NB Financial Innovation

February 1

Chris Dunford

NexThought Monday: Why Microfinance Should Embrace – Not Resist – A New Brand

We live in the Age of Brand Management. The holy grail of “brand managers” is always the simple and compelling message, told by words, images, stories and evidence. In their constant quest, truth is both resource and constraint on what they can say, show and imply. There is constant tension between the subtle complications of reality and the simple clarity of what moves people to admire and support. As we get a better grasp of reality, or it gets a firmer grip on us, a healthy sense of integrity often demands change in the way we brand.

Take, for example, the microcredit movement, which became the microfinance industry, then the financial inclusion space.

For more than 20 years, I was responsible for Freedom from Hunger, an organization older than me and an early adopter of microcredit. In the late 1980s, microcredit became our strategic focus as the programmatic vehicle for multiple services to support our tagline “Self-Help for a Hungry World.” We learned the rationale and mechanics of group-based microcredit directly from the movement’s best-known pioneers and advocates: Muhammad Yunus of Grameen Bank, John Hatch of FINCA and Jeff Ashe of ACCION. We fell under the spell of their conviction and enthusiasm, even if remaining skeptical of their often soaring rhetoric.

Their conviction and enthusiasm was merited, given the sorry state of anti-poverty work in the 1980s and earlier. Development services to support food security, income generation, child education, and health improvements — all requiring behavior change “for their own good”– were usually greeted by the poor with depressing lack of enthusiasm, much less gratitude. It was tough just to get people living in poverty to show up – even for free services. But offering microloans was a very different story. Development service veterans were amazed by the enthusiastic response and the willingness to follow strict rules and even pay the full cost of the service.

Moreover, microcredit had a very different “feel” compared to traditional moneylending. Rather than preying on the desperation of the poor, microcredit provided loans for microenterprise. Remember that microcredit arose within the microenterprise development community, because access to credit had been identified as a, if not the, major constraint to informal sector business development in developing countries, where the informal sector dominates the lives of most people. And there was the prospect of microcredit providers becoming fully self-sustaining through just the financial margin on credit operations, even achieving enough profit to attract investors. It truly seemed to be an anti-poverty breakthrough, if not a minor miracle. The grand story, richly illustrated by actual cases of “transformative change” in the lives of the poor, was also remarkably compelling of public support, both political and philanthropic.

The microcredit movement, however, was also characterized by an almost literal allergy to serious impact measurement. Influential experts at esteemed institutions like Ohio State University and the Boulder Institute maintained that sophisticated impact research could never definitively demonstrate impact and that repeat borrowing by the same “clients” offered sufficient evidence of program success. Even measuring the poverty status of incoming clients was dismissed in favor of easy tracking of the size of loans offered and repaid. A trifecta of practitioner enthusiasm, academic legitimacy, and public demand for compelling stories shaped the general branding of the microcredit movement.

Questioning the ‘Theory of Change’

What can be called the microcredit movement’s “theory of change” was seldom rigorously articulated, much less subjected to the simplest of logical and factual tests. That theory involves steps that people from poor households are assumed to take. First, they take loans; second, they invest this money in microenterprises; third, they manage these microenterprises to yield enough return on the investment to increase their household income and consumption. The result would be poverty reduction, because the clients start out below, then rise above, a national or international poverty line.

After retiring from leadership of Freedom from Hunger, I was given the opportunity for 18 months (January 2012 through June 2013) to look into the available evidence relevant to this theory of change. For all four questions below, it was surprisingly difficult to find relevant evidence. Here is what I found (subsequent research has supported or expanded upon these conclusions):

What percentage of the local population takes loans from MFIs?

What few data I could find indicate that many, probably most, people don’t take loans from microcredit providers (e.g., MFIs) even when they can.

What percentage of loans is invested in microenterprises?

There is very wide variance across countries and MFIs, but I grossly estimated that 50 percent of loans taken are invested in microenterprise. If we accept that maybe 50 percent of eligible poor people actually take loans from MFIs, I concluded that maybe 25 percent of eligible poor people are in a position to increase household income thanks to MFI lending.

What percentage of loan-supported microenterprises managed to increase profit enough to substantially increase household income?

Recent randomized control trials (RCTs) provide much useful evidence for answering this question. My takeaway: Seldom is the return high enough to generate major increases in household income and expenditure.

What percentage of microcredit clients are poor?

The best overview I found was by Lucia Spaggiari of MicroFinanza Rating in her 2012 report: “Poverty outreach: Big expectations, mixed results, transparency opportunity.”

  • Africa: Poor people are 41 percent of the clients of the average MFI vs. 65 percent of total population of the average country
  • Asia: 41 percent vs. 55 percent
  • Latin America and the Caribbean: 10 percent vs. 28 percent
  • Europe and Central Asia: 9 percent vs. 19 percent

Most important in these data is the gap shown between MFI poverty outreach and the poverty level of the country in which the MFI operates – the poverty gap.

We don’t have to set up an experimental (RCT) design to get answers to these four questions. Good point-in-time surveys are sufficient, but they have seldom been done. The data we do have show that the answer to each successive question narrows the potential transformative success stories to a very small percentage of people living in poverty, even in areas where the average MFI operates. There is tremendous variation around the mean, by country and by MFI, but the general conclusion seems logically solid – and easily validated or refuted by doing more, relatively simple survey work.

Let’s be clear. There are many, many well-documented cases in which poor households do in fact invest their loans in microenterprises that do in fact grow and yield enough profit to substantially increase the household’s income and consumption, sometimes even enough to rise above the national and international poverty lines. But these cases are a small minority of the households that participate in microfinance. Again, there are surprisingly few data on just how sizable the minority is, but they are still a small minority, which means the classic microcredit theory of change doesn’t describe the full value of microcredit for the majority of poor households who participate. Yet participate they do – at least 150 million relatively poor households! So what’s going on? What’s in it for them?

Consider this quote on p. 101 of the March 2000 paper by Jennefer Sebstad and Monique Cohen:

“The use of loans to smooth incomes and the resulting impact on reducing the variability of consumption suggest the positive impact of microcredit on reducing the vulnerability of client households, but not necessarily their income poverty.

“One explanation for greater impacts on vulnerability … is that there are many channels through which microcredit can reduce vulnerability, but fewer channels through which it can single-handedly reduce poverty.”

It is notable that the Sebstad and Cohen paper was published almost 16 years ago, well before the recent round of RCTs, financial diaries and research syntheses came to much the same conclusions (based on a firmer evidence base, of course). As Portfolios of the Poor and Poor Economics show so well, most households are not counting on this poverty-reduction effect of microenterprise investment; they just do business as one of several ways to keep the wolves of hunger and ill health at bay, to clothe and shelter themselves, and to have a little enjoyment in their lives, too. Call this poverty alleviation – reducing the uncertainties and stress of being poor. Not so many are using microcredit in a way that will raise them from the ranks of the poor – poverty reduction – because there just aren’t that many opportunities for thriving enterprise in the absence of robust local economic development. We’ve known this truth for some time now, but the dominant microcredit theory of change has been slow to yield to a more comprehensive theory that is in sync with the full range of motivations of the poor to use financial services.


The rebranding of Microfinance

There has been a profound rebranding of microcredit over the past 25 years. First, the label “microfinance” replaced “microcredit” to embrace savings in particular (which research shows is more popular and effective for consumption smoothing than borrowing, when it can be done safely), and also the full array of financial services offered by banks – but to the poor as well. Second, the “financial inclusion” concept has become dominant in order to embrace the full range of financial service providers, not just MFIs, and the full range of the “unbanked,” not just those living below an official poverty line.

But these rebranding efforts have aimed to create separation from microcredit and its classic theory of change rather than rebranding microcredit itself. This is problematic for two reasons. First, it ignores the central role of “credit” (lending), the main income-generating engine of most financial service providers. Second, it ignores the central role of “micro” (small enough to be suitable for the poor), the most compelling rationale for public and philanthropic investment in broad financial inclusion.

In reviewing the recent RCTs, I discovered that together they provide an impressive body of evidence that microfinance does indeed improve the effectiveness of household efforts to smooth consumption and cope with financial shocks – often substantially when savings is combined with microcredit or access to informal borrowing. However, it is notable that only two of these studies were focused on this question. There needs to be more and better research on this question. In particular, we need studies that actually measure variability of consumption over periods long enough to include the inevitable shocks that impact the poor. And we need these studies to disaggregate the poor into various levels of vulnerability to shocks, like the excellent Flory study in Malawi.

Beyond the ‘consolation prize’

A new theory of change is emerging from the evidence: People from poor households tap microfinance services to smooth consumption and build assets to protect against risks ahead of time and cope with shocks and economic stress events after they occur – leading to poverty alleviation.

Poverty alleviation is an unsatisfying consolation prize for practitioners, donors, fundraisers, investors and policymakers who have staked their careers on microcredit for poverty reduction. Naturally they resist rebranding “downward,” but the evidence leaves them little choice. There is a narrative, however, that illuminates the path from consumption smoothing to poverty reduction.

Poor households (like any households) strongly prefer to expand the financial service options available, as long as the new options do not foreclose old ones and do not impose unmanageable social, financial or legal obligations. Therefore, they are likely to maintain their engagement with their informal groups and networks for loans and savings opportunities, even while using more formal options as they become available.

Likewise, they maintain access to formal general-purpose microfinance services (e.g., MFIs), even as they seek access to larger, longer-term borrowing and saving opportunities. This is a process of layering rather than replacing. Households seem to want multiple layers of options that offer reliability, flexibility, affordability, etc., which often mean trade-offs among these desired characteristics; hence the need for diversity of options as well.

General-purpose microfinance (informal and formal) serves to build assets that provide a store of resources to draw on in the face of shocks and financial stress. Given a respite from shocks, accumulation of these assets can also take the household to a higher level of security, enabling access to services and wider support networks that may position the household to participate in more complex forms of financial services. This may include financial services from commercial banks or from buyers, input suppliers or specialized value-chain investors, who can provide larger, longer-term loan capital and technical assistance that can make a real difference in smallholder agricultural productivity. Alternatively, this more solid base of assets may be used to secure capital to start or grow a non-farm enterprise. Or these assets could position one or more household members to get a job with a regular wage or salary. Why not all three options?

Taken together, these benefits could form the basis for a new story for microfinance – one that’s both good and truthful, even if it’s not the greatest sound bite. It’s also a wonderful opportunity for brand managers to earn their keep.


Photo credit: Living-Learning Programs via Flickr.


Chris Dunford is the former president of Freedom from Hunger.


Financial Inclusion
financial inclusion, financial products, financial services, microcredit, microfinance, microsavings, research, social impact