NextBillion - An Initiative of the William Davidson Institute at the University of Michigan

Monday, October 10, 2016

ON A shelf in Buland Iqbal’s tiny roadside shop, cassette tapes are slowly turning pale in the sun. Nobody wants them these days, even in a dusty suburb in one of India’s poorest states. So Mr Iqbal has branched out. First he moved into renting DVDs, then, more boldly, into pay-television. A loan of 31,000 rupees ($465) from Sonata, a microfinance firm, helped him acquire a few satellite dishes and decoder boxes. It seems like a clear-cut success for microlending. In fact, Mr Iqbal’s loan illustrates why microlending does not work all that well, and how it needs to change.

The idea of springing people from poverty by advancing them small amounts of money is old: in the 1720s the author Jonathan Swift was lending to “honest, sober and industrious” men in Dublin. But the modern template was created in the 1970s. Grameen, a Bangladeshi outfit, encouraged poor women who lacked collateral to form small groups in which each borrower was liable for all the others’ debts. Groups met weekly and handed their payments to a loan officer. Astonishingly few defaulted. By transferring tasks normally done by well-paid bankers to poor people, Grameen had brought costs down so much that it could afford to lend tiny amounts.

Grameen Bank and Muhammad Yunus, its founder, were jointly awarded the Nobel peace prize in 2006. Almost immediately, microlending ran into trouble. The poor women in the borrowing groups proved as ruthless as any bailiff: researchers turned up stories of delinquents forced to sell livestock and cooking pots to make weekly payments. Soon came over-indebtedness and mass defaults in the Indian state of Andhra Pradesh, in Pakistan and in Nicaragua, where the president, Daniel Ortega, sided with the “no pago” movement.

Then the “randomistas” put the boot in. In 2015, after examining the results of randomised controlled trials in Bosnia, Ethiopia, India, Mexico, Morocco and Mongolia, American researchers questioned whether microlending worked at all. As expected, offering small loans increased business investment. But it had a negligible effect on poor people’s fortunes. Borrowers seemed to cut back on wage work in order to spend more time bent over their sewing machines or running their small, not terribly profitable shops.