A metaphor for all things under-rated

Microcredit, a concept spearheaded by Nobel Peace Prize winner Mohamed Yunus, received widespread admiration as a substitute for government poverty alleviation solutions. Based around the idea of social collateral, where borrowers are grouped together to assume joint responsibility for the repayment of a single loan, Microcredit boasted very high repayment rates and promising results. At first glance, these figures may seem impressive. The statistics however, are a distortion of reality; the reality is a context where microfinance has made underwhelming progress in reaching the goals it set out to achieve.


Microcredit is the solution to the unavailability of credit to the poor in developing countries. The poor often have low creditworthiness, stemming from little wealth and assets to serve as collateral, which makes banks perceive them as high-risk borrowers. Credit’s inaccessibility to the poor is then worsened by the already existing gap in credit in developing countries due to poor infrastructure, low investor and business confidence and poor regulation to support such credit markets. This is because the poor have no substitute for banks as the credit market does not allow for the growth of such substitutes. Consequently, these two phenomena have translated into a shortage of credit, with the few issuers of credit being very selective with those to whom they lend their money. The absence of credit constrains investment that will yield additional income and accumulate wealth, breaking the cycle of poverty. The innovation of Microfinance is the alternative to conventional money lending institutions: it does not require collateral, it provides small amounts of money and it initially sets low interest rates. It is a lending system catering to the poor.


Creativity, to the capitalist mind, is synonymous with opportunity. Over time, commercial banking concepts have seeped into the microfinance system, distorting its mission. Mohamed Yunus, the pioneer of Microfinance himself, was appalled at the “mega profits” that some microcredit banks enjoy. When a bank is righteous enough to give money to the poor, financial sustainability becomes hard to achieve with a heavy outflow of funds that cannot be offset by relatively smaller inflow of funds. Soon, the banks have to turn to private investors to ensure that the fund pool is adequate. Over time, as the prominence of private investors grows, the motive to fix poverty is overpowered by the desire to maximize profits to keep investors satisfied.


This explains the monstrous rate of interest Banco Compartamos, a non-profit organization turned for profit bank, set between 75 percent to 100 percent, as a higher interest rate means larger profits for banks. Ironically, banks are now focused on ensuring that borrowers can make payments on time, gradually shifting their focus to the richer of the poor: a form of segregation based on the ability to repay. The overall effect is that the microfinance is now selective, as the elements of inclusion have now dissolved from its model.


Common belief dictates that microfinance facilitates the development of small-scale enterprises. A Department for International Development (DFID) funded review showed that money given to the poor is used primarily for consumption. It claimed that “the microfinance craze has been built on ‘foundations of sand’ because ‘no clear’ evidence yet exists that microfinance programs have positive impacts.” Atkinson and Messy show that education is an important determinant of financial literacy in all countries under the Financial Capability Survey funded by the World Bank Russia Trust Fund. Since a majority of the people receiving these loans are poorly educated, their financial literacy levels correlate to their poor level of education. As a result, they cannot be expected to divert their money into investment. Consequently, from the poor’s perspective, consumption becomes the only form of expenditure; it is often the case that they spend most of their income on consumption, so it seems sensible for them to spend this extra money on consumption as well.


The constraint to development arises when the people are still expected to make repayments for the loans that they have borrowed, which they do by recycling their loans. Bearing in mind that they have not generated an income making source through investment, they must now cover the expenses of the interest repayment, which can be appallingly high in some cases. The interest repayment then becomes an additional cost, so the people end up worse off than before. This rise in institutional debt burdens not only adds to the existing anxiety of the poor, but it also translates into an increased direct financial cost to the poor.


However, for the sake of debate, let us assume that the typical microcredit proponents assumption is correct: microcredit does promote the development of enterprise. In this paradigm, enterprises originating in developed countries focus on operating in the primary sector. As the Prebisch-Singer Hypothesis dictates, primary products have little value addition in comparison to secondary and tertiary sector products, so the potential earnings that these primary sector business owners can make in relation to business owners from higher sectors would be lower, yielding relatively little additional income. One may wonder if these business owners can develop niche market catering enterprises. Realistically, this is not true because product development in niches requires research and innovation. Even if these business owners want to serve market niches, their incomes do not support the upfront costs of research and innovation. With enterprise development constrained, microfinance proves yet again that it fails to make substantial improvements to the quality of life of the poor.


Proponents are also quick to point out that microfinance empowers women, since its approach is focused on women who are believed to make better expenditure decisions than men. Out of a sample of 120, a study by Aminur Rahman from the University of Manitoba, showed that 70% of the funds that women receive are used by men in a village in Tingail region, Bangladesh. The problem is the conservative impression of a typical family unit prevalent in developing countries, where decision making revolves around the male figure assuming the lead role in the family. As a result, women become facilitators of the transfer of funds from the bank to the lead male figure in the family. From this point, the same cycle of inefficient fund allocation occurs.


Research also points out an increase in pressures applied on women who obtain these loans. Vanu, a woman from the site in which the study was carried out, narrates a story of a woman who hung herself after defaulting on a microfinance loan. This is because of a cultural bias that associates a negative reputation with a woman who defaults on a loan balance, which does not exist with men. Rahman also puts forward the notion that microfinance initiatives focus on women because of their positional vulnerability. Interviews with local workers employed in a microfinance institution under the scope of the study testifies that women are considered passive and submissive, which translates into better compliance with the institution. Here we see that microfinance institutions divert from their public transcript, or the promise made in its mission statement to empower women, to view women as an item of exploitation. This glaring defiance of microfinance to achieve its objectives is once again a testament to how microfinance falls short of the objectives it tries to achieve.


Microcredit, in theory, sounds like the ideal solution to poverty. Practically, however, it fails at eliminating poverty and improving the quality of life of the poor. Despite claiming to promote enterprise development and gender equality, microfinance has contributed little to promoting enterprises that add value and generate large income streams that create wealth, and to empower women, who still serve as pawns to dominant male figures because of cultural issues that microfinance cannot solve. With corporate influence in the microfinance system, objectives of microfinance institutions are now focused on profit, compromising on the reach of microfinance to the poor.


Policymakers will now have to look at other substitutes for poverty alleviation. Experts point to cash handouts, implemented in African countries that have brought significant improvements in quality of life, as a substitute for microfinance. Practical implementation could entail the government’s issuance of “handout cards” to the poor, with designated amounts of money for each essential item of expenditure, such as food, healthcare and education. These balances can only be utilized at government-approved centers such as hospitals and public schools, for example. In a real world scenario, this would mean that when an individual spends money at a government approved hospital, the individual produces this card and the cost of healthcare would be deducted from the funds allocated for healthcare. Such an approach would restructure how a household conducts its expenditure, while ensuring that handouts by the government are not diverted into other areas, ultimately enhancing the quality of life of the poor. However, the ability of developing countries to invest in technology is a question to which the answers are uncertain.


With so many unanswered questions, the undeniable truth is that research on microfinance and any possible substitute has barely scratched the surface; the potential areas for discussion are plenty, and the unchartered waters of exploration are many.