nine
Billions Served
Neither a borrower nor a lender be;
For loan oft loses both itself and friend.
And borrowing dulls the edge of husbandry.
This above all: to thine own self be true,
And it must follow, as the night the day,
Thou canst not then be false to any man.
In the last eight chapters, I have examined microfinance from more angles than ever before in one place. I have placed modern microfinance in the flow of history. I have shared the viewpoints of the user at the metaphorical teller window and the manager behind it. I have surveyed the diversity of microfinance and investigated the strongest claims for its virtues: microfinance as abolisher of poverty, enhancer of freedom, and builder of industry. Now I sum up the lessons, ponder what lies ahead, and advise how to influence it.
You know the popular image of microfinance: it was invented by that guy in India who won the Nobel Prize; it gives loans so people can start businesses and lift themselves out of poverty. My job in the first part of this book was to peel back that image and discover a more credible, complex story. Modern microfinance is not merely another foreign-aid fad foisted upon the poor, as a cynic might have it, doomed by its naïveté to fail. If it is a fad, then it is the longest in the history of overseas charity. What explains its persistence is its remarkable success on the market test: poor people are willing to pay for reliable financial services. Microfinance is best seen as arising organically from several sources: the real needs of poor people for tools to manage tumultuous financial lives; a long historical process of experimentation with ways to deliver such tools; the creativity, vision, and commitment of the pioneers, including Muhammad Yunus; and the business imperatives of mass producing small-scale financial services.
The scene having been set, I then delved into the evidence on microfinance's role in development, airing its most serious defenses. I tried, in the words of my colleague Ethan Kapstein, to be critical but not cynical. In tackling these chapters, I realized that I needed to look at the question of impact within several conceptions of “development,” each leading to different questions and types of evidence. In particular, while randomized impact studies have recently and rightly received much attention, they do not tell the full story—no more than a randomized trial of mortgages in the mid-2000s would have told us everything we needed to know about the impact of the mortgage industry.
The lessons from chapters 6–8 distill to these:
—Credible evidence on microfinance's success in development as escape from poverty is scarce. At this writing, essentially two credible studies of microcredit and one of microsavings are in the public domain. The two of credit found no impact on indicators of household welfare, such as income, spending, and school attendance one to two years out. But the celebrated sequence from credit to enterprise is more than a myth. The study of group credit in Hyderabad, India, spotted an increase in profits among the 31 percent of households that already had a business, as well as more business starts among households of relative education and wealth.2 Meanwhile the randomized study of a commitment savings account in Kenya found that this service, too, helped existing business owners invest in their enterprises. Unlike with microcredit, the boost to entrepreneurship showed up as improvements in household welfare.
—The evidence is mixed on whether microcredit in particular spurs development as freedom, strengthening poor people's tenuous control over their circumstances. Financial services inherently—but not automatically—enhance agency. Poor people whose incomes are volatile and who can't work when injured or sick need financial services more than the global rich so they can put aside money in good days and seasons and pull it out in bad. Loans, savings accounts, insurance, even money transfers can help. Researchers who have spent weeks or years with borrowers have collected a range of stories about microcredit's effects. Some women have found liberation by doing financial business in public spaces. Others have been made to sit in meetings until all dues are paid. And even more disturbingly, some have had their cows or chicks or trees taken by peers in order to pay off their debts.3 These contradictions are not hard to understand because credit is both a source of possibilities and a bond. Overall, it is hard to feel sanguine that stories of empowerment are the whole story.
—The success on which microfinance can stake its strongest claim is in industry building. With time, the microfinance industry has increased in size, efficiency, and diversity of offerings, partly because of competition. More institutions are becoming domestic intermediaries, taking deposits from and lending to locals. In few realms can foreign aid and philanthropy point to such success in fostering Schumpeterian development. But this success still leaves scope for critique. The enthusiastic supply of credit for microcredit has distorted the industry, undermining the drive to take savings and spurring unwise lending, even bubbles. Enthusiasm for credit appears inherently destabilizing in competitive markets where microfinance institutions (MFIs) can grow fastest by poaching each other's clients, leading people to take several loans at once, and where no credit bureau gives MFIs the full picture.
Overall the great strength and hope of microfinance lies in building self-sufficient institutions that can give billions of poor people an increment of control over their lives, control they will use to put food on the table more regularly, invest in education, and, yes, start tiny businesses. The least realistic expectation is that it will provide an escape hatch from poverty. We would not expect access to reliable electricity to lift people from poverty, and we should not expect access to reliable financial services to do so, either.
Because poor people are willing to pay for financial services, MFIs can serve many from a modest base of charitable funds. Thus while the benefits appear modest compared to traditionally high expectations, the costs can be modest, too. Rich Rosenberg once recalled his oversight while at the U.S. Agency for International Development of “a few million dollars of donor subsidies in the mid-1990s” for Bolivia's Prodem. Along with its offshoot BancoSol, Prodem held 234,000 credit accounts by the end of 2009 and a remarkable 893,000 savings accounts.4 Rosenberg diagrammed the “value proposition” of microfinance this way:
Small one-time subsidies
leverage large multiples of unsubsidized funds
producing sustainable delivery year after year of highly valued services
that help hundreds of millions of people
keep their consumption stable, finance major expenses, and cope
with shocks
despite incomes that are low, irregular, and unreliable.5
This chapter reflects briefly on why that realistic value proposition was shouldered aside in many minds by an unrealistic one about escape from poverty. Then it sketches ways for the microfinance movement to best realize its real potential to build dynamic industries that bring freedom-enhancing services to billions.
The Effects of Causes
A big idea in chapter 5 is that microfinance as we observe it is the outcome of an evolutionary process. “Natural” selection explains the emphases on credit, groups, and women. The evolutionary perspective also explains a trait little noted in chapter 5: the mythology that promoters have woven around the workaday business of disbursing and collecting loans. Pankaj Jain and Mick Moore called it the “orthodox fallacy”—the idea, for example, that the poor pay back reliably because they all succeed in business.6 Almost no development project has held such strong and multidimensional appeal as microcredit. It appeals to the left with talk of empowering women and the right by insisting on individual responsibility. As the cliché goes, it offers a hand, not a handout. And because the currency of microcredit is currency itself, not textbooks or trainers, supporters feel that the money they contribute goes directly to the poor. To this extent, the intermediary disappears in the mind of the giver, creating a stronger sense of connection to the ultimate recipient. Peer-to-peer lending sites such as Kiva post borrowers' stories and pictures to strengthen this psychological bond.
Just as it hardly matters from the evolutionary point of view whether joint liability was invented or copied in the 1970s, it hardly matters whether microfinance promoters believed the mythology. What matters is that donors and investors who finance microfinance rewarded those who told certain stories, creating a selective environment that favored the promoters best at telling them. That microfinance leaders should accentuate the positive should not surprise. All of us who believe in our work tell the best stories we can to show how we believe we help. Jain and Moore put it well:
We are not suggesting here that the leaders of the big [MFIs] perpetrated some kind of fraud…. The picture is far more complex than that and notions of blame or of individual responsibility are irrelevant to our objective of obtaining practical understanding of why and how [MFIs] have been so successful. Our limited evidence suggests that the orthodox fallacy blossomed and spread in large part because that is what people in aid agencies wanted to hear, thought they had heard, or asked [MFI] leaders to talk about and publicise. To the extent that [MFI] leaders did foster a particular image, this could be seen simply as targeted product promotion in a “market” of aid abundance….
To justify the continuing flow of that money to their own particular organisations and to the microfinance sector as a whole, [MFI] leaders and spokespersons have gradually found themselves, through a combination of circumstances and pressures, purveying a misleading interpretation of the reasons for their success. They emphasise a few elements in a complex organisational system, and are silent on many key components.7
Perhaps the mythologizing of microfinance was historically necessary to build support for the good cause of delivering useful financial services to billions. But in addition to being largely wrong, the mythology has damaged the microfinance movement in several ways. First, it has amplified the emphasis in favor of one service, microcredit, delivered in ways conceived at one time, about three decades ago. Second, the mythology has spread the idea that investing in microcredit, putting poor people in debt on a large scale, is automatically good for them. In 2004, for example, the U.S. Congress acceded to a campaign run by the nonprofit group RESULTS to require that half of all U.S. microfinance aid go to “very poor” people, despite the lack of evidence that the poorest wanted and could safely handle such credit.8 Third, the global acceleration of funding for microcredit since the mid-2000s, effectively predicated on the idea that more is always better, is also a cause of the debacles in India and elsewhere, which now haunt the movement. Last, now that high-quality studies have emerged that contradict the high-flying myth, the public standing of microfinance may dive, like Icarus after he flew too close to the sun. In short, the mythology has brought bubbles and backlash. The question now is whether microfinance will survive its own success.
This book is an attempt to develop a more honest story of microfinance, so that Icarus will neither fly too close to the sun nor brush the waves, and so that the movement will realize its fullest potential to serve poor people. How well it succeeds, along with other efforts to bring realism, depends on how much the supporters of microfinance change their behavior. If people continue to channel billions to the best storytellers, they will continue to distort the very thing they mean to support. But if they recognize how their choices have been part of the problem, then they can become part of the solution.
You Can't Have It All
Economics is sometimes defined as the study of the optimal allocation of scarce resources. Really there is more to it than that—resources are rarely allocated optimally anyway—but the definition is apt in that dismal scientists often think in trade-offs. Rejiggering a factory produces more toasters but fewer microwaves. In chapters 6–8, I reviewed microfinance in light of each of the three notions of success. But that sequential analysis is only an input to a broader synthesis. Having built the evidence base by scoring microfinance against various standards, it is time to think across them. One useful way to do so is with the notion of trade-offs.
Microfinance versus Everything Else
Trade-offs await on two levels: in comparing microfinance to other charitable projects, and in comparing styles of microfinance. On that first, broad level stands the grand question of this book: Does microfinance deserve all that praise and funding? Or should supporters channel their charity and aid elsewhere?
Since there's not much evidence that microfinance lifts people from poverty or even reliably empowers them, it might seem sensible for funders and investors to dump it and move on. But the degree of our ignorance about its effects is not unusual. The impacts of building clinics or training judges or digging wells are also variegated, uncertain, and poorly studied. Thus, limited evidence is not a strong argument against microfinance and for other activities.
I think that financial services for poor people do deserve a place in the world's aid and social investment portfolios, for two reasons. First, microfinance has compiled impressive achievements in building institutions that enhance the freedom of millions and could do the same for billions. These achievements come with the caveats already noted, but because microcredit is generally safe in moderation and encompasses more than microcredit, the caveats are not fatal. Second, a principle of diversification applies: given the uncertainties about the impacts of microfinance or anything else, and given that poor people need many things, it is wise to invest in several strategies at once. That said, I will argue below that from the perspective of delivering appropriate financial services to poor people, microfinance's slice of public aid and private charity—about $3 billion in 2009, as noted in chapter 8—has grown too large. Microfinance would do better on its own terms if less money went into it. To this substantial extent, then, there is no trade-off between microfinance and other kinds of aid. Less money for microcredit and more for bed nets would be a double win.
Microfinance versus Microfinance
Within microfinance, trade-offs are harder to avoid. In the late 1990s, specialists hotly debated the trade-off between taking subsidies in order to serve the poorest and weaning MFIs off subsidies so that they could grow to serve more people, even if that meant bypassing the poorest. Economist Jonathan Morduch called the split between the “poverty” and “sustainability” advocates the “microfinance schism.” Within this breach, however, a seedling of thought grew that questioned the inevitability of the trade-off: businesslike sustainability, the argument went, need not cost much in depth of outreach to the poorest. Bangladesh was Exhibit A. But, true to his training, Morduch doubted that the choices could be dodged so easily.9 With coauthors, for example, he demonstrated that increasing a microcredit interest rate 1 percent (not 1 percentage point) in Dhaka, the capital of Bangladesh, reduced borrowing by slightly more than 1 percent on average. The implication is that even in Bangladesh, cutting subsidies to an MFI might make it more self-sufficient but would also put formal financial services beyond the reach of some poor people.10
The evidence gathered in this book also hints at trade-offs, especially in the short term between development as freedom and development as institution building. Recall the end of chapter 7: “On any given day, in any given place, the immediate business interests of the lender conflict with the agency of the borrower.” MFIs can do credit more easily than savings or insurance, yet credit by nature curtails freedom more. Imposing constraints on borrowers, such as through group meetings and weekly payments, protects an MFI's bottom line. Higher interest rates may boost the profitability of MFIs and the dynamism of the industry—and flirt with “usury.” Inversely, layering non-financial services on top of financial ones may enhance women's agency but also requires subsidies.
If it is easy to point out choices, it is harder to make them. The advantages and disadvantages of building subsidy into microfinance, such as through low-interest loans from social investors, vary over time and space according to formulas that can only be vaguely estimated. Even if we knew exact consequences, ethical imponderables would arise. How are we to weigh cheaper services for a smaller group against more expensive services to a larger group?
In the face of such unknowns and imponderables, I suggest two principles of judgment. First, a project is mostly likely to achieve its potential when it follows its natural constructive tendencies. If your daughter were a piano prodigy, you would get her piano lessons. But note the emphasis on “constructive”: you would probably not nurture her tendency to sociopathy. By this principle, microfinance is likely to do the most good when it plays to its strength: turning modest amounts of aid into substantial industries that provide reliable services. Among charitable projects, microfinance is in this respect truly prodigious.
In contrast, aid for microfinance does not stand head and shoulders above the rest in reaching the poorest, let alone lifting them out of poverty. The (limited) evidence suggests the contrary, that microcredit is more likely to help those who already have businesses or who, because they are better off to start with, can start a business more easily. With respect to Morduch's “schism,” I therefore favor those who seek to do microfinance in a self-financing, businesslike way in order to responsibly maximize reach. This may sometimes mean making choices that reduce the freedom of clients, such as lending to the poorest through groups rather than individually. However, the history of microfinance, short as it is, includes many examples of businesslike MFIs evolving their products to increase freedom, such as in moving to savings.
And that leads to the second principle of judgment: don't give up hope on dodging trade-offs. The dictatorship of hard choices is only absolute if MFIs are squeezing every possible ounce of productivity from the capital and labor they consume and technology is static. But perfectly efficient firms reside only in textbooks, and technology is always improving. Thus the choices in microfinance today are not entirely dismal. The chief opportunity spied by some of the sharpest observers today, including the Bill & Melinda Gates Foundation, is in taking savings, perhaps especially through high technology (see below).
Too Much Credit for Microcredit
The financial innovations channeling billions into microfinance are marvels. Yet because the ample and cheap finance feeds mostly into microcredit portfolios, it has at least two downsides. It dulls the initiative to take savings as an alternative source of funds. And it encourages microfinance organizations to grow faster than they can safely manage—indeed, drives them to do so, because of the way competition favors the most aggressive players in the short run. Fast microcredit growth is not always bad.11 But if there is some maximum amount of microcredit that a populace can sustainably absorb, the faster that line is crossed, the worse. Recognizing these risks while accepting that credit for microcredit has its place forces hard practical questions. How should investors collectively define and enforce Aristotle's golden mean? If they can define it in some way, can they legislate it in practice, divvying up the limited investment pie among themselves? Or if moderation cannot be enforced, would the next-best option be to browbeat certain classes of investors into withdrawing altogether?
Drawing the line to minimize either side effect of excessive lending to MFIs is inherently arbitrary at the margin. As for the concern about undermining the incentive to take savings, most MFIs cannot and should not emulate the purity of Bank Rakyat Indonesia (BRI) circa 1990, which as a century-old government-owned bank was stout enough to resist the World Bank's offers of credit. Even mature MFIs should diversify across funding sources because each source has its costs and risks. Accepting that borrowing by MFIs is reasonable in principle, it is hard to pinpoint the right amount. Perhaps it should go more to young MFIs, then taper as they grow. But according to what formula?
As for the second concern about ample finance—that it will cause dangerous credit expansion, even bubbles—drawing lines is notoriously difficult here, too. Bubbles are certain only in retrospect. To ground my thinking about this challenge, my research assistant Paolo Abarcar and I set out to answer an impertinent question about the microcredit bubbles that popped in 2008–09 (see chapter 8): Who inflated them? We combed through the annual reports of the largest MFIs in four relevant countries.12 In Bosnia, Nicaragua, and Pakistan, it turned out, foreigners supplied most of the $1.46 billion in credit for the bubbles. And most of that money seems to have come from loans that were made or guaranteed by public agencies. (In the latter case, private entities make the loans, but public ones assume some or all of the risk of default.) Number one in Bosnia was the European Fund for Southeast Europe, a conduit for European government donors. In Pakistan, the top lender was the Asian Development Bank, followed by the Pakistan Poverty Alleviation Fund, which passed through credit from the World Bank. Some big lenders were private companies that manage funds from both public and private investors. BlueOrchard, for example, was number one in Nicaragua and number two in Bosnia (see table 9-1).
One important message from these tallies has to do with their novelty. Laboring to answer the question of who inflated the bubbles, I realized: almost no one knew. The data summed here were incomplete, uncertain in some respects and, at one to two years of age when gathered, out of date next to the tempo of hypergrowth. But they were the best that were publicly available. In the years before the bubbles burst, hardly any investor saw the big picture because hardly any had tried. Perhaps key people at BlueOrchard and other intermediaries understood the situation. If so, they seem not to have advertised it heavily.
A Credit Bureau on Investment in MFIs
This story should sound familiar: A set of borrowers, microcreditors in this case, are taking loans from many sources. Total borrowing is expanding rapidly. No one is tracking all this activity, much less whether the borrowers can reasonably be expected to handle all the debts they have contracted. And the easy credit is hiding the very problems it creates, since unpayable loans are quickly refinanced with new ones. In other words, the cross-country microcredit financing scene resembles the within-country microcredit market in some places, with untracked multiple borrowing creating the risk of overborrowing. In the mid-1990s, Alex Silva struggled to raise a few million dollars for the first microfinance investment vehicle, ProFund (see chapter 8). Now microfinance investment managers are struggling to place the funds they have on hand.
One response within the microfinance world to the excesses of lending has been to attack the manifestations. The Smart Campaign, a joint project of CGAP and Acción International's Center for Financial Inclusion, has signed up more than 600 MFIs to endorse six principles of responsible lending: avoidance of overindebtedness; transparent and responsible pricing; non-coercive collection practices; proper staff behavior; mechanisms for redress of grievances; and privacy of client data.13 The organizers well understand that fine words do little in themselves. But they can help change the culture, for example by giving social investors a benchmark against which they can hold MFIs accountable.
Table 9-1. Top Five Creditor/Guarantors to Top Five Microfinance Institutions with Data, Four Countries with Microcredit Crises
Source: David Roodman, “Who Inflated the Microcredit Bubbles?” Microfinance Open Book Blog, March 27, 2010 (j.mp/9bRASO).
a. “Mixed” institutions are privately run conduits for mixes of public and private money.
Unfortunately, the history of financial manias teaches us that a heavy tide of capital will overtop or sweep away all but the sturdiest embankments. In the United States, the trillion-dollar buildup to the crisis of 2008 tossed aside ratings agencies and central bankers—supposed agents of restraint—like so much flotsam. Only jurisdictions with the firmest regulatory restraints on lending, such as North Dakota and Canada, held back the tide. The Smart Campaign and other such efforts, while constructive, are not powerful enough to stop the problem of overeager lending. Something else is needed to attack the problem closer to its source: a campaign aimed directly at credit for microcredit, with the goal of restraining it.
What should be the demands of such a campaign? How should moderation be defined and enforced? Within nations, one corrective for overeager lending is the credit bureau. By analogy, investors in microcredit at least need to establish ways to share information at high frequency, such as quarterly, on the financial obligations of MFIs in which they invest. This could happen informally. A credit bureau with information on microcreditors could publish high-frequency data on investment flows into MFIs and lending flows out of them, aggregated where necessary to protect the confidentiality of individual deals. The body could develop indicators of individual, regional, and national lending growth. Based on soft standards analogous to the rule of thumb that mortgage payments should not exceed a third of income, it could issue warnings of various severity levels. (Think of yellow and red traffic lights.) These external reference points would help microfinance investment managers resist higher-ups, politicians, customers, and citizens who are eager for them to pour more money into microcredit. The body also could gather data relevant to when credit for microcredit undermines the initiative to enter the savings business. It could analyze whether a given MFI realistically could obtain permission to take savings, study the cost of taking savings, and compare that cost to that of external capital in order to gauge the distortion from cheap credit.14
Like ordinary credit bureaus, such a centralized brain for the microcredit investment business would reduce but not eliminate problems. The toughest problem might be imposing the restraint implied by a serious commitment to savings: would microfinance investors support a body that advised them to slash their operations, to stop picking the plum MFIs? They might if they saw it as essential to the industry's survival.
Public versus Private Investment
An alternative to regulating the sizes of the flows is to regulate who can emit them, favoring those more apt to act with care. In a 2007 report called Role Reversal, Damian von Stauffenberg, founder of the first microfinance ratings firm, MicroRate, and industry consultant Julie Abrams argued that public investors ought to exit MFIs when private ones enter. The job of public investors (which they call international financial institutions, or IFIs) is to “go where the private sector does not yet dare to tread; to assume risks that private capital would find unacceptable.” Yet that's often not what has happened. Table 9-1 shows that substantial amounts of public and private money entered Bosnia and Herzegovina, Morocco, and Nicaragua. To explain why, von Stauffenberg and Abrams pointed to the incentives at work in public agencies that favor disbursement for its own sake:
Whether top decision-makers are aware of it or not, there are powerful incentives for IFIs to maximize their microfinance exposure, and to do so by concentrating on the largest and safest borrowers. Microfinance has acquired such a positive image, that a sizeable exposure in this sector has become a sign of an IFI's commitment to development. This is reinforced by an IFI's need to disburse its microfinance budget each year. Since IFIs are not primarily profit-driven, their success is often defined by the amounts that have been lent. If a budget has been allocated to microfinance, that budget must be spent—and spending it on a few large loans to top MFIs is far quicker, cheaper, and less risky than lending to, and nurturing immature institutions.15
On its face, the rule that public investors should exit when private investors enter is blunt and has a fuzzy rationale. It is not obvious why private social investors pursuing that “positive image” should behave more constructively than public social investors doing so. Private investment funds also feel pressure to get money out the door and associate with success; many of them are not primarily profit-driven.
But conversations with industry insiders have persuaded me that the public–private distinction has teeth. The nub of the matter is that most private investors are small specialists. Bad calls can permanently damage their reputations. Such mortal risk focuses the corporate mind. As private companies with staffs numbering in the dozens rather than thousands, they are much less rule-bound, more agile. In contrast, major public investors such as the International Finance Corporation (IFC) are muscle-bound generalists. After the recent crises, the private investors seemed quicker to recognize and respond to troubles than the public investors; they even gently discouraged prospective investors in their funds. By contrast, in the last, dark days of 2008, when global financial Armageddon seemed nigh, the IFC and Germany's KfW joined forces to announce the Microfinance Liquidity Facility. It was meant to prevent a sudden scarcity of capital from choking sound microlenders. It would inject up to $500 million into MFIs via leading fund managers such as BlueOrchard and responsAbility. Although it was a smart, swift, and bold proposal, it took five months for the first of the money to trickle out and another four before operations were in full swing. By the time the money fully arrived, in September 2010, private microfinance fund managers were struggling with a surplus rather than a deficit. Despite the excess of liquidity, the facility created more of it, disbursing $76 million over the rest of 2010.16
Given the dangers of surfeit and the continuing dominance of public investors, curtailing the flow of public money into microcredit portfolios would probably make the world a better place. It is a practical proposal: a relatively small group of actors, including heads of development banks and parliamentarians holding the purse strings, could make it happen.
If the microcredit investment industry cannot be run in a way that minimizes harm to the goals of responsible lending, safe deposit-taking, and healthy institutional growth, it probably should be shut down altogether, save for a catalytic role in developing new MFIs through seed capital and training grants. Because of the dangers of aggressive lending, too little direct financing of microcredit portfolios is better than too much. A fundamental problem is that the evidence of microcredit's overall impact on poverty and freedom is ambiguous. If it is this hard to assure that such investment does more good than harm, the movement may be barking up the wrong tree. Helping microfinance play to its strength, building lasting institutions, calls for less investment, not more.
Deliberately Seeking Savings
The lives of the poor are full of risk. Their incomes fluctuate sporadically by day and season. They are more prone to injury and illness, yet more dependent on physical health for their livelihoods than wealthy people. If poor people's chief financial problem is managing unpredictability, then seemingly insurance is the financial service they need most. Certainly, exploratory efforts to insure the poor should be supported, and successes should be applauded. Going by the history of today's rich countries, life insurance is the most promising avenue for takeoff. The prospects are perhaps best in South Asia where, just as with microcredit, skilled staff are cheapest relative to the incomes of those to be served. However, as we saw in chapters 4 and 5, insurance is inherently more complex than credit and savings, which cuts against the microfinance industry's imperative to streamline. On balance, microinsurance for the billions appears a less practical ideal than microsavings for the billions.
Savings is a conceptually simpler service, with much going for it. Shifting toward savings and away from credit should help microfinance perform better on all three of the senses of success considered in this book. Experience and common sense say that the poorest are more willing to save than to shoulder the risk of credit. Meanwhile, as we saw in chapter 2, savings can do almost anything credit can. People can save to start a business, pay tuition, finance a funeral. And like insurance, it can buffer families against financial shocks. It lacks the leverage of insurance—a dollar a year in premiums can instantly buy $100 in life insurance, but a dollar a year in savings only adds a dollar a year to shock absorption capacity. Yet savings has the advantage of accessibility in the case of any misfortune, not just certain insurable ones.
To achieve its full potential, savings needs to be offered in a variety of forms, perhaps including ones that haven't been invented yet. In principle, accounts can be completely liquid, for maximum flexibility, though in practice these are costly to administer. Commitment savings better approximate the discipline and rhythmic efficiency of loans. Exploration beyond those standard product types deserves the same energy historically poured into elaborating and refining microcredit. An interesting credit-savings hybrid is Stuart Rutherford's “P9,” which he is piloting through SafeSave's rural sister in Bangladesh, Shohoz Shonchoy. It is designed to eliminate two barriers to saving: lack of discipline and lack of periodic lump sums of income, such as paychecks, from which to set aside money. At the same time, it strives for flexibility. A customer starts with a zero-interest loan of 2,000 taka ($28), of which the bank disburses just two-thirds, putting the rest in a zero-interest savings account; the loan becomes the lump sum from which to save. Despite having received less than 2,000 taka, the customer pays back that much so that she ends up with a net savings balance. She repays on a schedule of her choosing. She then repeats with optionally larger amounts, so that after a typical seven cycles, her savings exceed her loan balance. Once she reaches 20,000 taka in savings, she can withdraw it all, continue to “borrow to save,” or just save conventionally, now with interest.17
One big responsibility is assuring the safety of deposits. Informal, small-group savings arrangements meet the responsibility through witness. In a Village Savings and Loan Association of thirty women, as described in chapter 4, every member can watch as the three key holders secure the group's lock box. But when clients are too numerous for direct witness, government supervisors are usually needed. It sounds like a simple step, but when an external body assumes responsibility for the safety of savings at an MFI, it causes a massive departure from credit-only microfinance. Regulators and supervisors take an interest not only in the savings side of the operation but the previously ignorable credit side, too, since the lending puts the deposits at risk. Overseers must devise and enforce formulas to govern MFI behavior. One such formula is the “capital adequacy ratio”—for example, a ratio of 10 percent means that for every $10 in outstanding microloans, the MFI must have at least $1 on hand in its own cash or some other ultra safe form ready to absorb losses on the loan portfolio and protect deposits. The government also may regulate the lending in order to assure that it is aboveboard and prudent, for example by requiring that the banks keep files with specified documentation on each borrower. They may impose constraints on the ownership and board composition of the MFI to prevent crony capitalism and assure that if the MFI needs to call in more capital, owners will have deep enough pockets to comply.18
This is the stuff of conventional banking regulation. Bringing it to microfinance requires surmounting several challenges. One is that enforcing and complying with all these rules costs the MFIs and the government money. As noted in chapter 8, for MFIs, collecting the required documentation and filing the required reports drives up the cost of taking savings. In an authoritative review of regulatory issues in microfinance, Rosenberg and colleagues write that it is not unusual for compliance to cost 5 percent of assets in the first year and 1 percent or more per year thereafter. Likewise, especially in poor countries where government agencies are chronically underfunded, supervisors may lack the staff to monitor all of a country's MFIs and other deposit-taking institutions. And because most MFIs are too small to undermine confidence in the banking system generally, MFIs are a low priority. Recognizing such limits, the authors point to a trade-off: only allow a few MFIs to take savings, or allow more to do so, bringing financial services to more people, but with little or no supervision. However supervisors make this trade-off, they should take care not to overestimate their own capacity to effectively oversee the MFIs they license, and they should require any unsupervised MFIs to inform customers that no guardian angel is watching.19
Recent events in Nigeria show what can happen when supervisors overreach. In 2007–08, the central bank defined a new type of financial institution, the Microfinance Bank, and issued an absurd 800 licenses to start them. The banks could do both savings and loans. The unit assigned to supervise them was woefully understaffed. The result was unsurprising: 800 little institutions taking depositors' and investors' money; growing fast, making sloppy loans; paying rich salaries to top officials; and running up records of fraud, default, bank runs, and failure. At this writing, the central bank has revoked more than 100 licenses.20
The other challenge in keeping savings safe is adapting conventional regulation to microfinance. Although poor savers deserve the same protections as rich ones when it comes to capital adequacy, the job of setting guidelines is easily botched. Some traditional rules can undermine the microcredit approach, for example by requiring all loans to be backed by collateral or viewing a nonprofit MFI that would own the majority of its for-profit offspring as a crony capitalist.21
Chapter 8 laid out the argument for young MFIs to start with credit, then branch into savings. This path is not the only one available. Among the exemplars of microsavings, the largest and smallest, BRI's unit desa system in Indonesia and Rutherford's SafeSave in Bangladesh, took savings from the start and so far have rewarded their clients' trust. Many of ProCredit's banks took savings from birth or moved into it quickly, exploiting the financial muscle of their parent organization. But accepting the credit-then-savings path as reasonable, it follows that at any given time not every MFI should be expected to do microsavings.
And just as not all MFIs are suited for savings, not every organization that does microsavings needs to be an MFI. Institutions of different form, with a comparative advantage in reliability, can also do the job: Village Savings and Loan Associations; credit cooperatives and their more formal and regulated cousins, credit unions; and established savings banks, public and private. If the end is the expansion of microsavings, promoters and regulators should be ecumenical about the means.
Along with keeping savings safe, a primary task in making microsavings work is controlling cost. A study by the Inter-American Development Bank of MFIs in Latin America found that for microsavings accounts, defined as those under $100, holding $1 in deposits cost an astonishing $2 per year, mainly in bank tellers' time handling tiny deposits and withdrawals. Clearly the economics of banking impose limits on how small the accounts and how poor the people that can be offered savings accounts. Happily, the situation is not as bleak as this statistic suggests. Just as microcredit is expensive in Latin America (partly because of the high cost of employees relative to loan sizes), so should we expect microsavings to be. The economics are probably better elsewhere. Meanwhile, despite the high costs, the Latin MFIs maintained many of these costly, small accounts, and for reasons: a sense of mission to serve the poor; an expectation that many balances would rise over time; and the use of the savings relationship as a platform to sell insurance, money transfers, and credit.22 Although the economics are probably better elsewhere, cost remains an impediment. The great hope for reducing it lies in modern technologies, such as mobile phones and smart cards.
The Technological Frontier
For economists, the flavors of microcredit that started the microfinance revolution—solidarity and village banking, individual microcredit—are technological advances. Although they were low-tech in the everyday sense of the word, in context, they were fresh ways to extract more value from a given amount of labor and capital, providing services at a lower price than previously possible. Since those days, circa 1980, microfinance has not changed so much as a retail product. SKS in India does group microcredit much as Muhammad Yunus and his students invented it, albeit with a computerized back office. Compartamos in Mexico does village banking more or less as John Hatch and FINCA refined it. But new, high-tech ways of connecting people and transmitting information may bring a second revolution to the movement.
People often use new technologies first as slot-in replacements for their predecessors. The desktop computer began in many offices as just a fancy typewriter, a new machine for preparing printed documents. It takes a while for societies to discover wholly new uses, such as e-mail, that make the initial uses seem quaint. In the microfinance world, an early response to advances in communications and computing was to use them to make standard models more efficient, such as by keeping records at group meetings with Palm Pilots.
But the future of microfinance appears to differ radically from its past. In the mid-2000s, Brazil used satellite links and barcode readers to extend its banking system to all of the country's 5,561 municipalities, including 2,300 that had never been banked before. Post offices and corner stores now operate as “banking correspondents,” agents who can handle transactions on behalf of regular banks far away. They handle the conversion between paper and electronic money, so that customers can, for instance, arrive with cash and make a water bill payment that is transmitted electronically to the utility. The system has handled trillions of dollars in payments.23 In South Africa and Namibia, a company called Net1 delivers government welfare payments to nearly 4 million people by charging their smart cards. Cardholders can convert balances to cash at any store with the appropriate point-of-sale card reader. The cards look like ordinary credit cards, and the machines that read them look like ordinary card readers. But inside, the technology is more advanced: The cards and readers are designed to operate in decentralized fashion to accommodate unreliable power and communications infrastructure. They contain chips that store encrypted transaction histories of their owners and the owners of other cards or readers that they have recently touched, allowing them to pass around and back up securely encoded transaction histories like ants passing chemical signals. When the readers do connect by phone to central computers, they synchronize everything they have. And because the cards are computers, they can provide extra services when passed through readers, such as extending a loan on the fly, based on on-card data about the cardholder's history of welfare payments and servicing of past loans.24
The greatest potential for technological revolution in microfinance comes from one stupendous fact: some 5.3 billion people now tote mobile phones.25 Access to connectivity is converging to universality. Put otherwise, there are now 5.3 billion people with globally networked computers in their pockets. What can they do with those besides talk and text? Access financial services, for one.
In fact, a phone company created one of the most successful financial services for poor people yet. Called M-PESA, the phone-based money transfer system was launched in 2007 by Kenya's Safaricom with the help of a £1 million challenge grant from the U.K. Department for International Development. Although the service was born out of the microcredit movement, in pilot tests ordinary Kenyans began doing something other than credit transactions with it: sending money to each other. As Safaricom developed the system, it realized that the “killer app” for M-PESA was not patching a 1990s communications technology onto a 1970s financial technology, but sending money home. In Kenya, many rural families send a husband or son to Nairobi to work and support the family from afar. Before M-PESA, physical transport of cash was costly and dangerous. One could spend a day or so taking cash home oneself and get robbed on the way. One could pay informal money carriers, again risking theft as well as fraud.26 M-PESA offered a radically safer, more reliable way to send money over long distances. In just three and a half years, M-PESA reached some 13 million, or 60 percent, of Kenyan adults.27 It handles more transactions than Western Union.28
The first thing Kenyans usually want to do when they receive electronic money is cash it. This they do by visiting any of the 23,000 M-PESA shops scattered among the markets, slums, and villages, which like Western Union storefronts convert between the old and new forms of money for a fee.29 The shops are franchise businesses, operated by entrepreneurs in agreement with Safaricom. Almost all the shops I visited during a trip in 2010 were run by women. For these business people, providing the on-demand conversion between paper and electronic money takes work and involves risk. They must staff their shops, project demand for cash, keep enough on hand, and transport it between the shops and the bank at the risk of robbery. In return, these entrepreneurs keep 70–80 percent of the commissions, the rest going to Safaricom.30 As that split suggests, the M-PESA shopkeepers are the muscle and bones of M-PESA.
The phone-based electronic interface is the skin: it holds the system together. Understanding how gets to the core departure from traditional microcredit. For one, the phones allow the managers behind M-PESA to monitor transactions in real time and anticipate cash demand efficiently.31 As well, the phones make M-PESA's e-money seem real and trustworthy. The instant a customer deposits cash into his phone account, Safaricom verifies his new balance with a text message, which stays in his phone's memory. More generally, the phones let customers hold Safaricom and its agents accountable for promises of service to a degree impossible in informal ways of sending money. When someone sends money home, both he and the recipient get text messages, which prove that Safaricom representatives are obliged to surrender the funds to the recipient upon request.
That accountability in turn allows the delegation and professionalization of cash transport. Before M-PESA, village women might have gone individually, by foot or by bus, to the nearest market town to pick up cash sent home by husbands. Now an M-PESA agent can do it for all of them, all at once, saving time.32 When I visited Kenya, my fellow travelers and I were taken to the market at the crossroads in the town of Holo, not far from Lake Victoria. Before M-PESA, we were told, people trekked 25 miles by foot or bus to Kisumu, on the shores of the lake, to get their cash—and spent much of it in the market there. Now the cash comes to them through M-PESA, and they spend it locally. And so the Holo market is bustling.33 Access to the new mobile money technology has increased access to the old mobile money technology, cash.
M-PESA shows how information technology can create new efficiencies and empower clients. It brings a more conventional banking experience to a poorer clientele, offering an alternative to the power relationships of traditional microcredit, in which bank employees lean on clients to lean on each other and the ultimate sanction is the loss of future access to loans. With mobile-phone based payments, the relationship is less credit centered, thus more freeing. In contrast with a microloan, which can be viewed as a locked-in sequence of transactions, each small mobile transaction stands on its own, with fees measured in pennies. Such tariffs give clients complete control over the flow of payments in and out while guaranteeing the provider a profit at each step. Ignacio Mas, who jumped from the world's largest mobile phone company, Vodafone, to the world's largest philanthropy, the Bill & Melinda Gates Foundation, explains that charging by the transaction “is analogous to prepaid airtime for mobile operators: a card bought is profit booked.”34
I suspect that we are on the cusp of a technological revolution in microfinance. Mobile payments look to me like a kind of infrastructure, like electricity supply and the Internet. Technology connects people in a radically new way and creates possibilities that will take years for human ingenuity to discover. It will disrupt every field that it touches. The week I was in Kenya, Safaricom launched a partnership with Kenya's dominant MFI, Equity Bank. With a few key presses, M-PESA users can now move electronic money into an Equity savings account that pays interest. They can apply to get automatic loans too, just as with Net1's system. And they can buy personal accident insurance.35
Overall, as seen in Brazil and Kenya, technology is rearranging the economics of banking the poor, centralizing core banking functions while decentralizing the interface to the customer. The new approach splits retail from wholesale while linking via wires and radio signals. The retailers are local shopkeepers who provide the interface between paper and electronic money. They substitute for the loan officers of traditional MFIs, but they do not hold clients' money. That job is performed by regulated institutions behind the scenes. Recall how one major impediment to safe savings is the limited capacity of governments to supervise banks. Communications technology is accommodating this limitation in a new way, making it more economical to link the poor directly to traditional, supervised banks. The digital interface of a card or a phone doesn't make the human interface obsolete; rather, as with M-PESA, it provides a new way to delegate customer service to people who can do it more cheaply than brick-and-mortar banks can do.
Coming Full Circle
I began this book with two opposing stories. One was about Murshida, who climbed out of poverty on a ladder of microcredit. The other was about Razia, who slipped down a rung after taking loans. I did so to expose how storytelling forms the public image of microfinance and to make the case for serious research that tests such stories. Good research brings us as close as we can come to the truth about something as diverse as the microfinance experiences of 150 million people.
Though I have examined services other than credit and notions of success other than escape from poverty, there is no denying that the grain of sand that seeded the imperfect pearl of this book is the common belief that microcredit cuts poverty. As a child of bitterly divorced parents, it goes against my grain to choose sides. I see the world in grays. While I cannot dismiss traditional microcredit as pure hype, I also cannot defend direct investment in microlending as a great way for aid agencies, philanthropists, and social investors to help poor people. Microcredit is one thing; outsiders financing microcredit portfolios in bulk is another. Consider:
—While microcredit gives people a new option to manage their complex and unpredictable financial lives and helps some build businesses, it also leaves some worse off and has a potentially addictive character. On the creditor side, it often pays to keep lending to clients in a continual cycle. On the borrower side, the need to pay off one loan often leads people to take out another. Overlending and overborrowing become more likely as creditors multiply and compete, often by lending to the same clients.
—Although good studies show microsavings and microcredit stimulating microenterprise, those on microcredit so far have found no impact on poverty.
—Qualitative studies by people who immersed themselves in a village for a month or year corroborate this ambivalence. Some women find liberation in doing financial business in public. Others find entrapment in the intertwining debt obligations and peer pressures.
—Enthusiastic flows of money into lending are inherently dangerous. They can reward overly rapid lending and, in competitive markets, nearly force it through a vicious cycle in which each lender strives to keep up with its peers. The microfinance movement has compiled a rather long list of disasters in recent years: Bosnia, India, Morocco, Nicaragua, Nigeria, Pakistan. Probably none will be fatal, but together they point to a deep problem of instability.
Credit is undoubtedly useful in moderation as a way for people to discipline themselves into setting aside money for big purchases. It becomes dangerous when it is pushed too hard. Thus, the mythology that has grown up around microfinance is not just deceptive but destructive.
How much support for microcredit is too much? Incomplete evidence cannot support a certain answer. But choices today must be made on the evidence available today. To the practical question of whether social investors ought to keep pouring billions of dollars per year into microcredit, I say no. Seed money for pilots and start-up MFIs is one thing; large-scale, submarket financing of microcredit portfolios is another.
The long-term goal should be to create balanced, self-sufficient institutions that offer credit in moderation, help people save and move money safely, and push the envelope of practicality on insurance. If these goals can also be achieved through institutional forms less associated with traditional microcredit, such as commercial banks and phone companies, that should be encouraged. While such paths may superficially contradict the credit-centered mythology advanced by some of the founders of modern microfinance, it is the truest realization of their vision: building businesses that serve the bottom of the pyramid, giving billions of people more leverage over their difficult financial circumstances.
Nimble social investors have helped build such institutions with money and advice, and they can do so again. Indeed, the history of microfinance reviewed in chapter 4 shows that small amounts of intelligently placed aid were invaluable to the microfinance movement. The Ford Foundation and the U.N. International Fund for Agricultural Development gave crucial early support to the Grameen Project. The U.S. Agency for International Development worked behind the scenes in Indonesia and Bolivia, as did Germany's Gesellschaft für Technische Zusammenarbeit in India, on the self-help group program. The United Kingdom's aid department made a tiny but timely challenge grant to launch the M-PESA pilot. The focus for outsiders should be making such critical, opportunistic investments, in the failure-accepting spirit of venture capital. It should not be building giant machines for indebting the poor.
At the end of day, I cannot dismiss Razia's story as immaterial to the morality of favoring credit. Nor can I dismiss the story of Eva Yanet Hernández Caballero, whom Compartamos featured on its website until her knitting business unraveled and she began missing payments on loans with triple-digit interest rates.36 I cannot dismiss chapter 7's story of Jahanara, the microcredit borrower and moneylender who boasted “that she had broken many houses when members could not pay.”37 I cannot dismiss the story of families in Andhra Pradesh who lost wives or husbands, mothers or fathers, to suicide after they fell into debt—debt that included microcredit.38
But neither can I dismiss the manifest hunger of poor people for reliable tools to manage their money, nor the extraordinary success of some microfinance institutions in creating and serving this market. The best way forward is to celebrate what is good in this achievement and build on it.
Better banking will no more abolish poverty than better clinics or schools ever have. By and large, what ends poverty is not the direct delivery of services to poor people but industrialization, in all its disruptiveness. Over the last third of a century, judicious support from donors and social investors for microfinance has contributed to such economic transformation in a small but respectable way, catalyzing innovations, institutions, and industries, and reaching millions. Over the next third of a century, donors and investors can go much farther. They can help build a global industry to give billions of poor people the tools they need to manage their wealth.
1. G. Blakemore, ed. 1974. The Riverside Shakespeare (Boston: Houghton Mifflin). “Husbandry” might be “economy” in modern English.
2. Banerjee and others (2009), 17.
3. Rutherford (2004), 30; Karim (2008), 19.
4. MIX Market, “Number of depositors and active borrowers, mature Bolivian MFIs, 2009,” custom report (j.mp/qK7kFj [September 19, 2011]).
5. Rosenberg (2010), 5.
6. Jain and Moore (2003), 28.
7. Jain and Moore (2003), 28–29.
8. The law defines “very poor” as living on less than $1,000 per annum in Europe and Eurasia in 1995 dollars, under $400 in Latin America, and under $300 elsewhere. Microenterprise Results and Accountability Act of 2004, Public Law No. 108–484, §252(c).
9 . Morduch (2000).
10. Dehejia, Montgomery, and Morduch (2009).
11. Gonzalez (2010b).
12. Where one institution had guaranteed another's loan—promising to pay it if the borrowing MFI did not—we attributed the amount to the guarantor. The U.S. government's Overseas Private Investment Corporation is an example of a guarantor.
13. Smart Campaign, “Campaign Mission & Goals” (j.mp/oYQ0dY [September 2, 2011]).
14. Liliana Rojas-Suarez, senior fellow, Center for Global Development, Washington, D.C., conversation with author, April 30, 2010.
15. Abrams and von Stauffenberg (2007), 1.
16. Microfinance Enhancement Facility (2011); Martin Holtmann, head, Microfinance Group, Global Financial Markets Department, International Finance Corporation, Washington, D.C., interview with author, May 5, 2011. Interpretation of the facts is the author's.
17. Stuart Rutherford, “Product Rules” (j.mp/epwJlh [April 24, 2010]).
18. Christen, Lyman, and Rosenberg (2003).
19. Christen, Lyman, and Rosenberg (2003), 19, 28.
20. Rozas (2011), 16–17; Central Bank of Nigeria, “CBN Grants Provisional Approval for New Licenses to 121 MFBs,” press release, October 21, 2010 (j.mp/lMNDP7).
21. Christen, Lyman, and Rosenberg (2003).
22. Maisch, Soria, and Westley (2006).
23. Gallagher (2006).
24. Schwarzbach (2006).
25. ITU (2011).
26. Hughes and Lonie (2007).
27. Jack and Suri (2011), 4.
28. Mas and Radcliffe (2010).
29. Jack and Suri (2011), 4.
30. Eijkman, Kendall, and Mas (2010), 3.
31. For more on the management structure behind M-PESA, see David Roodman, “Make New Media of Exchange, but Keep the Old,” Microfinance Open Book Blog, May 26, 2010 (j.mp/c3tbXx).
32. Eijkman, Kendall, and Mas (2010).
33. Frederik Eijkman, cofounder, PEP Intermedius, Kisumu, Kenya, conversation with author, May 18, 2010.
34. Mas (2009), 57.
35. Ignacio Mas, “M-KESHO in Kenya: A New Step for M-PESA and Mobile Banking,” Financial Access Initiative blog, May 27, 2010 (j.mp/je9Pse).
36. Keith Epstein and Geri Smith, “Compartamos: From Nonprofit to Profit,” BusinessWeek, December 13, 2007.
37. Karim (2008), 23.
38. For example, see Soutik Biswas, “India's Micro-finance Suicide Epidemic,” BBC News, December 16, 2010 (j.mp/hq6S8U); Yoolim Lee and Ruth David, “Suicides in India Revealing How Men Made a Mess of Microcredit,” Bloomberg Markets Magazine, December 28, 2010.