This is not charity. This is business: business with a social objective, which is to help people get out of poverty,” said Muhammad Yunus, founder of Grameen Bank and Nobel Peace Prize recipient while attending the World Health Congress in Washington, DC in 2005. Over the years, micro-credit has been both celebrated and vilified as a development tool. Does micro-credit that is given to the poor so they can start or expand small enterprises help to lift them out of poverty? Is microcredit a panacea, or ineffective in alleviating poverty? The evidence surrounding this topic is nuanced, with various scholars holding varying opinions about the effectiveness of micro-credit.

On-going debates 

Nobel Prize winning Economist Amartya Sen writes that the essence of development should be about increasing an individual’s freedom in his book ‘Development as Freedom’. Sen defines freedom differently from libertarians—not only as freedom from interference in one’s affairs, but as a broader agency in one’s life that enhances capability. In such a context, if micro-credit expands the freedom of the poor, then by Sen’s approach, it is an effective development tool. For example, micro-credit may empower a woman in the family to start an enterprise and make more financial decisions. But not all those who are poor are also entrepreneurial. If they borrow loans for consumption without making productive investments, they will face difficulties on loan repayment and eventually fall into a debt trap. For instance, in South Africa, consumption accounts for almost 94 percent of microcredit use. Clients also tend to borrow from multiple sources, resulting in a case of over-indebtedness. This impedes their freedom and exposes them to increasing vulnerability.

Research published by the Centre for Global Development has shown that Mexico’s Compartamos Banco charged interest rates as high as 195 percent on its microloans to poor women. Anthropologist Jason Hickel from London School of Economics who is highly critical of microcredit providers writes, “In the past we would have called such people loan sharks, but today they’re called microfinance providers, and they crown themselves with the moral halo that this term carries.” There are instances when microcredit has become a socially acceptable mechanism for extracting resources from the poor. This is a challenge in Nepal as well. Owning to the relatively higher on-lending rate and spread, Nepali Microfinance Institutions are able to extract wealth and resources from poor clients and transfer it to those shareholders who are more well-off. 

However, the case is different with the Grameen Bank, a social business-created for pro-social goals, which today has nine million borrowers, 97 percent of whom are women. In fact, Yunus is aghast at the business practices of the one-time charitable micro-lender that has turned into Mexico´s most profitable bank, Banco Compartamos. Yunus asserts that fostering entrepreneurship is the solution to poverty and he has expanded his concept to developed countries via Yunus Social Business that was founded in 2011. “Australia has poor people. America has poor people. Europe has poor people” he says, “and inequalities within and between countries are getting worse”.

Existing evidence

Meanwhile, research that has come out of MIT’s Poverty Action Lab (J-PAL) using randomised controlled trail methodology has shown that just as there is little support for microcredit’s strongest claims, there is little support for microcredit’s harshest critics as well. Drawing lessons across seven impact evaluations from around the world, economists Abhijit Banerjee, Esther Duflo, Dean Karlan and Jonathan Zinman argue that for those who choose to borrow, microcredit “succeeds” in leading some of them to expand their businesses, although it does not appear to fuel an escape from poverty. Their work yields little support for the hypothesis that microcredit causes harm, although it asserts that micro-credit is not the “miracle” that it sometimes claims to be. 

None of the studies found microcredit to have a significant impact on the income of the average borrower. In the India and Morocco trials, consumption among microcredit households was no different from the control group. Likewise, there was no significant positive impact on schooling rates of children and women’s decision-making power in the family.

So how can we make microcredit work better? Microcredit plays its role as a financial product in an environment where financial access is limited, but it should also emphasise other financial products and services such as micro-savings, micro-insurance, remittance, leasing, and money transfer. “We must think beyond the standard microcredit model. Modern microfinance—savings and insurance, and more flexible credit products—often has generated larger impacts than simple credit,” says economist Dean Karlan of Yale University. In the context of Nepal, the central bank should constantly regulate micro-finance institutions and encourage financial literacy programs that promote responsible financial behaviour, especially among the poor. We should also explore ways of expanding the capacity of micro-enterprises to smaller enterprises, and in improving supply chains of local products. In this way, the positive impact of micro-credit can be augmented.

The existing evidence shows that microcredit is generally beneficial for the poor, but not necessarily transformative in the ways often advertised by many policymakers and donors. If not properly designed and delivered, micro-credit is just a quick fix to address a far more complex issue of poverty. To enhance the positive impacts of micro-credit, there is a need to have a closer look into the enforcement of the client protection principles, and diversification of financial products and services. And moreover, if transformative change is to be sought in terms of fighting global poverty, there is a need for structural changes in the global political economy that is driven by richer, powerful countries and particular institutions such as the World Bank and the IMF. 

Dr Dhakal is Managing Director at Centre for Social and Economic Studies (CenSES) Nepal; Siwakoti is a Research Associate at J-PAL, Abdul Latif Jameel Poverty Action Lab