Microfinance

Evaluating Microfinance: CGD, IPA and other experiments

The CGD has a bunch of reports evaluating the impact of microfinance. The initiative is led by David Roodman, who authored the Microfinance as Business report (previously covered here). The article explains how their assessments are different:

Understanding how microfinance affects clients is not straightforward because there are several possible explanations for why, say, a borrower is doing well compared to her non-borrowing peers. The credit might be helping–or perhaps the borrower was already comparatively prosperous and would have fared as well even without the loan. These new papers elucidate cause and effect by performing controlled experiments, in which a few parameters are randomly varied and the effects measured.

Controlled Experiments?

The idea of ‘experiments’ sounds good. It gives scientific legitimacy to what are essentially social phenomena marked by multiple variables, complex correlations, and extraneous - often invisible - factors. I need to look at these reports to see just how ‘controlled’ they are.

Another organization that has been taking a similar approach to impact assessment is Innovations for Poverty Action (IPA). Genevieve has joined IPA and will lead a couple of evaluations in the Philippines, including one on group vs. individual lending that sounds awfully close to what the CGD has published.

I have two propositions for Genevieve that could lead to some interesting evaluation projects.

Experiment One: Social Impact - Profit vs. Development Benefits

First, there is an inherent tradeoff between microfinance as a business and as a development tool. Microfinance will largely benefit one of two stakeholders - commercial enterprises and their shareholders, or poor borrowers. As Muhammad Yunus recently made me realize the two are mutually exclusive.

So, how may one test this assertion? Evaluating the interest rates offered by MFI’s and asking the following questions may offer a few clues:

• How do MFI rates compare with what a money lender was offering?
• How do they compare to those of Grameen Bank - which says it can offer lower interest rates by being ‘non-loss, non-dividend’.
• Is there a trend towards higher interest rates, the higher the commercial pressure on an organization? Do banks offer higher rates than independent MFIs, than grassroots NGOs?
• Did an MFI’s interest rates go up after it partnered with a bank?
• Have aggregate interest rates gone up over time, as the need to prove development benefits has gone down?

This is an important test, because if true it allows us to categorize MFIs into two groups and then test for development impact across them. It may also show that most MFIs today embrace the rhetoric of a ‘market based development solution’, ignoring the fact that development benefits accrue only when the solution is priced somewhat below the market rate (set by the money lender). In other words, the major benefit of these providers is to expand the market by bringing in external funds, not any development impact, per se.

Experiment Two: Generating Enterprise - Equity vs. Debt

My second assertion is that microfinance is inherently flawed as a tool to create ’sustainable enterprise’. Studies show that microfinance ends up funding consumption of individuals. This may well be commendable in itself. However, if our goal is to create enterprise for long-term economic growth how can microfinance be more effective?

The problem is that the incentives of MFIs are not oriented towards generating sustainable enterprise. They are oriented simply towards repayment of loans. The latter is not an indication of success of the former. One way to generate private enterprise through ‘the market’ may then be to use equity, not debt, to fund micro and small entrepreneurs.

So, here’s another test. Do organizations which take equity stakes in micro and small enterprises (MSE) have a better incubation success rate than microfinance providers?

© 2007 The Discomfort Zone.