Microfinance: taking a step back

Like other developing countries, Pakistan is deploying microfinance as a way of lifting people out of poverty. The basic assumption is that poor people lack access to affordable capital and once credit is streamlined they can build micro enterprises and lift themselves out of poverty.

However, apart from anecdotal case studies, there is no conclusive evidence about the impact of microfinance on poverty alleviation. Furthermore, some studies suggest that microfinance certainly does help the poor but not necessarily through building up their enterprises.

According to the Consultative Group to Assist the Poor (CGAP) most of the poor use micro loans as a reliable instrument to smoothen their consumption or when in need of a large amount of cash. The most worrisome fact for the poorest of the poor is their income volatility.

The recent estimates released by Pakistan Microfinance Network suggest that the country’s potential micro finance market is about 27.4 million borrowers, whereas microfinance currently reaches around 1.8 million people. However the more interesting statistic from Pakistan is that microfinance savers have surpassed microfinance borrowers by a comfortable margin, as the former category includes around 2.14 million accounts.

Does this mean that, amongst the poor, the savers outnumber entrepreneurs investing money in their business? The CGAP study seems to lend credence to this paradoxical finding. As it is dubious to claim that the poor people have earned their savings through their micro enterprises, this finding only points in one direction. The poor have deposited their own savings into the system, aiding its operation – although it has always relied on external support. It also suggests that the micro savers would necessarily be different from micro borrowers, which is supported by the fact that only one out of seven saving accounts are mobilised through microfinance institutions – the rest are managed through conventional banks.

It is claimed that the default rate of the microfinance borrowers is very low – around 2.5% worldwide – a statistic which is used to argue that poor people are reliable in repaying their loans. Evidence from Pakistan’s experience, available to the author during his research, does not refute this number but suggests a painful explanation. Most of the microfinance borrowers do not repay money on time from business profits – they repay it by borrowing from another source – which could well be another microfinance institution. Thus the reported default rate actually conceals the dynamics of micro businesses and creates a potential hazard. Unfortunately, the CGAP study also points in a similar direction – poor people find the micro loans very useful – and accessible – for their consumption needs, so regardless of the source of cash for repayment, they would normally pay.

It is evident that microfinance has helped the poor in managing their cash flows and in sustaining their income levels; however, it has not necessarily helped them to come out of poverty by increasing their income levels. We can’t turn people into entrepreneurs by just providing them with capital – if this were so, we would not have seen countless examples of “rags to riches” throughout the world without the aid of any formal credit!

Very interesting. And the point about “case studies” at the beginning is very important. Aid proponents, seeing so many failures of their policies, continually look for “new-style” aid projects that might work. Backing micro-finance is often suggested. But, things often only work in the context of a particular time, place, circumstances and group of people. There is a sort of Goodhart’s law at work here. If you take the projects out of that context and try to aid them more generally, you actually lose the features that made them work in the first place – because they are not necessarily replicable. To targeting something with aid actually stops the “something” from working.

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