First Step in the Microfinance Theory of Change: Take a Loan or Save – Do They?

The classic microfinance theory of change is simple: a poor person goes to a microfinance provider and takes a loan (or saves the same amount) to start or expand a microenterprise which yields enough net revenue to repay the loan with major interest and still have sufficient profit to increase personal or household income enough to raise the person’s standard of living.

There are three key steps the poor person must take to make this theory true:

1. Take a loan from (or save with) a microfinance institution (or similar entity)

2. Invest the money in a viable business

3. Manage the business to yield major return on the investment.

All three steps have to be verified by evidence. I’ll take the steps one or two posts at a time.

Take a Loan from or Save with a Microfinance Provider

With the advent of the Global Financial Inclusion Database (Global Findex), there can now be more productive, evidence-based estimation of the percentage of a population that has access to financial services. “Access” is quite hard to measure. It is the possibility of “use” rather than actual use. This is desirable; we want people to have the choice to use or not use as suits their needs and preferences.

But for the convenience of measurement, data are drawn from reports of actual use. For example, the Global Findex reports that 50 percent of a global sample of 150,000 adults in 148 “economies” had an account with a formal financial institution (bank, credit union, microfinance institution). Building confidence in this figure, Jonathan Morduch says this finding matches the result of aggregating a range of independent surveys from ten years ago. More applicable to our interest in the poor, the Global Findex reports that only 23 percent of adults living below $2 a day have a “formal account.”

Even actual use is tricky. If we know only the percentage of the population with bank accounts, we don’t know to what extent people actually use the bank accounts or for what purposes. But we know they have access to banking services. It is a low estimate of the possibility of using financial services, but it is a credible number.

Another credible number is the percentage of the global adult population who are currently borrowing from (9 percent according to Global Findex) or saving with (23 percent) formal financial service providers, including microfinance providers. Narrowing the population to the poorest two quintiles (the bottom 40 percent), who are less likely to do business with banks or even credit unions, we can estimate the “market penetration” of microfinance services for the poor—about 8 percent of Q1 (the poorest quintile) and 13 percent of Q2 (the next poorest) are saving with formal financial institutions.

Freedom from Hunger’s notion of “microfinance” includes community-based savings methods, such as savings groups (ASCAs or ROSCAs without external capital infusion), in which case the percentage of people saving with microfinance providers goes up, dramatically in some regions of the world. According to Global Findex (p. 34 of the report), 19 percent of sampled adults in Sub-Saharan Africa report having saved in the past year using a savings club or person outside the family. Among just those who report any savings activity in the past 12 months, 48 percent use community-based savings methods. However, use of community-based savings methods is less common elsewhere among the developing countries (10-20 percent of savers in contrast to 48 percent in Sub-Saharan Africa). Of course, people can save with both formal providers and community-based methods—5 percent of adults in Sub-Saharan Africa use both at the same time.

If I did a deep dive into the Global Findex database, I could give you a more direct and accurate estimate of the percentage of adults in total, and poor adults in particular, with outstanding loans from (and/or active savings accounts with) microfinance providers. I know the data are there, because questions 2b and 2c ask whether the respondent has recently borrowed from or saved with a microfinance institution. Anybody want to volunteer to go get these percentages?

The problem with “actual use” data is that we don’t know whether the people who did not report actual use really had a choice to use or not use—a microfinance institution may not have been locally available.

Here’s a data point that seems to get around this problem. Banerjee and Duflos (Poor Economics p.219) report from their RCT research in Andra Pradesh:

“Even in Hyderabad, where there are several competing MFIs, the sign-up rate for any microcredit loan among families who were eligible to borrow was only 27 percent, and only 21 percent of those who had a small business had taken a microcredit loan.”

No doubt there are several other studies that report such data. It would be good to compare.

Let’s take into account that not all wannabe borrowers do so all the time. Therefore, over the lifetime of an MFI, considerably more than 27 percent of eligible borrowers will probably take a loan at some time or another. Let’s also acknowledge that more people at every income level seem to be saving (especially with community-based methods) than are borrowing (from both MFIs and savings groups). Still, we can conclude that many, probably most, poor people don’t take loans from or save with microfinance providers (both formal and informal) even when they can.

In short, the classic microfinance theory of change doesn’t apply to a whole lot of poor people, because so many choose not to participate even when they can.

In the next post, I’ll move on to Step Two—invest the money borrowed or saved in a viable business. Specifically, of those who use a microfinance provider to obtain a “usefully large sum” of money, how many invest the money in a real business? This is a harder question to answer.