By Manav Khindri
Illustration by Keo Morakod Ung
Microfinance was long touted as the future of solving the developing world’s poverty problem. Defined as the process of lending small amounts of money to people deemed too poor for bank credit or other traditional forms of borrowing, microfinance was tipped as a powerful tool to spark local poor economies into life. It was pioneered by Muhammed Yunus, whose lending of $27 to 42 women, who all agreed to act as co-guarantors, in the Bangladeshi village of Jobra led to his founding of the Grameen Bank – whose business model of ‘small loans at low interest rates to groups of borrowers’ became the template for the Global South’s route out of poverty. But the hype surrounding this seemingly revolutionary method has long since waned, and horror stories of individuals suffering under piles of debt they cannot pay back, and in some tragic cases being driven to suicide, raise an important question: what happened along the way?
Firstly, it must be said that microfinance’s support was certainly not baseless. In many of its successful cases, microfinance has offered something which many in the Western world take for granted – freedom. The chance to invest in their own business has empowered many, especially women, to obtain the necessary means to escape domestic abuse and start afresh, in countries where laws and cultural norms make it harder to do so. Undoubtedly microfinance has had a transformational effect on the lives of those who have seen it implemented effectively.
However, it does not suffice to build an argument on anecdotes, given the lack of robust evidence to support microfinance’s wider success. Since the first microfinance IPO, involving Mexico’s Banco Compartamos, took place in 2007, the industry’s practices have diverged from Yunus’ initial values. After commercialisation and expansion, and the investment from big players in the banking world such as Morgan Stanley and JP Morgan, the client-protection standards of organisations providing microfinance have been heavily criticised. The industry is shrouded in secrecy, and heavy reluctance from lenders to release information about their terms is widespread, although many estimates place rates between 25-40% – far from the affordable access to credit envisaged by Yunus. A much larger proportion of borrowers fall victim to predatory practices, and the benefits are felt only by a fortunate few.
Short turnarounds to first payment dates and huge penalty fees (which launch the effective interest rate well beyond the 40% mark) have led to the nullification of almost any business growth for micro-borrowers. Rather than stimulate growth and prosperity in impoverished locations, microfinance has become another mismanaged tool exploited by predatory lenders for profit. In Sierra Leone, for example, where archaic colonial laws mean that mounting personal debt is treated as a criminal matter, victims not only face the mental and financial implications of high debt burdens, but also serious jail time. While many microfinance programs would point to the repayment rates greater than 90 percent, this figure cannot be taken at face value; many victims are forced into taking out more loans to pay off existing ones, leaving people stuck in a perpetual vicious cycle. In places like India, where community is at the heart of local culture, defaulting on loans and having to face your co-guarantors in the community has often, sadly, been a source of shame – and in more than a few cases has resulted in victims taking their own lives.
The microfinance industry has also had its efficacy questioned. According to Dr Jason Hickel of the London School of Economics, 94% of microfinance borrowing in South Africa is spent on consumption, not geared towards business investment. As such, the loans have become no more than a temporary fiscal stimulus, rather than the spark to tackle poverty via sustainable economic growth. It is perhaps unclear whether this undesired outcome arises from gaps in the financial literacy of borrowers, or a lack of due diligence from lenders. However, to rely on the former explanation only serves to shift the blame onto victims faced with little alternative, and exonerate those who seek to squeeze as much profit out of vulnerable people.
In sum, microfinance is most definitely an example of a noble idea executed in a flawed manner. Providing local business owners with access to cheap credit to grow their ventures grew into granting not-so-cheap loans indiscriminately, with the aim of growth and prosperity morphing into one purely of lender profit. In the case of boosting consumption, unconditional transfer programmes would most certainly be more cost-effective and less predatory. But where microfinance really misses the mark is in its view of poverty as an isolated problem existing outside of the global economy, just waiting to be solved. As Dr Hickel explains, poverty is the cause of decisions regarding the structure of the global financial system made over the course of many decades; Structural Adjustment Programs (SAPs), which laid out the conditions which must be met in order to receive IMF or World Bank loans as early as the 1980s, had devastating effects on countries to whom prosperity was promised, and were very beneficial to Western institutions and banks. As a result, poverty is not simply something which a ‘magic’ instrument like microfinance can solve. It has, without doubt, had both its advantages and drawbacks, but to seriously tackle global poverty, one has to really dig deep into the structures and institutions which enabled it in the first place.
UCL Rethinking Economics 