Thursday, January 12, 2012

What makes a microloan work?

In the past couple of weeks the microfinace debate has picked up again with the release of David Roodman's new book "Due Diligence: An Impertinent Inquiry into Microfinance". Even though I haven't yet read the book, I can almost surely assert that it is an excellent and well-researched work, as I have been following Mr. Roodman's Microfinance Open-Book blog for more than a year now.

One of the most heartbreaking things you can tell a microfinance practitioner goes something like this: "On current evidence, the best estimate of the average impact of microcredit on the poverty of clients is zero." (TIME Magazine) But this is exactly what David Roodman says. And this is ok, since he is a researcher and this is his job: to look for best practices in international development, criticize whenever he sees something wrong and start a dialogue, so that we - international development practitioners - see our mistakes and improve them.

As I said I have yet to read Due Diligence, nevertheless, I already know that I will be disagreeing with some of the book's main points. I, of course, am no expert as Mr. Roodman, but from what I have heard, read, and learnt in the last two years about microfinance and - most importantly - from my work at Color Me In! I would argue that microfinance does work when done right.

"Done right" is, of course, an oversimplification of a very complicated process. For developmental workers like Sarah, CMI's Founder & Executive Director, this process includes years of hard-work on the ground, talking and listening to people, and genuine desire to help people. For people on the other end - microfinance clients - it's also a lot of hard work and a deliberate choice to empower him or herself instead of just living off donors' handouts for the rest of their lives.

So you see, for microfinance to work and stand up to it's main promise of lifting people out of poverty, there is no place for multi-million-dollar banks, corporate-heads, and traditional investors. When Muhammad Yunus gave his first microloan, he didn't envision Grameen Bank to be headquartered in one of Dhaka's skyscrapers. For if he did, that microloan would have never worked. When any company grows so rapidly, top-management always loses its connection with the customers. That's exactly what happenned with SKS Microfinance, Grameen, and Compartamos. And microfinance clients are no ordinary customers: they are much more vulnerable, limited with their resources, dependent on a microloan and in need of fair treatment. Many clients of big microfinance banks are not getting such treatment.

Because microfinance clients are often extremely-poor, giving them a loan can also be very risky (despite all the impressive rates of return reported by many MFIs). That is why loan officer to client connection is so important: microfinance agents cannot just go and handout microloans to any poor person in need. If there is no group lending scheme involved, officers have to access person's willingness and ability to start an income generating activity and repay the loan. In order to do this, a loan officer has to care about his work and about his/her clients. In case of huge MFIs it is often not the case.

To sum up, microfinance takes heart and hard work. Both on the part of a microfinance organization and a loan recipient. And in microfinance, as maybe nowhere else, small is big.

P.S. To learn more how microloans work for the clients of Color Me In! check out Sarah's blog that she writes from Zambia and some of the photos with interesting stories behind them.


  1. The central thesis of this post appears to be that microfinance will only work - that is, reduce poverty - when done by charities rather than commercial operations.

    As far as I am aware, there is simply no evidence for this view. To my knowledge, no data or study has shown that nonprofit MFIs do reduce poverty while commercial MFIs do not. Indeed, areas with a high concentration of nonprofit MFIs do not even seem to be less prone to credit crises than areas with a high concentration of commercial MFIs.

    Impressions and anecdotes gathered from working with MFIs cannot substitute for rigorous studies and data analysis.

  2. Thank you for your comment, Rachel. First of all, I absolutely agree with you that rigorous studies and data analysis are as important as stories from-the-ground that we here from MFIs. I actually think that academic studies and research such as the one presented by Mr. Roodman are one of the best "smart aid" tools.

    Second of all, I wish I articulated it better in the post, but my main point is that no matter whether an MFI is a for-profit or non-profit the two main ingredients of success are heart and hard-work, both on the part of microloan officers and their clients clients. I think we would be right to assume that non-profit (or aid) workers care more about their job and customers than for-profit workers. Or at least they should, simply because they are AID workers. Of course, it's not always the case.

    Why do I think that employees of for-profit MFIs care less about their customers? Because the main goal of any for-profit enterprise is to increase its income. Thus, if these MFIs have to sacrifice their customer care to increase profits, they will do it. (That's just my logic, I am not aware of any scientific studies on this topic.)

    I tend to agree with Muhammad Yunus, who calls for a strict separation between social businesses and traditional businesses, saying that good intentions and profit-maximization can mix, but at some point one will always have to choose between the two. I believe that for social businesses, who are clear about their primary goal - to solve any given social problem - and who are financially self-sustainable, it is easier to do the right thing and continue focusing on their clients' needs. For for-profits - especially the ones responsible to their shareholders - and for non-profits - ever dependent on donors' money - it's much harder to do.