What’s gone wrong with microcredit? asked Brian Keeley on this blog last month, in response to the growing furore in India and Bangladesh surrounding the activities of micro finance institution. Muhammad Yunus and the Grameen Bank are under attack from politicians in Bangladesh. In turn, Professor Yunus has become more vocal in his criticism of commercial micro finance institutions, although the commercial firms continue to enjoy the support of a number of articulate and influential commentators.
It was always likely – and desirable – that microfinance would lose some of its lustre. It never was the easy solution to global poverty that some of it cheerleaders claimed. Nor has the discussion around the impact of microfinance been helped by the simplistic characterisation of charitable microfinance as “good” and commercial microfinance as “bad”. Good practice is good and bad practice is bad, irrespective of the financial structure of the company.
Less attention has been paid to what might be called the political economy of microfinance. What impact have micro finance institutions had on economic relationships in the communities in which they operate, with particular reference to the distribution of power? Might the current crop of anti-microfinance stories have more to do with fear of changes to the power structure than with the level of interest rate charges?
Back in 1942, the American sociologist C Wright Mills wrote* that, “Not violence, but credit may be a rather ultimate seat of control within modern societies”. Given the central role of credit in a modern economy, whether this be a Western urban economy or an Asian rural economy, it is not surprising that the control of credit matters both to borrowers and to lenders.
Where credit is freely available, borrowing can be a purely commercial transaction. In this case the cost of credit (the interest rate) and the service provided by the lender (the way the borrower is treated) are the two most important consideration. Borrowers choose from whom to borrow based on the quality of service provided and the cost paid for the service. If they don’t like the price or the service they can go elsewhere.
Where credit is not freely available, borrowing is often connected to a wider range of activities that are determined by the traditional social structures. Wealthy families control the flow of money to their clients who, in return, are expected to do more than pay back capital with interest. Client communities, which might include extended families or, in some cases, whole villages, are expected to work for their patrons and to vote for them at election time.
Recent fiction by Daniyal Mueenuddin and Aravind Adiga capture the complexities of the power structures of these client communities and document the corrosive impact that they have on the lives of the poor. In such communities the very idea of providing credit on a purely commercial basis is a direct challenge to the political status quo.
In many parts of the world quasi-feudal relationships between rich landlords and poor clients remain in place. These social structures are also paternalistic, with women forced mostly into subordinate roles in education, in work and in politics. It is in communities such as these that microfinance has had a revolutionary impact: credit is now available on purely commercial terms, without regard to traditional social obligations and gender roles. Micro finance institutions are offering the poor a chance to borrow freely: they pay interest on their loans but that is the only price that they pay.
Who has most to lose from the growth of microfinance? The illegal loan-sharks for sure; poorly run state banks too; and, of course, those who benefit from political systems built on patronage, corruption, the buying of votes and the preservation of a culture of dependency.
Today, micro finance institutions are under attack from members of the political elite in India and Bangladesh. The only surprise is that it has taken so long for these reactionaries to start fighting back.
* C Wright Mills, Power, Politics and People, p. 46, Oxford University Press, 1963.
Five years ago, microcredit was going to “put poverty in the museum”. The concept earned its creator, economist Muhammad Yunus, a Nobel prize and was hailed by aid workers, activists and journalists.
Today, microcredit – or the provision of small loans to some of the world’s poorest people – gets less glowing coverage: News stories report that it is in “crisis” or a “mess” or “under siege”.
What’s gone wrong?
To some extent, microcredit is a victim of its own success – a process many date to 2005 (which, perhaps ironically, was the UN’s International Year of Microcredit. What was once a niche – often charitable – activity became “a trendy asset class” for professional investors, according to the Financial Times. The numbers are striking – by 2009, the FT reports, “global microfinance had around $12bn in cross-border investment, up from $4bn three years ago”. Worldwide, borrowings are estimated to stand at $65 billion, against $24 billion in 2006.
The origins of microcredit were more modest, and go back to Yunus and his Grameen Bank, which began as a research project in Bangladesh in the mid-1970s. Yunus’s idea was to provide poor people with small loans at reasonable rates, along with access to banking services and financial advice.
Integrating poor people into the financial system was an innovation in itself, but Yunus went even further by targeting loans at women, who are often unable to borrow money for a combination of legal and social reasons. More than 90% of Grameen’s borrowers are women, most of whom use the money to start or build up small businesses. A repayment rate of over 95% made Grameen both a social and business success, and the idea went on to be copied across the developing world.
That was true of nowhere more than India, and it’s there where microcredit has hit the buffers. The BBC, and many others, have reported on a “suicide epidemic” among micro-loan borrowers. As more and more lenders entered the market, the initial focus on lending for business purposes faded. Instead, many borrowers took out home loans, and then faced intimidation from lenders to pay back the money. The deaths have fuelled a backlash, with opposition politicians in the Indian state of Andhra Pradesh urging borrowers not to pay back their loans. Repayment rates are reported to have plunged to 20%, and there are doubts about the financial soundness of some lenders.
Sounds familiar? The details may be different, but in a sense India has seen a credit bubble not unlike the subprime and mortgage bubbles that caused so much trouble in Western countries. The danger is that, in India’s case, the crisis will bring down the entire microloan sector, which would be a great pity, especially for people struggling to escape poverty. As The Economist notes, microcredit “is not a magic bullet, but nor is it intrinsically harmful”.
What’s needed to make it work better is a bit more realism. Yunus has doubts about whether microcredit should ever be offered by for-profit operators. “Poverty should be eradicated, not seen as a money-making opportunity,” he believes. However he also accepts that for-profits can play a role, but by focusing primarily on servicing the needs of the poor and not on maximising profits.
Realism would also help when it comes to assessing the impact of microcredit. Claims made for its social benefits at the height of the frenzy were probably overstated. Indeed, a study by Yale’s Dean Karlan suggests that in some cases microcredit can make it harder for people to set up new businesses because lenders primarily give money to existing business owners.
Microcredit deserves to be seen as part – but only one part – of the solution to poverty. Other financial tools, such as providing poor people with savings accounts and insurance policies, also need to be more widely available.
Despite microcredit’s current woes, it would be a pity to throw it out. Drawing a parallel with the West’s financial crisis, development writer David Roodman argues that “you wouldn’t say that just because of the mortgage crisis, we shouldn’t have mortgages.”