How much evidence do we have that the recently unbanked poor are getting a comparatively good deal from microfinance providers?
The most basic narrative of microfinance is that the poor are able to get loans from microfinance providers at substantially lower interest rates than are charged by local moneylenders. This assertion may seem obviously true, but for the Evidence Project of Freedom from Hunger we can’t take anything for granted. What is the evidence of lower interest rates?
Consider the benefit of a microfinance institution entering the scene where there was none before. We might assume this MFI would displace the moneylenders as the preferred alternative to family and friends as lenders. In Chapter Two, Portfolios of the Poor reports interest charged by a couple of moneylenders in South Africa as 20% and 30% per month. Considering that MFIs would not dare charge more than 5% (including fees and such) per month in any country, the poor should be getting a much better deal from the MFI. For a $100 loan held for one year, the borrower saves at least $180. How can you beat that deal?
Well, the poor often prefer to take a loan for only one month, but the saving is still at least $15 – a lot of money to save in one month. However, microfinance institutions usually do not offer one-month loans; more often four months minimum, sometimes nothing less than one year. The interest differential doesn’t look so persuasive, given that moneylenders offer one-month and even shorter loans.
But why would the poor go to moneylenders or MFIs when they can get interest-free loans from friends and family?
My starting point for exploring how financial services help the poor is Portfolios of the Poor. This book and its financial diary method helps us understand what the poor are doing, not just those who step forward to be clients of current microfinance services. The book’s orientation and messages liberate us from the institutional straightjacket to revisit fundamental questions of what we might do to help the poor help themselves deal with financial issues. For me and my colleagues at Freedom from Hunger, and apparently for so many others, the book resonates with the studies and stories we’ve been hearing from clients for decades and gives us a broader perspective in which to situate those stories.
The relevance of Portfolios of the Poor may depend on whether we see the target market for microfinance as the budding micro-entrepreneurs or as the households struggling to have enough food to eat every day. Of course, there is broad overlap between these two types (how broad the overlap is still an open question). While the authors of Portfolios did not explicitly focus on the latter group, their financial diary households were clearly struggling to stretch their tiny and unpredictable incomes to make sure they eat every day. Of course, this is the kind of household that Freedom from Hunger wants to focus on. When we ask whether the poor get a better deal from microfinance providers, we are asking about households like the ones featured in Portfolios of the Poor.
So what do we learn from Portfolios of the Poor?
First of all, it is clear that these food-insecure households need both loans and savings, not one rather than the other. They are borrowing and saving big time (a technical term) but in tiny amounts and mostly for short periods. Of all borrowing, well over ninety percent in the poorest part of the three-country sample was from informal sources. And the great majority of the informal sources of loans are not moneylenders but family and friends – interest-free. Even where microfinance institutions are readily available, as in Bangladesh, these diary households were depending primarily on interest-free loans from informal providers.
So what costs does microfinance reduce for the poor? The answer is beginning to look pretty complicated.
From Portfolios, “The time, energy and emotional toll of borrowing informally appear to be global phenomena.” (p. 55 in the paperback) Tim Ogden confirms and extends the conclusions of the Portfolios authors: “Looking at the financial services that the poor actually use the world over, from savings clubs to prepaid cards to microcredit to payday loans, there are a few common themes. Perhaps most important is that the poor are willing to pay relatively high explicit costs to offset implicit psychological and behavioral costs: shame, convenience, and temptation.” Imagine the stress of having to piece together the sum of money you need by going to people who know you socially. The amounts and timing of these loans are unreliable, certainly not private, and subject to arbitrary and often unforeseen terms.
In contrast, microfinance institutions are reputed to offer reliable, rule-bound and relatively impersonal, private and transparent access to credit (and increasingly, saving services). But they offer a truly superior deal to the poor only if they also offer the flexibility of terms and close-to-hand, any-time-of-day convenience of borrowing from friends, family, neighbors, shopkeepers and employers. Moneylenders are reputed to offer more privacy and reliability than friends and family, along with the requisite flexibility and convenience – for a phenomenal fee which is bearable only for short periods.
Now we see that a “better deal” is not simply a matter of relative price. The other dimensions we have to look at are amounts that can be borrowed or deposited, flexibility and reliability and transparency of terms, convenience and reliability of access, and privacy of transactions. We have to compare microfinance (and similar) institutions, moneylenders and family/friends/shopkeepers/employers on these dimensions.
What does the evidence tell us? Can you suggest other dimensions or types of providers for comparisons? What about costs other than financial costs, like health costs and opportunity costs? Can you provide leads to more evidence? Please let us know what you know by leaving a comment. If you know of some good studies or other sources of relevant evidence, I’ll invite you to do a guest post for this blog.