Speakers:
Milford Bateman - Senior Research Fellow, ODI
Ha-Joon Chang - Reader, Cambridge University
Mark Napier - Financial Inclusion Specialist

Chair:
Karen Ellis - Head of Business and Development Programme, ODI

Discussion                                           

Karen Ellis opened the presentation by stating that the idea that microfinance is not working has been a distinctly minority view up to now. The dominant opinion has been that microfinance institutions have been successful in helping microenterprises get started and expand and that this has been good for the poor. However there is still a real lack of evidence of sustainable impact arising from microfinance on the macro level of an economy and on the micro-level

Milford Bateman - ODI

The discussion was then passed onto Milford Batemanwho began by explaining that the origins of microfinance were to be found in India, Pakistan and Bangladesh, stemming particularly from the ideas of Akhtar Hameed Khan who pioneered a form of microcredit in the 1960s. Professor Muhammad Yunus and his Grameen Bank ideas followed on from these earlier models. They suggested that encouraging the poor to take part in income generating activities which would be funded by microcredit would help the typical local community escape from its poverty.

The international donor community places high value on microfinance because it is a form of non state self-help, and it positions individual entrepreneurship as the only way for the poor to try to find a way out of their poverty. This has been an over-arching goal of the international donor community for many years, particularly from the 1960s onwards when forms of collective effort by the poor, especially communism/socialism, were beginning to attract many developing countries. The cost of supporting banks like Grameen was assumed to be minimal, because the poor were found to be “bankable” - that is, they generally paid back any microloans received. This meant that these banks could become self sustaining. . This aspect of microfinance received a lot of attention in the 1980’s as the “Full Cost Recovery” mantra was being preached by the international development community at the time, a mantra that stated that the poor needed to pay for the full costs of any of the services that they used. This in turn led to the neoliberalisation of microfinance institutions in the 1980’s.

By the 1990s CGAP and USAID were actively pushing this commercialised “new wave” microfinance model, where microfinance institutions were seen as for-profit institutions which would be incentivised to survive as any other private institution. However in the early 2000s it was seen that microfinance was not helping to reduce poverty which in turn gave researchers more scope to analyse in more depth what was really happening at the level of the local community thanks to the microfinance model.

One of the issues which were found was that the Grameen model did not look at the minimum efficient scale of any microenterprise seeking a microloan. This meant that a large number of loans were being disbursed to microenterprises and subsistence farmers that were very unlikely to be able to survive beyond a few months or, at most, years.  Poor people would then lose their assets when their microenterprise failed, as well as fall further into debt. Moreover, the poor found it difficult to repay microcredit when interest rates were at 30% to 40%, which only added to the problems of running such a tiny business, and so contributed further to the high failure rate of microfinance clients in general.

A second factor was that Yunus misunderstood the “fallacy of composition” argument with regards to microfinance, wrongly concluding from one successful case of microfinance that lending to everyone in the local economy would help them all to benefit and escape poverty. This suggested to him the need for microfinance institutions to be scaled up in order that everybody could access a microloan.

However in areas which were saturated with microfinance institutions, it was often found that there was a fall in price in the products sold, leading to falling profits for local microenterprises. This came as a result of a large number of microenterprises being able to supply the same products, in turn leading to lower prices for these products and less margins for profit for these microenterprise owners.

Microfinance institutions could thus be seen as a form of the Morgenthau Plan, a plan formulated by US government during the Second World War aimed at getting rid Germany’s capacity to engage in large scale warfare once the conflict came to an end. The Morgenthau Plan aimed to dismantle all large and medium sized enterprises, leaving only small and micro enterprises with little technology content. This plan was halted when it became clear that a strong Germany was needed to help fight communist ideas coming from Eastern Europe. Today, microfinance institutions are responsible for the “Africanisation” effect, which is the multiplication of only petty trade-based microenterprises.

Milford Bateman then went on to explain how microfinance was not an appropriate form of finance for the most productive farms, which he said were mainly small family farms, but is however the type of “support” that most farms end up getting by default. The small family farms that could most productively use small farm credit lose out due to their size and relative complexity, but the smallest and least productive ‘postage stamp’ farms get access to as much microcredit as they want. This adverse selection problem also means that agricultural cooperatives, which are hugely important in helping to generate what are called ‘collective economies of scale’, also losing out on sources of finance.

Microfinance institutions, through their practices, end up extending informality and at the same time also extending & legitimising bad business practices. They also tend to destroy social capital & solidarity by creating negative social pressures to repay loans. Many neoliberal-oriented governments in developing countries have been encouraged by the international development agency mentors to use the growing supply of microfinance as an excuse to cut down social infrastructure that would otherwise be hugely useful for the poor. The argument is that the poor should be able to deal with the lack of infrastructure and social welfare support by using microfinance to purchase important services from private sector providers if they exist.

In the 1980s and the 1990s the World Bank and other international institutions began a process of ‘neoliberalising’ microfinance institutions, which lead to these institutions charging high interest rates in order to become financially self-sufficient. Microfinance institutions can indeed survive with high interest rates, but the microenterprise structures that then begin to emerge around them are weak and unsustainable. Microfinance institutions can therefore survive by charging high interest rates, but the local economic structure they end up producing is weak and unsustainable. The microfinance institutions end up as ‘cathedrals in the desert’. Another important point are the high costs of these microfinance institutions resulting from the high salaries and bonuses paid to their managers and executives; this helps to keep interest rates much higher that they would otherwise be if the institution was genuinely dedicated to resolving poverty. These high interest rates are also often justified because they allow microfinance institutions to expand their operations to include other poor people. However this means poor people are effectively being asked to pay these high interest rates so that other poor people can have access to microfinance, which is a very shaky moral justification for expansion. The very poor are helping out other equally poor, which is hardly an equitable and fair solution to poverty. In addition there is no real evidence or experience that these high interest rates are actually helping the poor escape poverty, because most microenterprises cannot operate upon such a high cost.

Milford Bateman then explained why, if they are so bad for sustainable development and poverty reduction, why it is that microfinance institutions received and continue to receive such wide support. The first reason is that the international donor community loved the self help message of MFIs such as Grameen. In addition the Washington-based institutions needed to encourage all financial institutions to stand on their own two feet, and microfinance institutions stood out as good examples of this. This would help them as a way of removing development banks from the policy agenda, which is a long-standing ambition of the Washington-based institutions, such as the World Bank. Finally, having microfinance means that l the poor can be told to rely on the market as the final judge of whether they can live or die, rather than seeking out collective solutions to poverty using their collective power represented by their sheer numbers.

Clearly microfinance institutions are a major misdirection of scarce funds & resources, similar to central planning: microfinance is the market-driven allocation of resources into the least inefficient uses, whereas central planning was a plan-driven allocation of resources into the least efficient uses. Microfinance institutions therefore institutionalise poverty and underdevelopment rather resolves it.

Ha-Joon Chang – Cambridge University

Ha-Joon Chang continued the discussion by agreeing with many of the things that Milford Bateman said. The common view is that you need entrepreneurship for development, a view which has become the pillar of the mainstream thinking in regards to microfinance. However, if individual entrepreneurship is the key to development, we need to explain why is it that in Benin, for instance, more people are self employed than in the USA yet the country remains very poor? In most developing countries there is a high percentage of self entrepreneurship, for example in Ghana 65% of the working force is self employed. In fact, as economies develop however they become less and less dependent upon very simple entrepreneurial activity and much more dependent upon collective activity and institutions.

Ha-Joon Chang then continued by stating that when you have people with limited productive capabilities and limited access to resources, once they are given money to invest, they generally all l end up producing the same thing. In order to make microfinance credit work you need a range of collective institutions, such as cooperatives for agriculture, local business associations etc. otherwise individual based entrepreneurship will not take the people that are receiving microfinance credit very far. Finally Ha-Joon Chang stated that it would be impossible to expect people who have to repay 40% or more interest to be able to develop a serious business that would possibly involve technology, innovation, training or any meaningful complexity, .

Mark Napier – Independent consultant

Mark Napier replied by explaining that he agreed with large parts of the argument, however he had issues with the explanation given on the role microfinance institutions and what they should do in a competitive system. He argued that that there is a role for microfinance in a multifaceted word, a role which sits alongside different financial institutions. He went on to state that these institutions do actually work properly if you are lucky enough to live near one but that there has been an overestimation on the impact that they have had on the whole economy. The global financial crisis will be the final ’ nail in the coffin” for subsidised forms of MFI credit, together with powerful economic trends that are changing the nature of supply and demand such as an emerging middle class with changing & more complex financial needs. In addition there are new models of delivery based on new technologies such as the mobile phone.

He agreed that the oversupply of microfinance credit is now creating problems of over indebtedness for the poor. So it is legitimate to ask whether microcredit really is helping poor people. Mark Napier then explained that not everybody wants to be an entrepreneur and not everybody wants a formal job and it is for these people that microfinance credit cannot really be useful. Mark Napier continued, explaining that even though there are models of best practices for how access to finance can support development, in reality you would not want to import these models as you would want to first analyse particular markets to identify particular issues and what interventions may be best needed. In this regard it is clear that the Washington Consensus does not work everywhere and so it is important to look at what is best suited to each particular market.

In Rwanda 3% of adults use microfinance institutions, the numbers are thus very small and at the same time commercial banks have also begun to reach out to the poorest people. Given the right policies and incentives you will be able to see formal financial institutions (such as banks) be able to increasingly provide access to the poorest people. For example the Basic Bank Account model from South Africa has resulted in seven million clients (of which 72% never had a bank account) to be able to access financial services, this model has also been tested in Mexico and Pakistan as well as in a number of other countries. Another example is the Equity Bank model, a model where a bank is set up to analyse, understand and serve the needs of a particular segment of a market (i.e. the poor).A third example is the Downscaler model where a large organisation seeks to enter particular segments of the market. Finally there is the example of very successful remote banking operations, such as Mpesa.

Questions & Comments

1.       How did you select the groups you investigated, and if it wasn’t a random sample how are you confident that circumstantial factors are not driving the negative factors?

Milford Bateman: The chosen groups not analysed in a statistical sense, but rather regions with a sufficient number of microfinance institutions were chosen. One of the earlier arguments ranged against those criticising microfinance was that we are not seeing any impact because we simply don’t have enough microfinance – this was the ‘critical mass’ argument. Bateman noted that by choosing country, regional and local examples of microfinance ‘saturation’ this argument could no longer be deployed against those challenging the conventional wisdom relating to microfinance.    

2.       International donor institutions were preaching the Full Cost Recovery model but also at the same time these microfinance institutions seem to be wasting a lot of money, how do you reconcile the two?

Milford Bateman: The Full Cost Recovery model was about getting the poor to pay for the full cost of the services they accessed; such services may pay for themselves but are a major waste of money if they don’t provide the services they are supposed to provide, such as developing the local economy. An institution that is able to survive ‘on the market’ has no value as a development institution if it does not do what it was designed to do.

Ha-Joon Chang: Poor people are a high risk group in terms of repayment, so by leaving it to the market they will have to be charged 40% interest rates; hence there must be some element of subsidisation in order to reduce these high interest rates.

3.       Did you also look at some other microcredit schemes such as insurance?

Milford Bateman: The original Grameen bank model was failing and so other components were bolted on to the microcredit package in order to make it look like it was working. However these extra ‘bolt-on’ components were beyond the scope of the study.

4.       Is it possible to rank the problems with the MFIs and which ones are the key problems that need to be resolved?

Milford Bateman:  This is not something I attempted to do. However, let me say this. I think one of the major, if not catastrophic, drawbacks to the microfinance model is the fact that it has misallocated finance for many years now. In Latin America, even the Inter-American Development Bank (IaDB) now accepts that here has been a large misallocation of resources, especially in Mexico and Bolivia, countries which have really bought into the microfinance paradigm.  Consider also Vietnam, which instead of going the same way adapted the Chinese rural and urban credit cooperative development model and this has been critical in promoting small and medium enterprises that have much more potential to generate sustainable outcomes.

5.       A comment was made that a Social Performance Task Force was created in order to try to address the problems highlighted in the book, the criticisms made in the book are relevant but the industry is trying to address them.

6.       Malcolm Harper: Microfinance institutions don’t need donors anymore; they are now a business and there is nothing we can do about it.

Milford Bateman: Even though they may be self financed as with any business, they still have an obligation to help develop communities. However if most microfinance institutions are not doing this, as he argued is the case, then they are effectively blocking other institutes which could be ‘doing development’ instead.

7.       MFIs seem to offer the Holy Grail against poverty and donors grabbed it without checking their information since they were looking for something new because everything else had failed. What has the subprime debacle taught us about what people know about banks?

Milford Bateman: Microfinance institutions are on a precipice due to the global financial crisis and are thus also involved in a subprime style debacle; the level of indebtedness within these institutions cannot go on forever. Many are on the verge of collapse as we speak and are only keeping going thanks to a Wall Street-style ‘extend and pretend’ process of continually rolling over microloans that might not otherwise be repaid.

Mark Napier:  The issue was whether people who got loans should not have got them in the first place, but they were otherwise unfairly lent to.