Making Microfinance More Effective
For the 2.5 billion people who live on less than $2 per day, shocks such as illness, crop failures, livestock deaths, farming-equipment breakdowns and even wedding or funeral expenses can be enough to tip them, their families, or even an entire community below the poverty line. A major challenge for international development efforts is determining which financial tools provide durable buffers against such setbacks.
While meeting this challenge is a clear priority for policy makers and donors, it is also a major profit opportunity for commercial players who can solve market failures and create real value. Personal savings, insurance, credit, cash transfers from family and friends and other financing mechanisms offer promising opportunities to create security and steady employment but they require a nuanced understanding of product design and the local market conditions in order to be effective.
We recently conducted a literature review of rigorous academic studies of financial service innovations among the very poor to find out what services and products would unlock the most value for those at the bottom of the pyramid. Our findings are captured in a working paper which we summarize below.
Traditional microcredit hasn’t lived up to expectations, but we are learning how to improve it. The Grameen model of microfinance gained a great deal of attention in the international development field after early data showed that it was associated with high repayment and low default. This model makes small loans, usually to women, without requiring collateral. However, seven randomized evaluations from around the world show that this type of ”one size fits all” microcredit product did not increase the average incomes or consumption of households. Expanded access to microloans did lead some entrepreneurs to increase business investments, but rarely to increased profits. Only one study found that microloans increased women’s decision-making power.