News & CommentaryArchive
Oct 17, 2008
Cutting Edge Research on Microfinance
For the next two days we’re attending a conference of microfinance researchers hosted by Innovations for Poverty Action and the Financial Access Initiative. The conference is not your typical microfinance conference – all the presentations are by academic researchers who are conducting randomized controlled trials to learn how, how much and why microfinance works (or doesn’t). That being said, the research is not being done for academic purposes alone but to learn with microfinance organizations how they can improve their products and their impact.
Since we are “live blogging” our emphasis will be on speed – forgive us for any typos and be aware that the summaries of the presentations we’re providing don’t come close to fully explaining the studies they are based on. As we can we will update the posts with links to the presentation materials and/or papers themselves.
Now on to the conference:
The opening presentation was given by Jonathan Morduch of NYU and the Financial Access Initiative. Morduch set the stage by considering both the tremendous progress that has been made in research on microfinance in the last decade and the huge remaining gaps in knowledge we have. These gaps are critically important because although the industry has grown rapidly (from roughly 14 million clients a decade ago to 150 million clients today) the number of people without access to formal financial services remains in the billions.
One of the key challenges for quality research highlighted by Morduch is the difficulty in getting out of the very powerful popular narrative about microfinance: it “works”; women start small businesses; borrowers work their way out of poverty. If there is one thing we do know, it’s that reality is far more complicated than the narrative.
A non-comprehensive list of the “big questions” that still need to be answered according to Morduch:
1) Does microfinance work? Quite simply we don’t have nearly enough data on “plain-vanilla” impact. In fact, there are only a small handful of methodologically sound studies of impact that exist today.
2) Is microfinance cost-effective? Because of the lack of quality impact studies we still know very little about whether microfinance’s impact justifies the huge volumes of development and philanthropic capital being devoted to it. It’s quite possible that the money could have more impact if it was invested in health or water initiatives for instance.
3) Who benefits from microfinance? Virtually all of the microfinance studies so far look at average impact. But it’s very important to understand if a 20% average improvement in household income means that everyone benefits roughly 20% or that half of the people benefit 40% and half don’t benefit at all. And if there are significant differences in benefits, what are the factors that affect it? How do we more appropriately target the right clients?
4) Why are microbusinesses not growing? One of the undeniably truths about microfinance that is obscured by the marketing narrative is that very very few of the businesses started by borrowers ever grow to employ anyone outside the immediate family of the borrower. This is a problem because if the businesses are not growing, there is a hard ceiling on how much both family income can rise and how much community-level impact can be achieved.
5) Why and how are loans used for consumption? Another piece of the microfinance puzzle obscured by the “women starting their own business” narrative is that a significant volume of loans are not used for business investment but for consumption – which includes paying medical bills and school fees and buying food. We need to know a lot more about how that works so that we can design products that are appropriate for that very legitimate, though decidedly unsexy, use of credit.
6) How do households think about prices, fees and interest rates? There is plenty of controversy in microfinance over the interest rates charged for loans. However, annual interest rates are often a bad way to think about the cost of microcredit for a borrower. Consider for instance that the $2 fee people often pay to withdraw $20 from an ATM is in fact a 200%+ annual percentage rate. Of course people don’t think of it as an interest rate; they think of it as a fee. And because it’s never going to exceed $2, people are willing to pay. The same is true of a lot of seemingly very high interest rate microcredit loans. The loan is for a very short amount of time and so the annual percentage rate is a poor way of thinking about the cost. What we don’t know is how borrowers think about the difference between interest rates and fees – and therefore we don’t know how to design the best products from the client’s perspective.
7) How does the microfinance industry really work? There’s a widespread belief that competition in microfinance is a good thing – it will improve the quality of products and service and drive down interest rates. But we don’t know that this is true. In fact, there is very little evidence from locales where there is competition that interest rates fall materially. Another raging argument is how non-profit/subsidized microfinance affects for-profit microfinance institutions, and vice versa. Proponents of for-profit microfinance argue that subsidized microfinance limits the scalability of for-profit institutions – which would ultimately be good for everyone. Again though, we don’t know whether this contention is true.
8) Are we about to run into significant problems with over-indebtedness and debt traps? A small but vocal group of microfinance critics has been raising this issue for some time. With the intensification of use of microfinance in some locales combined with issues like food and fuel inflation, over-indebtedness could become a big problem for many MFIs and their clients very soon.