6 myths of microfinancing

Over the years, I've been really impressed with the stuff I've heard about microfinancng charities like KIVA. The idea of helping people in developing countries launch and support small businesses, changing their lives and the lives of their children, makes a lot of sense. And the personal stories that go with microfinancing are pretty appealing.

I'm starting to re-think my opinions on microfinancing, however, after reading some of the research done by GiveWell.org, an organization that casts an evidence-based eye on what different charities do and whether they actually get the results they claim.

It's not that microfinancing is bad, per se, GiveWell says. It's just that the system doesn't measure up to the hype. And if you've got a limited amount of money to spend on helping other people, there might be more effective ways to do it that produce more bang for your buck.

GiveWell has written a ton on this, but I'd recommend starting with a blog post of theirs from a couple of years ago called 6 Myths About Microfinance Charities that Donors Can Live Without. This piece provides a succinct breakdown of what questions you should be asking about microfinance charities, and provides lots and lots of links for deeper digging. The myth that surprised me the most:

Myth #6: microfinance works because of (a) the innovative “group lending” method; (b) targeting of women, who use loans more productively than men; (c) targeting of the poorest of the poor, who benefit most from loans.

Reality: all three of these claims are often repeated but (as far as we can tell) never backed up. The strongest available evidence is limited, but undermines all three claims.

• [Tommy Timefishblue]

  http://www.workers.org/2010/world/microloans_0304/

  • [Perch von Radical]

    Wow, biased article.

    • [Tommy Timefishblue]

      Like every article.

      • [Guest]

        at that site

        • [Tommy Timefishblue]

          I’m not a fan of workers.org in general, but I don’t see what’s wrong with this particular article. Do articles only count as unbiased if their bias is neoliberal? Because the bias is so prevalent in the media we’re exposed to all the time that it’s become background noise?

        • [Guest]

          Timmy, what strawmen you erect….

• [Jesse]

  There’s also a good empirical econ paper on microfinance by a few of the big names from MIT’s Poverty Action Lab, here: 
  http://econ-www.mit.edu/files/4162 The basic takeaway is “the effects are nuanced and vary a LOT by household.”

• [Aaron Huslage]

  I believe that Charities are really bad at the whole Microfinance thing and that the real broad-based success stories are seen when Banks are created to do this work. Investment and accountability can create a climate that helps to make things work better. Look at Grameen Bank in Bangladesh as a good example of this. 

  Charities are part of the problem in many poor places. They have failed to create stable, sustainable institutions of finance, governance and livelihood so people get stuck where they are at. Microfinance is definitely only one piece of the puzzle, but a good one when done correctly.  

  • [Hugh Stimson]

    This seems like a somewhat semantic argument. Grameen Bank could reasonably be described as the first of the microfinance non-profits, and the model for those that came after. They receive funding from a variety of contributors and in turn distribute microloans to the poor.

    They are not a for-profit bank in the traditional sense.

  • [Maggie Koerth-Baker]

    Actually, if you read through GiveWell’s research, it seems to suggest that loans, from anybody, aren’t necessarily the best way to do this. Although systems that help people build up savings could be. 

    • [EH]

      “Money doesn’t solve everything.”

  • [Guest]

    Charities do it for intangible reasons, banks do it only for tangible reasons? Something along those lines.  The opportunity cost of one’s own ego can be really high.

  • [ZikZak]

    Charities [...] have failed to create stable, sustainable institutions of finance

    Yeah, as opposed to the unshakably stable and sustainable financial system that the banks have given us.

• [Kieran Manners]

  Third world usury is freaking sweet and definitely won’t be something we look back on with regret. Don’t worry, this isn’t the same thing as that nasty third world debt that has broken the backs of developing countries for the past half century, because THEY didn’t have a lovely earth-toned website and a social media presence! 

• [Royce]

  Yeah, that evidence is is extremely limited, which suggests this overwhelmingly negative tone is a bit premature. I have had a blast with Kiva over the last ~3 yr. I’ve yet to get a delinquency or default over the course of a few hundred loans. I hadn’t really considered whether they used the money for the stated purpose.  If they do not, this suggests that a fair number of updates are, in fact, fraudulent. On thinking about this, I find I don’t really care.

  I don’t view it as charity at all- simply a better use of my savings. On average I think every one of my kiva dollars has been loaned out 7 times.  Even considering inefficiencies, or whatever, the system allows me to participate about at 20x the level I can give annually to charity *and* this money revolves over twice a year, on average.

  It’s amazing … I can lend money that I wouldn’t otherwise use to someone on the other side of the world, especially because my income [pathetic by US standards] is ~5-20x  larger than these borrowers… I guess my opportunity cost is $50 in interest or something.

  • [Tommy Timefishblue]

    Yes, the evidence here is limited compared to the evidence that’s come from the blast of an experience you, Royce, had, as someone whose enjoyment is irrelevant to whether or not microlending actually helps any poor people.

    • [Royce]

      Ultimately yes I have to take the word of the orgs involved that the microlending is a helpful practice. Perhaps you are right and the updates from “apparently” pleased Kiva entrepreneurs are actually coerced by usurious third world thugs.

      I find nothing that in reading on these ‘myths’ to suggest that micro harms people. I only see uncertainty added to generally positive claims.

      • [SedanChair]

        It sounds like you’ve decided not to look too hard. Congratulations, you’re an amoral financier!

        • [Royce]

          If you are not trolling, please show me the damning evidence that I missed. All I observed was uncertainty, faulty metrics, and a lack of good data.

      • [svyoder]

        Evidence that microfinance hurts many poor people:

        Is Microfinance Pushing the World’s Poorest Even Deeper Into Poverty?
        http://www.tnr.com/article/world/98499/microfinance-drive-poverty

  • [svyoder]

    Too many Kiva lenders suspend critical thinking because they love the Kiva-manufactured experience and “story” that microfinance is single-handedly saving the world that the resent or ignore evidence to the contrary.
    The hype-driven microfinance bubble has led to championing microloans over everything other kind of approach, and for-profit microfinance is leading to a form of third world ‘sub prime’ overindebtedness. Inadvertantly, Kiva is causing a situation where poor people who have little or no business skills, and are financially naive, borrow beyond their ability to repay – thus pushing them further into poverty:

    Too Much Microcredit? A Survey of the Evidence on Over-Indebtedness
    http://www.cgap.org/gm/document-1.9.55377/OP19.pdf

• [Bob Harris]

  Occasional guest-blogger here, jumping in. Hi! Giant fan, Maggie. Your writing is constantly clear, well-thought-out, and fun. Thanks for existing!

  I’ve spent the last three years working on a book about microfinance, and to that end I’ve traveled to visit microlending institutions and their clients in enough countries that I’ve lost count — top of my head: Peru, Bosnia, Poland, Lebanon, Morocco, Kenya, Rwanda, Tanzania, India, Nepal, Vietnam, Cambodia, the Philippines… you get the idea. I’ve also made more than 3800 Kiva loans myself, managed a lending team that has raised more than $1.4 million, and gotten to know the folks at Kiva pretty well.

  The critiques on the page linked here are correct as far as they go. But the whole “debate” about microfinance is a bit strange.  It’s a tool, nothing more or less. Nobody debates whether a hammer “works.”  It depends on what you do with it.  When microfinance is practiced well, it rocks.  When it’s practiced poorly, it sucks.  Just like a hammer can be used to build or home or destroy it — very much like that, in fact.

  Usually, it’s used pretty darn well.I’ve met way too many families all over the world whose lives were changed for the better because they had a wider range of financial choices. I could tell you individual stories, and they’re all moving and cool and funny and wonderful, but granted, that’s anecdotal evidence. But look at the numbers. The explosive growth of the practice is voluntary. And poor people are as smart as you and me—they’re just poor. With rare exceptions, they haven’t been fooled into signing up by the tens of millions.In fact, lots of responsible lenders require potential clients to take free training in goal-setting, financial literacy, and even health education before they’re even eligible for a loan. For every SKS, there are dozens of places like Urwego in Rwanda or Juhudi Kilimo in Kenya where the clients’ welfare is paramount, even though it’s a profitable business.The trick is in coming up with lending practices that fit the local economics and culture.  And that’s not something you can scale or characterize globally.

  Microlending has also created the very platform upon which other and potentially more useful services can be offered, including savings, insurance, and money transfer—this last being the most overlooked part of the economic lives of the poor. 

  Do I wish more Kiva lenders realized that they’re actually re-funding loans that have already been made? Yes, of course. But I know it, and I still make loans almost every day, because, as the link notes, that’s a good thing, and the only practical way the system can even work.

  Is the empirical, peer-reviewed evidence that microlending “works” lacking? Absolutely—in large part because useful studies would be almost impossible to design, thanks to an inability to control other factors.  (David Roodman, a microfinance agnostic whom I’ve interviewed and admire, and who is quoted so frequently in the link, includes a lengthy section in his book about how extremely difficult it would be to do a useful study that controlled for other economic factors.)

  But am I certain, after following the practice first-hand around five continents, that the practice often changes lives for the better? Absolutely, with ripple effects of hope, communication, and the knitting together of communities (sometimes in postwar environments, where this is essential) that are impossible to qualitatively measure but are no less real.

  In any case, it’s in more than 100 countries, so the practice isn’t going away.  The discussion now needs to move from “are airplanes a good thing?” to “how do we make sure airplanes crash less?” and “how do we get airlines to learn best practices and tailor their services better?”  That would be doing everyone—including, most especially, the clients in the field—the biggest favor.

  My two cents, anyway.

  Thanks!

  Bob Harris

• [Jamie Osborne]

  Welcome to the party! MF has been getting beaten up by development theorists for quite a while.

  There is huge power that middlemen loan coordinators have over the loan recipients, that result in predatory loaning practices and further oppression of the landless poor. Loans require no collateral. There is no regulation of these secondary loan agents so interest rates skyrocket.

  Is important to note that Grameen (and Kiva) may describe the goals of their work as social improvements, but they are getting seriously paid. They have access to cheap resources through an unending supply of lenders and an infinite supply of customers, poor loan recipients. Access to finances is the seen as a cure for poverty, but it is really a lack of access to power that keeps the poor in place. Financial development strategies that don’t address this are only good for enriching the lenders.

  Berkeley’s Anaya Roy has been especially effective at hammering the issue of poverty capital and the continuation of typical exploitative practices (micro-exploitation). She’s a brilliant, critical development rock star. I highly encourage digging through her work to better understand the complex relationships between poverty and development.

  http://www.fpif.org/articles/poverty_capitalism_interview_with_ananya_roy

• [questions]

  You should be careful about taking advice from Givewell. They have a history of astroturfing, lying about competition and covering up their actions. The people who were caught doing this still run the company. They were caught on Metafilter.
  See:
  http://mssv.net/wiki/index.php/Givewell
  http://metatalk.metafilter.com/tags/givewell

• [KanedaJones]

  We’re either all going to support people, or we’re not… the real mythology is the dichotomy between the “deserving poor” and their opposite.

  You will never know who the deserving poor are.

• [geetus]

  It should also be pointed out that Givewell has a big fat “Mistakes” button on the top of their homepage that includes the astroturfing incident and other problems they’ve had.

• [Kevin Cotton]

  Please do not perpetuate this nonsense.

  GiveWell’s ‘studies’ are self-referential garbage.

  They might as well be saying ‘not to give money to people that don’t pay us or we don’t get a piece of’.

  A lot of blog posts don’t really necessitate any real due diligence but commenting on a system that apparently challenges the status-qua enough to get this kind of attention deserves, at least, a cursory look at the source and intentions/ramifications.

• [AbleBakerCharlie]

  I don’t know anything about GiveWell’s cred, but in the larger view, I’ve thought the data has suggested for a long time that microfinance did not have the powers often attributed to it. It had all sorts of pleasing aesthetic characteristics- acknowledging that the poor are capable of being entrepreneurial like anyone else, and offering the allure of a self-sustaining, surgical intervention- that getting this person a new roof or this person a motorcycle would unwedge the human capital trapped in villages and slums, and they’d finance their neighbors loans, and it’d all pick up steam. It’s a satisfying vision- with the even more satisfying primate element of generating a steady stream of testimonials, without fail. 

  It’s been some time now, however, since folks like Sachs and others made pretty convincing arguments that the “aid trap,” of countries steadily consuming aid past the timescales where the aid-giving countries had themselves developed, was uniformly the result of two factors- insufficient lump payments to create productive public infrastructure rather than paying for its products, and corruption siphoning off said aid and leading right back to the former condition. Microfinance might buy the aforementioned motorcycle, but it cannot buy the roads they require to shuffle goods around, nor ensure that taxing the owner of said motorcycle will fund more roads versus the palace of the local bureaucrat. Playing Cold Wars games certainly didn’t help with the good governance requirements that would help aid stick- but once again, microfinance doesn’t provide a means for leverage.

  The studies that have been done have been fraught, but have confirmed what you might have guessed from your own life- that someone dropping $100K in your lap might be sufficient to fund a business or pay for a degree and thus kick you into entirely different social strata, but that handing out $500 will pay a bill, pay for Christmas, whatever- and having to pay it back likely disincentivizes a choice to use said capital in something fundamentally risky like business versus just covering expenses. Which is fine- but it’s not generally what’s on the label.

  The second major element that’s always bothered me is the scant acknowledgement that historically (and presently) lending to the poor in the developed world is fraught as it is- for both parties. Without the buffering capacity of extant capital and valuable labor to ensure employment on the part of the lendee, lending to the poor is inherently risky, which leaves two choices- devoting some fraction of your capital as a hedge to ensure repayment (enter the rough dealing of loansharks and payday loans,) or ignoring said risk by attracting further investment with the lucrative returns to date, and be in a rush to move capital out the door to less and less qualified applicants and wait for the default rate to explode in your face (the subprime mortgage bubble.) Certainly at the beginning, the situation was less charged- if those funding the loans were viewing their outgoing cash as charity, any amount of repayment at all was functionally matching funds. Now that microfinance has grown, there are steadily growing signs that it’s one more stop for the global money train, who very much like their money back, and it’s been some years since I first say reports that the likes of Kiva and Grameen had more money than they did applicants…

• [David Tyler]

  GiveWell’s modus operandi, since their inception, has been to badmouth other charities on internet forums in an attempt to raise their own profile and attract donations. They have identified a cashflow, and inserted themselves as middlemen to scoop off a percentage. They’re the non-profit sector’s equivalent of StubHub.

   The other thing they spend a lot of time doing is trying to justify their outrageously high overheads – I remember that at the time their founder was caught red-handed astroturfing on Metafilter (and boy, did that cause some outrage!), their overhead was in the region of 50% (yes, they were trousering half of the money that people thought they had donated to charity).

  And surprise surprise, here they are talking down competing methods of supporting development in which they don’t get a piece of the pie.

  Please don’t treat them as a credible source of information.

• [Jonathan Roberts]

  “At the time of independence in 1971, 20 percent of the population was landless. By 2009, this had risen to more than 70 percent of the rural peasant population.”Some of the statistics like this one as well as the implicit assumption that the country’s troubles can be all traced to microfinance make me question their conclusions. On the other hand, assuming that indiscriminately distributing loans to uninformed poor people will improve their lives as well as making lenders richer seems to be quite similar to making the same assumption about mortgages in the west.

• [Jay Stephens]

  Many-time kiva lender here.
  Every time MF or Kiva specifically has come in for bad press, I’ve followed it up, read the sources, and been underwhelmed.
  I think the consensus is:
  MF works in many cases, makes things worse in some cases
  MF is sometimes falsely “touchy-feely” at the front end
  MF sometimes hides field agents with unfair interest rates
  MF sometimes makes the wrong call about where to draw the line for supported projects (e.g. Kiva field agents lending to cock-fighting establishments).
  All in, I think there’s a significant net positive from small lenders dodging some first world problems and lending money to people who, lets face it, would otherwise often turn to loan sharks or worse.
  Having said that, for those who DO lend thru Kiva et al, it is totally worth taking an extra 5 minutes checking out the field partner and the recipient in as much detail as you can before clicking “Lend”.

• [stephenl123]

  If you want real, well researched, info on micro-finance, try:  http://www.ffhtechnical.org/

• [James Cook]

  Dunno what the statute of limitations should be on bad behavior online, but GiveWell’s founders were punished by their own board in 2007 for online misrepresentations. The two people punished are still in charge, per their current “People” page:

  Founder of a Nonprofit Is Punished by Its Board for Engaging in an Internet Ruse
  http://www.nytimes.com/2008/01/08/us/08givewell.html

  Nonprofit Punishes a 2nd Founder for Ruse
  http://www.nytimes.com/2008/01/15/us/15givewell.html

  Holden and Elie are still listed as being in charge:
  http://www.givewell.org/about/people