The Pros and Cons of Microfinance – A View From The Field (Part 2)

By Nick Hamilton, KF13 Haiti and Dominican Republic, KF14 Colombia

This is the second of a three-part article on ‘The Pros and Cons of Microfinance – A View From The Field’. The first part concentrated on the pros. The second will focus on the cons.

Most of the cons described below demonstrate one thing; microfinance assists on a micro level but is unable to affect macro-level influences. The latter are the main reason that people are impoverished in the first place.

During my time in Haiti and the Dominican Republic I generally found that there were two major obstacles that thwarted the success of microloans. The first was a lack of borrower education. While they can’t go as far as sending borrowers back to school, MFIs can certainly play a part in providing additional training. It’s not a quick win, but it’s a very effective one. Giving borrowers options of training courses in a variety of sectors allows them to broaden their horizons, pursue something they are interested in and, importantly, gives local communities a good chance of diversifying.

The second obstacle is a lack of everything that results from effective national governance: a strong economy, a functioning infrastructure, a lack of corruption.  Unfortunately, the MFI is powerless to affect these national-level influences.

Fixing the chain on the way to a repayment meeting in Haiti. Poor roads thwart borrowers and MFI loan officers alike.

If terrible road conditions prevent a borrower from traveling to the nearest large town to sell her produce in a cost-effective manner, the MFI can do nothing to change this situation. If communities have no electricity, no running water, no gas line and a terrible education system, the scope of what their people can achieve in entrepreneurial and development terms is incredibly limited.

In Haiti, more often than not borrowers would tell me that their main business challenge was a lack of frequent buyer activity. They couldn’t grow their business because people didn’t have enough money to buy their products. Practically no-one kept a strict 9 to 5 schedule because the demand wasn’t there. An MFI can’t affect a country’s economy.

My experience in the DR and Haiti (but especially in the latter) has shown me that a lot of development-focussed charity (i.e. not including medical/relief work) is pretty limited on a national level when conducted in countries lacking in infrastructure, stable economy and, above all, effective government. An honest and successful government with a clear direction is key.

If microfinance were to be successful across the board (and by success I mean real, tangible business and income growth) it would have to work on the assumption that all clients are natural entrepreneurs, or at least have a knack for making a business work. This is not the case. The fact is that most people, wherever they are in the world, are more suited to working as an employee than running their own business.

Food stall in Haiti

Furthermore, a community will not progress if it is only made up of tiny, one-man businesses. On one hand the problem is a lack of business variety. There is no benefit to a 30-family community if 10 people sell second-hand clothes and another 10 run small convenience stores. There is no benefit to the individual ‘entrepreneurs’ either. However, this is a reality. I’d say that around 90% of the borrowers I met in the DR and Haiti used their loans to invest in one of these 2 lines of business. This comes down to a lack of education, skills and knowledge of other industries. Again, I really think that this is the one offering that all MFIs should look to develop, if they have not already.

On the other hand, this also highlights a fundamental flaw of the Grameen group model, if its intention is to develop communities and society as well as the individual (often the two go hand-in-hand). The Grameen model gathers large groups of people and hands them loans to go and pursue a business practice as an individual. When I walk the streets of London I do not see a string of one-man businesses, incredibly limited in scope. I see a vast variety of businesses, ranging greatly in size, but all of which share one thing: employees. A community needs businesses of a certain size to progress.

Group lending has its pros (see Part 1 of this article) and its cons

Microfinance is supposed to promote business growth. If anything, this model is stifling it. It would be far more beneficial to all if MFIs assessed their potential borrowers and only lent to those individuals who showed enough promise to mount and grow a business to a size where they could employ other members of their community. However, such is the nature of the third world and the cost of administering loans that if MFIs in these countries did this they would not be sustainable. In this regard, I actually think the Grameen group model can be counterproductive in terms of economic development. I also think that it discourages some borrowers (especially males who are not obliged to stay at home) from venturing out of their communities to find better paid jobs at larger businesses. Simple job creation isn’t always a good thing.

One criticism I have of what I saw at Esperanza International is that loan sizes were too small. Loans generally ranged between $100 and $300 and, if borrowers repaid their loans in full and on time, they may have been granted a $50 increase on their next loan. That’s not enough to mount a serious business that’s going to go anywhere. It’s easy to say but I’d like to see MFIs like Esperanza International take a bigger risk on promising clients by offering them larger loans. I’d also like to see Kiva let its lenders share some of that risk by increasing its loan size limits. In addition, if entrepreneurs cannot inject enough cash into their business, when something goes really wrong (e.g. a farmer loses half his cattle or a borrower becomes incapacitated) then entrepreneurs may regress back to square one and lose all progress that has been made thus far.

What I saw was that most businesses were not actually growing but were just being sustained. It’s wrong to believe that all microloans will necessarily lead to business growth. I once saw a borrower on whose profile stated that he was applying for his 18th loan. It’s unlikely that this borrower was successfully growing his business.

Finally, one of the biggest bones of contention that people have with microfinance are the ‘high’ interest rates. I won’t delve into interest rates too much because I’m sure that in most cases they’re completely justified. Kiva’s assessment of MFIs is now thorough enough that they would not become partners if they were in any way usurious.

Many people who criticise high interest rates by comparing them to what they are used to in the developed world must understand that the two are incomparable. Loan sizes in the third world are far, far smaller and so the cost of processing that loan while remaining sustainable (or indeed making a profit) is much higher. Loan officers may travel for 2 hours to disburse a loan and will have to make the same journey for every repayment meeting. Road conditions may be so bad that half of the MFI’s fleet of motorbikes will constantly be under repair. Third world petrol prices are often incredibly high. The MFI may only have very slow internet for 2 hours a day, the electricity for which is provided by a high-cost generator. Country inflation rates may be extremely bloated and these need to be accounted for.

However, interest rates are high and require a borrower’s business to be run extremely efficiently if it is to turn a profit. With that I cannot argue.

To be continued in Part 3, which will published on Wednesday May 25th, 2011.

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