idea that MFI’s are better than other ways to help the world’s poor.
So why haven’t micro-loans taken off? One possible reason is the inherent tension between entrepreneurship and the stringent rules of MFI’s. While they can boast of a “zero-defaut” they may not be attracting the right people. Small business owners are expected to take risks and sometimes fail, whereas MFI’s do not tolerate failure. In short, micro-finance incentives playing it safe so it isn’t well suited to seek out those who thrive on risk seeking.