Global Policy Forum

The Microfinance Illusion: The Post-2015 Development Agenda Should Rethink its Development Approach for Local Financing

Print

Following the popularity of micro financing as a development policy, Professor of Economics Dr. Milford Bateman cautions against this form of financing for the post-2015 agenda due to the commercialization and poor regulation of the sector. It intended to alleviate poverty by providing financial access to those outside formal processes. However, widespread micro-financing has prevented economies of scale and saturated the supply market from small and medium sized businesses without corresponding increases in demand. Moreover, 80% of loans are used for non- revenue purposes such as health or housing and many institutions tend to charge interest rates 20-30% higher than market rates, creating repayment issues. Dr. Batemen suggests strict regulation for existing micro-finance institutions to deter fraudulent practices that prevent development, along with promotion of micro-savings, credit cooperatives and cooperative banks instead.



February 14, 2013

On 8 January, an ad hoc seminar on the challenges underlying microfinance was organized in Geneva by the United Nations Conference on Trade and Development (UNCTAD). The guest speaker at the event was Dr. Milford Bateman, Professor of Economics at the University of Juraj Dobrila Pula in Croatia and author of the book “Why Doesn’t Microfinance Work? The Destructive Rise of Local Neoliberalism,” published in 2010. According to Dr. Bateman, over-indebtedness and abusive interest rates set by unscrupulous microfinance institutions (MFIs) are nowadays compromising the promises that microfinance could bring to development. Below follows an overview on the issue based on Dr. Bateman’s point of view.

A beginning full of hope

Dr. Bateman opened his presentation by reminding the audience of the history of the microfinance boom, which started at the end of the seventies and became popular in the person of Muhammad Yunus, Doctor in Economics and Bangladeshi entrepreneur. The latter figures as a pioneer as he experimented with different forms of microcredit in the village of Jobra, close to Chittagong in Bangladesh, using his own financial resources. He founded the Grameen Bank (village bank) in 1983 with support from the Ford Foundation, and institutionalized a model of granting small loans to poor people in order to help them maintain and secure their productive activities within the informal sector. The main objective was to give people that are generally excluded from the conventional financial system (2.7 billion adults across the globe) [1] a chance to escape from poverty. Dr. Yunus once noted that through microcredit “poverty will be eradicated in one generation (and) our children will need to visit a ‘poverty museum’ to understand the reasons behind these troubles.” Dr. Yunus, together with the Grameen Bank, obtained the Nobel Peace Price in 2006 for “their efforts to promote economic and social development from the grassroots.”

By encouraging initiative and individual entrepreneurship, and by discrediting implicitly collective groupings like unions, social movements, cooperatives and any other form of development aid services, microfinance became quickly appreciated by neoliberal policy-makers, explained Dr. Bateman. The World Bank, the US Agency for International Development (USAID), as well as other donors started to massively promote this method to escape poverty that was considered “infallible.” As a result, microfinance became commercial, and thus profitable. In order to avoid the creation of multiple agencies, the total reimbursement of the microcredit was imposed on the poor against interest rates that followed the rules of the market. Moreover, meritocratic management methods were adopted to encourage microfinance institutions to grant more and more microcredit (higher salaries, bonuses, stock options).

Microfinance thus became the most in vogue development policy that attracted major amounts of financing as a result of the high expectations underlying this activity. After all, microfinance was expected to contribute to obtaining the Millennium Development Goals (MDGs), creating sustainable local employment opportunities, reducing poverty at community level, increasing revenues, strengthening women’s empowerment and improving the agricultural sector. As a result, the United Nations proclaimed the year 2005 as the International Year of Microcredit under the slogan “Building Inclusive Financial Sectors to Achieve the Millennium Development Goals.” Such interest allowed for fast microfinance development in Bangladesh, Sri Lanka, India, Mongolia, Cambodia, Bosnia, Mexico, Ecuador, Nicaragua, Peru, Colombia and especially Bolivia. In 2011, compared to other countries across the globe, the latter obtained the largest share (31.5%) [2] of microfinance investments in its national financial sector.

Key figures on microfinance around the world

According to Vulnerability: The State of the Microcredit Summit Campaign Report 2013, in 2011, 13 million fewer of the world’s poorest families received access to microcredit and other financial services in comparison to the year 2010. The report notes that this decrease marks the first time since 1998 when the Campaign began tracking this data that the total number of clients and the number of poorest families reached has declined. The total number of clients fell from 205 million to 195 million and the sub-set of families living in extreme poverty, defined as less than US$1.25 a day, from 137 million to 124 million.

Total growth in the number of microcredit clients the sub-set of clients living in extreme poverty [3]

JPEG - 16.3 kb

The 2013 report also finds that most parts of the world saw moderate or slowed growth, with the exception of 1.4 million new clients in Sub-Saharan Africa. Despite this reverse in 2011, the report underscores that microfinance institutions still provided microloans to more than 124 million households living in extreme poverty. Assuming an average of five persons per family, this means that more than 621 million people were affected.

Number of microcredit clients living in extreme poverty per region [4]

JPEG - 15.3 kb

Microfinance: from miracle solution to poverty trap

Dr. Bateman affirms without doubt that “microfinance constitutes a sustainable reduction of poverty in developed countries,” but insists that there is no proof that microfinance has a positive effect on the wellbeing of poor people. In addition, Hugh Sinclair, microfinance consultant, wrote in his book [5] that “the sector is more and more characterized by dramatic levels of greed, mercantilism, deceit and causing chaos on the stock market of Wall Street.” In the view of Dr. Bateman, the success of microfinance is nothing else that the result of “out of proportion” publicity campaigns, public relations, celebrity and show-business support, as well as mediatised statements by Muhammad Yunus.

According to Dr. Bateman, the shortcomings of microfinance are diverse. First of all, people were convinced that local demand for goods and services produced by micro-enterprises will increase with more supply. Yet, it can be observed that on a local informal market an increase in supply without a rise in real demand will not bring more employment or additional revenues. Even worse, the fact that more and more micro-enterprises are opening their business within the same market will saturate supply levels, leading to lower prices and sales revenues, and consequently lower margins, salaries and benefits. The latter will also result in fewer jobs, and in the longer term, bankruptcy of micro-enterprises. To illustrate his point, Dr. Bateman made references to a recent study in Bosnia-Herzegovina where more than 50% of newly-established micro-enterprises had to close their doors within one year of activity. “What we especially see in Bosnia-Herzegovina is the multiplication of small informal merchandisers within the streets earning poor revenues…. This has pushed numerous existing enterprises out of business. So, microfinance has created jobs by “informalizing” the economy to the detriment of small and medium-sized enterprises that the sector actually aimed to maintain, and of tax revenues,” Dr. Bateman explained in a specialized magazine [6].

The importance of economies of scale for making microfinance sustainable

Neoliberal policy-makers minimize too much the importance of having economies of scale [7], continues Dr. Bateman. He denounces the weakness of the microfinance model that multiplies micro-enterprises in the informal sector which are then incapable of collaborating with enterprises in the formal sector in order to enhance production processes that bring economies of scale. In his view, a country that wants to escape poverty needs integrated economic sectors that use state-of-the-art technology to innovate and reach new markets at national, if not international level.

In a recent article, he illustrates the scope of the phenomenon. “Africa has already more micro-entrepreneurs in relation to its population than anywhere else, (…). However, Africa remains trapped in poverty precisely for the reason that the continent is not able to develop more than a lean enterprise structure that is incapable by definition to bring sustainable growth in productivity.”

Abusive interest rates

Bankruptcy does not only push micro-entrepreneurs, who are often already poor, to resell the assets of their enterprise, but also to use their family savings and the little income they get from remittances in order to pay the remaining loans and interest rates. It is these interest rates that have led to numerous scandals, especially of some specific microfinance institutions. Dr. Bateman notes that the highest interest level ever registered came from Compartamos, the biggest microfinance institution of Latin America that is based in Mexico. It charged its clients an annual interest rate of 195%! Although Compartamos explains that it reinvests the benefits for the sake of development, specialists of the sector affirm that these practices have led to an increase in interest rates on the Mexican market, where average rates are around 70% versus 37% in other parts of the world [8]. According to Microrate, an independent rating agency, a microfinance institution that charges an interest rate between 20-30% above the average level can be considered exploitative.

India and in particular the south-eastern state of Andhra Pradesh, where the largest number of microfinance institutions are located, are nowadays known for the microcredit crisis that the country faced in October 2010, as a result of the malfunctioning of the sector. The circumstances of the crisis were especially dramatic as it led to a wave of suicides under women that could not longer repay their loans. This situation was the direct result of abusive practices by certain microfinance institutions, including SKS Microfinance, which – when it entered the stock exchange market – triggered a scandal by making it public that the annual growth of its profits had reached more than 100%. In particular, SKS Microfinance was being criticized for speculating on the fictitious creditworthiness of its clients, which created a situation similar to that of the sub-prime crisis within the real estate sector in the United States.

In response to the crisis, the government of Andhra Pradesh has adopted a law [9] that aims to strongly condemn microfinance institutions that push for the repayment of loans in a way that harasses borrowers – often members of Self Help Groups (SHGs) [10]. In addition, many microfinance institutions were put under pressure and approximately thirty institutions went bankrupt. The crisis allowed to partially clean up the microfinance sector with the adoption of a series of regulating measures by the Reserve Bank of India (RBI) that improve the governance and operational efficiency of microfinance institutions and assure the social nature that originally belongs to microfinance. But the Bank has also pushed 71% of the clients [11] to borrow once more from exploitative and illegal institutions as a result of more restricting rules for borrowing credit. “We have created microfinance to combat the abusers; we have not created it to create new abusers,” declared Muhammad Yunus during a meeting of financial experts at the United Nations.

Microcredit leads to more consumption

Dr. Bateman also denounced another surprising aspect of the microfinance sector: in contrast to what is often thought, the majority of microcredit granted is not used to finance the creation of micro-enterprises. Research on the use of credit, undertaken by the Centre de cooperation internationale en recherche agronomique pour le développement (CIRAD), a French agricultural research organization working for development, shows that approximately 80% of the loans are used to finance consumption and to cover health, housing or education costs. Although these issues are vital for families, they do not generate resources to repay the loans. This fact, basically a result of the simplicity to obtain a loan, pushes families (and often illiterate women) in a state of over-indebtedness. While microcredit is thus often targeted towards women with the aim to empower them, Dr. Bateman adds, it in fact brings the opposite effect when these women become trapped in debts. In his view, microcredit is mainly benefitting the investors of financial markets.

Steps to follow after 2015

Dr. Bateman calls on policy-makers to recognize the shortcomings of microfinance. Especially, he recommends all stakeholders working on the post-2015 development agenda to no longer support commercial microfinance institutions and to strongly regulate the remaining ones. They should step away from neoliberal donor methods, control fraud, and draw attention to the bad examples in microfinance in order to avoid that these models will be followed by others. He also proposes approaches to replace microfinance, such as by providing a minimum income to people or by introducing microsavings. The latter allows people to first save money before they can spend it. Another option is to “reorient the little resources we have” towards promoting and maintaining organizations engaged in the social and solidarity economy, such as:

Rural Credit Cooperatives (owned by those that have savings and the community): have proved to work well in Scandinavia, China, Brazil. A good example is Mondragon in Spain.

Cooperative Banks (owned by the community): are an example of supporting enterprises in a sustainable and cooperate way, for example in Northern Italy.

Community Development Banks (owned by the central or local State or by the community): allow for developing profitable enterprises for the community in the longer term. See for example Caja Laboral in Spain.

Development Funds (related to a development agency). For example, the Invest Northern Ireland (Northern Ireland’s Business Development Agency) and the Chilean Economic Development Agency (CORFO) have had access to funds that have allowed them to set up enterprises.

For more information, please read the publication of Dr. Bateman: Why Doesn’t Microfinance Work? The Destructive Rise of local Neoliberalism? (2010)

For more general information on microfinance, consult GCAP’s microfinance gateway.

[1] World Bank

[2] Florent Bédécarrats et al. « Nouvelles Gauches et inclusion financière : la microfinance contestée en Bolivie, en Équateur et au Nicaragua », Critique internationale 3/2011 (n° 52), p. 129-153.

[3] Source: Vulnerability: The State of the Microcredit Summit Campaign Report 2013

[4] Source: Vulnerability: The State of the Microcredit Summit Campaign Report 2013

[5] H. Sinclair: Confessions of a microfinance heretic: How microlending lost its way and betrayed the poor (San Francisco, Berrett-Koehler, 2012)

[6] Alternatives Economiques

[7] Economies of scale occur when the costs of production per product unit decrease, while the production output increases

[8] www.planetrating.com

[9] Ordinance to protect the women Self Help Groups from exploitation by the Micro Finance Institutions in the State of Andhra Pradesh

[10] Self Help Groups of 10 to 20 women are symbolic for the sector in India. In the 1980s, a programme has been set up to encourage banks to give small loans to these groups. In 2010, 4.5 million SHGs representing 58 million members, received credit in India

[11] letemps.ch


 

FAIR USE NOTICE: This page contains copyrighted material the use of which has not been specifically authorized by the copyright owner. Global Policy Forum distributes this material without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes. We believe this constitutes a fair use of any such copyrighted material as provided for in 17 U.S.C § 107. If you wish to use copyrighted material from this site for purposes of your own that go beyond fair use, you must obtain permission from the copyright owner.