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Does Microfinancing Really Work? A New Book Says No (TIME)

January 6, 2012

Senior fellow David Roodman was quoted in a TIME magazine article on his new microfinance book Due Diligence.

From the Article:

Politicians from Washington to New Delhi have argued for years that giving tiny loans to poor people to help them start or expand their businesses is a sure-fire way to help millions improve their lot in life, and drastically reduce global poverty, especially among women. The idea has become such a central feature of foreign aid programs (USAID pours millions into such projects) that the microfinance industry has ballooned into a multi-billion-dollar business operating in virtually every country on the planet. The question is: Does it work?

Unfortunately, only sometimes. That's the conclusion of an exhaustive new study of programs across the world, published on Thursday, which details how many loans leave poor people even more desperate than before — or at least, barely improves their circumstances. "On current evidence, the best estimate of the average impact of microcredit on the poverty of clients is zero," writes David Roodman, author of the new book Due Diligence and a senior fellow at the Center for Global Development in Washington.

Roodman's assessment is far different from the enthusiasm microfinance programs have generated since the first institution, the Grameen Bank in Bangladesh, opened in 1976. The bank's founder Mohammad Yunus won the Nobel Peace Prize in 2006 and is probably the third world's most celebrated economist. (PHOTOS: Below The Line: Portraits of American Poverty.)

The reality which Roodman found is far more complex than Yunus's original idea that millions could be lifted out of poverty if they only had access to credit — something regular banks have always been loath to offer. Roodman gathered evidence over three years from hundreds of lenders and borrowers in microfinance institutions — some with loans as small as $2 — in part by blogging about the issue on the center's website, and then posting his book online, chapter by chapter, as he wrote it, generating a furious global debate about the issue.

With his book now finally published in full, the findings are sobering. Although microfinance organizations have earned a reputation among U.S. and European aid agencies for having a remarkably high repayment rate on their loans — often a lot better than regular banks — Roodman found that some institutions' impressive repayment records come with a tragic price to borrowers.

In Bangladesh, for example, one researcher found women frantically borrowing money from their equally poor relatives, or choosing to forego basic necessities, in order to repay their microfinance loans. Most were terrified of what might happen if they defaulted — and had good reason to fear. Many microfinance institutions geared to women operate through borrowers' groups, in which each member is responsible for carrying the unpaid loans of others — so setting up intense peer pressure. "There are a fair number of stories where women cannot pay back their loans but they're in these groups," Roodman told TIME on Thursday. "So people come and take their roofs, flashlights, everything." (MORE: America's Poor: Why a New Measure Shows More People are Living in Poverty Than we Thought.)

Another failing of microfinance organizations, ironically, is the generosity of Western donors — a classic case of good intentions gone awry — who have rushed to support anti-poverty organizations which seem to yield some concrete results. Aside from the U.S., other major backers of microfinance programs in Africa, Asia and Latin America are the E.U. and the World Bank. "All the hype around microfinance has brought in more money," says Roodman. "There is probably an argument to grow carefully, step by step," he says. Instead, he says, there is "too much easy money from do-gooders." It has allowed institutions to lend money to people who might never be able to repay debts, and given them little incentive to generate their own funds. In addition, a 2004 U.S. law requires half of Washington's microfinance funds to go to very poor people, which Roodman believes increases the risks in their lives. "It is contrary to common sense," he says.

Roodman says the microfinance industry's giant success has allowed it to ignore perhaps the best way for poor people to improve their economic prospects: Saving money. Organizations have for years taken donations, then distributed that money to borrowers. Far from the perception that poor people have no money to save, Roodman found that many would prefer to save money for future emergencies rather than borrow cash to cover their immediate needs. "The more money we lend to microfinance institutions the more they can say we don't have to worry about savings," Roodman says. "Poor people can save, they just want safe places to do it."

Those changes are coming — in part because of challenges like Roodman's to the vaunted microfinance industry, and because big institutions like Grameen (now headquartered in a skyscraper in Bangladesh's capital Dhaka) have become major savings banks. The challenges are not only from analysts like Roodman. The industry's greatest shakeup might come in the form of mobile phones, with phone-banking organizations like Kenya's MPESA program spreading in Africa. With billions of mobile phones in the hands of poor people, Roodman believes phone-banking will soon overhaul the way microfinance operates — perhaps throwing up a phone-banking visionary for some future Nobel prize.

Read it here.