Two weeks ago, The Economist published a special survey on microfinance (MF). I also recommend the audio discussion with Tom Easton, New York Bureau Chief of The Economist.
While no accepted definition of MF exists, The Economist sees MF as formal financial services for the poor. Indigent people could have access to formal financial services just like those who live in the developed world. Many billions of people (perhaps up to 5) potentially constitute this market. Banks have discovered in the last decade how profitable this market could be – at least if MF's costs could be reduced.
The formal financial services the poor could benefit from are deposits, savings, insurance, loans, and fund transfers. Remittances, a fast growing business worth $225b a year according to the World Bank, could represent the entry point in the MF market for many big banks. In other words, MF used to be a quasi-charity, but it is now slowly moving into mainstream banking. Global and local banks are becoming more interested in this potentially huge market.
However, there is another aspect to MF, which The Economist’s survey only partially addresses. This is the idea that MF, especially group-lending (as practiced by Grameen banks), is a silver bullet to poverty. While MF gives access to financial services to millions of poor, it is primarily a source of funds for entrepreneurs who otherwise would have no funding. Through MF, people can finance small business ventures, lift themselves out of poverty, and eventually graduate in the formal economic world establishing business relationships with established banks.
Stephen Daley and I published a Mercatus Policy Comment earlier this year on MF in the Philippines. Steve conducted a series of field studies in Manila (see picture – click on it) and came back with a wealth of data and interviews of people involved in MF. The aim of our research was to understand, by talking to people on the ground, whether MF is indeed the silver bullet against poverty. We mostly focused on group lending, which is a common form of MF in Manila. Here are the conclusions of our field work research:
- Many of those who receive MF loans do not graduate into the formal economy – even successful entrepreneurs;
- The relationship with moneylenders is often very valuable to the client because of the strong ties that exist between them – and MF recipients prefer to maintain strong ties with moneylenders than loose ties with unknown bankers (which is why they stay in the informal economy);
- The institutional environment is crucial to the way moneylenders operate. In Manila for instance, Mumbais (local moneylenders) operate in an environment which is not conducive to the development of formal financial relations with their clients.
Overall, the Philippine case shows that while MF provides financing to many small entrepreneurs, it is unlikely to become the silver bullet against poverty because graduation into the formal financial world is limited. At best, it is a band-aid solution to poverty. Based on the evidence we gathered in the Philippines, we believe that institutional changes would have a greater effect on poverty than MF loans as practiced by Grameen banks.
For instance, allowing Mumbais to hold property and set up financial businesses could lead to a development of the financial system from the bottom up. Titling of real property would also improve the situation of many would-be entrepreneurs. We also found that who funds MF loans matters to the incentives recipients face. In this regard, the involvement of governments in MF is not good news. MF must remain a private endeavor, either driven by charitable concerns or by profits. As The Economist puts it: “Good banking is, in the end, no match for bad government” (p. 13).
At the end of the day, the emergence of MF as a mainstream banking business is good news for the world poor, but it remains to be seen whether this phenomenon (at least the group-lending side of it, which we studied) alone will have beneficial effects on poverty levels.