Microcredit was once hailed as "the solution for global poverty." (1) At the turn of the millenium, the world was full of hope for the latest tool in fighting poverty. The chair of the United Nations Committee on Poverty Statistics, Jonathan Morduch, declared: "The hope is that much poverty can be eliminated – and that economic and social structures can be transformed fundamentally – by providing financial services to low-income households." (2)
During the first decade of the millenium, microcredit gained the attention of most international development organizations and the United Nations and World Bank devoted extensive resources to promoting it. Governments invested in microfinance agencies and large private microfinance institutions developed.
Like all human systems, however, microcredit was subject to corruption and abuse. A series of catastrophes in 2010 sparked the crash of microcredit in India (3), and the dark side of microfinance began to be exposed.
Numerous studies have been conducted over the years examining the impact of microcredit. We've summarized some of the most important studies in a separate article, but the results are mixed. Microcredit is not the silver bullet it was once considered to be.
Five Reasons Microcredit Fails
- Most Microcredit loans are used to fund consumption as well as development. Studies have shown that many beneficiaries use their loans to cover short term emergencies rather than address long-term economic growth. (4) The result is that that microcredit may have minimal impact on income growth.
- Most Microcredit programs produce over-indebtedness.The dark side of microcredit is microdebt. (5)Microcredit introduces external debt into a community and can produce unhealthy dependence. Microcredit can also diminish existing informal safety nets and adversely affect social cohesion. (6) Many who receive loans lack ability to repay the loans and don't develop an incentive to generate their own sustainable source of funding.
- Most Microcredit loans are expensive and rely on high interest rates to meet operation costs. (7) Microcredit, which targets the poor, is much more expensive than commercial bank loans aimed at middle and upper class populations. Microcredit is rarely sustainable among the poor at modest interest rates and very rarely reaches the most poor. For example, the largest microfinance bank in Latin America, with over 2.5 million subscribers, Banco Compartamos, has charged nearly 200% per year on its loan products. (8)
- Most Microcredit loans promote economic inefficiency. In communities where microcredit is widely employed, copycat businesses often develop with a limited local market. Microloans enable the creation of new businesses, but the new businesses replace existing ones. Competition and lack of consumer demand in poor communities drive business failure and the majority of new businesses fail within a short time. (9)
- Most Microcredit programs exploit rather than empower. (10) The commercialization of microcredit over the past fifteen years has had a major negative impact: "commercial microcredit institutions are subject to demands for ever-increasing profits, which can only come in the form of higher interest rates charged to the poor, defeating the very purpose of the loans." (11) Heavy handed collection tactics have been documented as exploitative interest rates are combined with extortion. Financial literacy and education are often excluded as precursors to loan products. As a result, many poor become trapped in deepening cycles of poverty and debt.
Notice that we said "most." Microcredit is still making an impact and some microcredit programs are truly addressing extreme poverty. When the microcredit crisis began in India, Five Talents was already pointing to a different way to do microfinance. We focused on a triple bottom line of spiritual, social, and economic development that emphasized the holistic well-being of the individual and the community. We also developed a unique model for lending that focused on community education, local ownership and management, local resource mobilization, group guarantees, and savings-led programs for rotating or accumulating savings and credit. A key difference is leading with savings rather than credit.
Members deposit savings during a community savings group meeting in Burundi.
Today, the development world has distanced itself from even using the terms "microcredit" and "microfinance." Now the focus is on reaching universal "financial inclusion." (12)
We've developed a set of best practices for financial inclusion with programs focusing exclusively on the extreme poor. Five Talents has been successful in some of the hardest places in the world. While Grameen Bank failed, we've built the only two locally owned community banks in the world's most fragile state, South Sudan. Over time, our programs have matured and grown, but ultimately time and time again we come back to the timeless wisdom of a parable of Jesus: lets help people discover and use the talents and resources they have to invest in something bigger than themselves.
(1) Yunus, Muhammad. "Credit for the poor: Poverty as distant history." Harvard International Review 29.3 (2007): 20. (2) Morduch, Jonathan. "The Microfinance Promise." Journal of Economic Literature 37.4 (1999): 1569-614. (3) Arunachalam, Ramesh S. The journey of Indian micro-finance: Lessons for the future. Aapti Publications, 2011. (4) Boudreaux, Karol, and Tyler Cowen. "The micromagic of microcredit." The Wilson Quarterly (1976-) 32.1 (2008): 27-31. (5) Hulme, David. "Is microdebt good for poor people? A note on the dark side of microfinance." Small Enterprise Development 11.1 (2000): 26-28. (6) Dichter, Thomas. "Can microcredit make an already slippery slope more slippery?: Some lessons from the social meaning of debt." What's Wrong with Microfinance?. Vol. 7. No. 18. Practical Action Publishing in association with GSE Research, 2007. 7-18. (7) Rosenberg, Richard, et al. "Microcredit interest rates and their determinants: 2004–2011." Microfinance 3.0. Springer Berlin Heidelberg, 2013. 69-104. (8) Roodman, David. Does Compartmentos Charge 195% Interest. Center for Global Development, 2011. (9) Bateman, Milford. "South Africa's post-apartheid microcredit-driven calamity." Law, Democracy and Development 18 (2014): 92-135. (10) Rosenberg, Richard, Adrian Gonzalez, and Sushma Narain. "The new moneylenders: are the poor being exploited by high microcredit interest rates?." Moving beyond storytelling: emerging research in microfinance (contemporary studies in economic and financial analysis, volume 92). Emerald Group Publishing Limited, Bingley (2009): 145-181. (11) Yunus, Muhammad. "Sacrificing microcredit for megaprofits." New York Times 14 (2011): A23. (12) The World Bank. World Bank Group and a Coalition of Partners Make Commitments to Accelerate Universal Financial Access. [Press Release]. April 17, 2015.