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What’s gone wrong with microcredit?

14 January 2011
by Brian Keeley

Roses have thorns

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.”

 Useful links

 OECD work on poverty reduction

 The OECD Development Centre

 OECD work on India

 The OECD Social Institutions and Gender Index (SIGI)

 Atlas of Gender and Development  

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