Second Step in the Microfinance Theory of Change: Loan Use Part II

My inquiry of the Microfinance Gateway Library yielded around 300 papers that refer to loan use. Without reading all of them all the way through, I found only the following offer some useful data to add to the three studies I reported in my previous post (#21).

Bolivia – commerce 34%; animals for family 31%; consumption 30%; fattening animals 19%; inputs for agriculture or livestock-rearing 10%; artisan activities 9% (loans were counted more than once for multiple uses)

Egypt – enterprise 72%; pay down previous debt, personal consumption, or house improvement 28%

India – investment 72%; household needs 28%

Pakistan – (cash loans) business 19%; personal 81% – (in-kind loans) business 89%; personal 11%

Uganda – primary enterprise 98% (new clients) 81% (older clients); secondary enterprise 10% (new clients) 33% (older clients); other non-enterprise uses 1-14% (new clients) 4-17% (older clients)

Zimbabwe – enterprise only 60%; mixed (enterprise and consumption) 17%; enterprise and savings 25%

There are three interesting findings from these data. First, the percentage of loans used for business seems to be much higher than the approximately half for business found in the Bangladesh and Indian studies reported in my previous post. I suspect that variation among different providers is related to the way they structure and promote their loan products and the way they train their clients and follow up their actual use of the loan. Graham Wright urges Indian microfinance providers to stop doing “loan utilisation checks” (a waste of time/money and forces clients to lie or use the loan in a way that is less beneficial for the household), except for “larger, individual and enterprise development loans” extended on the strength of a credit officer’s assessment of cash flow in a particular business. Second, the startling exception is Pakistan, where we plainly see the effect of loan provider policies—some were MFIs that provided cash loans for business investment, and one provided business inputs in kind rather than leaving it to chance that a borrower would use cash to purchase business inputs (even then there was 11% leakage). Third, the Uganda data come from three MFIs and show that new clients are more compliant with their stated intentions to invest in their “primary enterprises” than older clients, who seemed to become confident enough with experience to fudge a bit more.

The wide variation in proportions of loans used for IGAs (income-generating activities) vs. non-IGA uses is no doubt also related to variation in how each study defined IGA and how the study asked the borrowers questions about their use of loans.

Freedom from Hunger has known for more than 20 years that the typical poor borrower does not use the whole value of the loan to invest in the one business declared as the purpose of the loan.

The Bolivia data cited above come from one of our studies in the mid-1990s, and one of the Uganda MFIs cited above was a Credit with Education partner. Our impact stories give similar information about loan use. Of the 146 mature clients in Credit with Education, 139 mentioned investment of their loans in particular IGAs. Only a few mentioned more than one IGA. As for using loans for non-IGAs, almost everybody mentioned something; however, the stories don’t always make a clear distinction between using the loan itself vs. using the income generated by the IGA to make purchases irrelevant to the IGA.

Impact stories from Peruvian clients repeatedly included remarks about needing multiple IGAs to be able to pay off their loans—diversifying to hedge their bets. Many of the clients really would like to simplify their lives by having just one IGA, but they are forced to support multiple IGAs just to keep up. Such diversification makes it quite difficult to really grow any one business substantially because of the amount of distraction. While a person takes out a loan to support one IGA, she is probably pursuing multiple IGAs to pay off the loan, which doesn’t bode well for business success in the way most of us would define it.

We also know that intent to invest a loan in an IGA may be sidetracked by more pressing, often unanticipated needs. Our research with five MFIs on three continents in 2008–10 revealed that microfinance clients commonly resort to using their MFI business loans to pay healthcare expenses—from 11 percent (at RCPB in Burkina Faso) to 48 percent (at Bandhan in India). An independent 2009 report by Alexandra Kobishyn of a study of Indian MFIs by the Center for Microfinance suggested that 17 percent of a loan goes to health and education combined.

Here is a particular story to illustrate our emerging understanding of loan use.

My earliest memory of interviewing microfinance clients is from 1989 in rural southern Mali (Bougouni Cercle). Kathleen Stack and I were working through a French-Bambara interpreter to converse with a middle-aged woman about the benefits she perceived from her participation in one of our first Credit with Education programs. When asked how she was using her current loan, her response was fairly typical of many women we interviewed on that trip and later trips to Mali. She used part of the loan to make and sell in the village her beignets (a sort of doughnut snack made from millet or sorghum flour), which generated the steady weekly income she used to repay the required installment of principal, interest and savings at each weekly meeting of her group. She held some money aside as an emergency fund, which she kept in the equivalent of a coffee can buried in the ground. And she invested some of the loan capital in buying locally grown millet or sorghum grain and storing it for several months until the price had risen substantially, as it always did in the soudure (the hungry season before the next harvest), when she had the option of selling it for considerable profit or feeding it to her family rather than pay the soudure prices.

Mind you, this diversification strategy was for use of a sum of 15,000 CFA francs (about $30)! My tentative but intriguing conclusion was that the loans were primarily enabling what I naively called an “insurance effect” for the woman and her family (and now smartly call “consumption smoothing”). In effect, this was a negative prediction about the prospects for substantial business development and family income growth (but more on that in the coming discussion of Step 3 – starting with my next post).

For very poor clients, poor enough to be chronically hungry, David Roodman sums it up best in Due Diligence (p. 27): “When you look closely, ‘microenterprise’ begins to look like one more resourceful survival strategy.”