Theme Three Wrap Up: More Profitable Business and Household Income?

by Lynne Davidson Jarrell

Lynne has graciously volunteered to summarize the posts under Theme Three, from her perspective rather than mine. Note that she points to the posts relevant to each topic she covers (the numbers are hyperlinks). Each post on this blog is assigned a unique number in chronological order of posting, and all the posts for each theme are listed by number and title on the right side of this page under “View by Theme.” Next week I will discuss what Theme Three means for Freedom from Hunger. Then on to Theme Four!

In theme three, we assemble the evidence to show the effect that microfinance has on business profitability and household income for the world’s poor. This requires three layers of evidence. The first layer is the evidence showing the extent to which the poor have access to, and make use of, microfinance opportunities. The second is evidence that the funds made available through the microfinance opportunities are used to invest in business. And for the third layer of evidence, we must assess whether or not those business investments lead to increased business profits and increased household income.

Do the poor use microfinance opportunities? The evidence shows that most poor people do not make use of microfinance opportunities. 

Based on one study in a community with several competing MFIs, eligible families commit to a microcredit loan at a rate of about 27 percent (post 20). This is a point-in-time estimate. That is, over the lifetime of eligible families, that number should be higher. Perhaps it is closer to 50 percent (post 24). Even so, it is important to note that this is 50 percent (maybe) of those who have access to a microfinance institution in the community – not 50 percent of the world’s poor. Interestingly, when we parse the data by income levels, we see that the rates are much lower for the poorest of those families. We know this by examining the data for the rate of savings with formal financial institutions (broadly defined to include community-based savings groups). About 8 percent of the poorest quintile and 13 percent of the next poorest are saving with formal financial institutions, whereas the overall rate across the adult population is 23 percent (post 20).

So we may conclude, tentatively, that about half of those who have access to microfinance institutions are taking a loan or saving with that institution.

Of those who take loans from or save with MFIs, do they invest those funds in businesses? We accept that most of the world’s poor either don’t have access to MFIs or if they do, they do not engage with those institutions. But of those that do, is there evidence that the funds are used to invest in businesses? The evidence shows that only a minority of MFI clients around the world use the full value of the loan to invest in a business as specified when they entered the relationship with the MFI.

Only study of women in Bangladesh found that about 15 percent used their loan as expected. An analysis of borrowers from Grameen Bank found that 31 percent of the loans were used to buy stock for their businesses. A study in India reveals that 30 percent of borrowers used their loans for starting a new business and 22 percent to buy stock for existing businesses (post 21). Studies on loan use in Bolivia, Egypt, India, Pakistan, Uganda, Zimbabwe report higher percentages than theses studies from Bangladesh and India, although the rates vary widely (19 percent in Pakistan to 98 percent among new clients in Uganda), and are at least partially dependent on how the loans are structured and the extent to which the providers follow up with clients (post 22). Loan use is also related to how “seasoned” a client is (new clients seem to be more cautious and therefore more likely to put loan funds toward the stated purpose).

With such variation in how loans are used, it becomes difficult to pinpoint an overall rate at which we can confidently state that MFI loans are used for the purpose of business investment. But that rate certainly lands somewhere between the low rates found in Bangladesh and the high rates in Uganda. In fact, the rates seem to scatter around a mid-point of about 50 percent. 

To summarize to this point, about one-half of the poor who have access to MFI loans and savings options take advantage of those opportunities, and about one-half of those are investing those funds in their business enterprises.

Of those who use MFI loan funds to invest in businesses, is there an increase in business profitability and household income? The answer is, not surprisingly, rather mixed.

Much (although certainly not all) of the evidence is a bit disappointing in this regard (“disappointing” is Chris’s word, post 26) if we are looking for a cause and effect relationship between investment and income. If we focus, however, on consumption-smoothing and economic shock avoidance (somewhat less lofty, but still important, goals), then we have good news to report. This issue will be further explored in Theme Four.

For now, we may conclude that “microfinance is good for microbusinesses” (post 30) and that microcredit may provide “a safety net” for participating households, although the households that enjoy the most benefits are the “middle” and “upper” poor (post 25) and those who are already engaged in a business enterprise. Credit with Education participants in Ghana and Bolivia increase their earnings relative to women not in the program. In Burkina Faso, participants also reported increased earnings from income-generating activities. But earnings are generally small and there is a lot of variability across participants. We must note that most studies are limited to 12 to 18 months, so there is some hope that we may observe greater gains when considered over a longer time horizon.

Coupling microcredit with other services provides a boost. We know from a comparison of clients who received credit with business education with those who received credit only that clients who received education demonstrated greater business knowledge and had higher business revenues, a higher repayment rate, and a higher retention rate than those who did not receive the business education. There was no evidence, however, that the education resulted in more business growth or increased household income (post 32).

The evidence for the benefits of savings comes in at least two forms. Formal microsavings investments help boost income and spending, and help participants weather the storm during periods of increased need (post 30). Informal savings group members are highly likely to increase their savings and other assets, and may invest in income-generating activities (post 31).

In sum, available data show that increases in business and household income due to MFI loan use is not dramatic, but rather variable and may be dependent upon factors such as income level of participants, whether or not they have an existing business prior to participation, and if they received other services (e.g., education) with the loan.