Can Microfinance Save the World?

Bruce WydickProfessor of Economics

University of San Francisco

No, microfinance cannot save the world.

Can Microfinance Save the World?

• What is microfinance?

• Personal experience

• Why don’t free markets provide credit to the poor?

• Growth of microfinance

• What drives high repayment rates?

• Does it help alleviate poverty?

• New issues in microfinance

What is microfinance?

• Movement with origins in Bangladesh

• Muhammad Yunus—Why doesn’t economic theory work for the poor?

• Beginning of Grameen Bank, 1976…

• http://www.youtube.com/watch?v=YxpTFwQx-A8

KQED Studios, January 2008

What is microfinance?• Many very small loans to the poor ($10 up

to $10,000+)

• Typically weekly, bi-weekly, monthly installments

• Loans go for small-scale entrepreneurial activity

• Usually for existing businesses, skills

• Urban, rural areas

• Allow the poor to participate in capitalism

Personal Experience• Dominican Republic 1988, Costa Rica 1989

• Berkeley Dissertation

• Dozen or so research articles related to group lending, impact of microfinance, credit information systems

Growth of Microfinance:• As of January 1, 2007, 133,030,913 households reportedly reached with microfinance, up from 13,478,000 reported in 1997. (Microfinance Summit)

• 92,922,574 were among the poorest when they took their first loan.

• 85.2 percent (79,130,581) are women entrepreneurs.

• Assuming 5 persons per family, the 92.9 million poorest clients reached affected some 464,612,870 family members.

What is responsible for growth in microfinance?• Not because of proof that it reduces

poverty

• Appealing to all ends of political spectrum!

What is responsible for growth in microfinance?• Not because of proof that it reduces

poverty

• Appealing to all ends of political spectrum!

Liberals:Empowers WomenReaches PoorestPro-ArtesianBenign on Environment

Pragmatists:Requires little/no subsidyLess costly than a revolutionNon-controversial

Conservatives:Not a handout, welfareIncentives for workProperty rights basedPro-Capitalism

The Political Spectrum

What makes credit markets unique?•In some markets we have full information…

•Asymmetric Information in other types of transactions

• Problem of Adverse Selection

• Problem of Moral Hazard

• Strong theoretical basis for intervention in credit markets

• (See S&L crisis, sub-prime mortgage crisis.)

Underlying reason why the poor are denied credit!

What about repayment rates?• Typically very high, 95-99% if best

practices followed.

• Some problems• government programs with giveaways

• correlated shocks to areas

• poor portfolio management

What drives high repayment rates?1. Skilled use of loan officers

Branch OfficeBranc

h Office

MAIN OFFICE

Branch Office

Branch Office

Branch Office

What drives high repayment rates?2. Group Lending

Branch Office

Branch Office

(Jointly Liable Groups)

Helps address:Adverse SelectionMoral HazardAdministrative Costs

Can Social Cohesion be harnessedas collateral for loans?

What drives high repayment rates?3. Dynamic Incentives

$ $ $ $ $ $ $ $$Problem: What happens when there are multiple lenders?

Does microfinance make a difference?

• This is a more difficult question than one might think…

Several problems:

• Self-selection bias

• Non-random program placement

• Measuring long-term effects (problem with experiments)

How do we measure microfinance program impact? (Crummy Ways)• "Super Naïve" method: Ask people if

program is helping them.

•"Naïve" method: Survey non-borrowers vs. borrowers

•"Still Pretty Lousy Method": Compare Old vs New borrowers

•"Sophisticated, but Still Pretty Lousy Method": Use matching models and propensity scoring to obtain a control group.

How do we measure microfinance program impact? (Better Ways)• Use "Difference-in-Differences" method on

treated and untreated groups (Problem: require baseline surveys)

• Use an "Instrumental Variable" to achieve identification of impacts; correlated with uptake but not impact. (Problem: a good IV is often hard to find.)

• Run a "Randomized Field Experiment" in which treatment groups are randomly offered credit. (Problem: hard to hold off borrowers from credit)

•Use "retrospective data" focused on the probability of fundamental events to a household; borrowed from finance "event studies".

Does microfinance make a difference?

Does microfinance make a difference?

Does microfinance make a difference?

Does microfinance make a difference?

Does microfinance make a difference?

Does microfinance make a difference?

New Innovations: Credit Information Systems• Problem with too many microfinance

lenders

•Difficult to ascertain debt load of a new borrower

•Need credit information system: Allows lenders to view both positive and negative information about borrowers.

•Greatly facilitated by the Web.

New Innovations: Credit Information Systems• Implemented a field experiment in Guatemala to test the effects of a credit information system among microfinance providers. • Involves installation of hardware and software used for the credit bureau between March 2002 and January 2003 in 39 branch offices of microfinance institution in Guatemala. • Had significant effect on both delinquent payments and defaults.

0

24

68

Pe

rcen

tage

s

-10 -5 0 5 10Months from rollout

> 2 mos delinquent Defaulted

Rollout: Changes in Default

New Innovations: Kiva.org

New Innovations: Kiva.org

New Innovations: Kiva.org

New Innovations: Kiva.org

Name: Virginia Chiquito

Business Name:

Gabinete de Belleza

Location: Guayaquil, Ecuador

Primary Activity:

Beauty Salon

Loan Requested:

$1,000.00

Repayment Term:

10 months - repaid monthly

Loan Use: Invest in furniture for the shop

Date Posted:

May 7, 2007

Date Funded:

May 9, 2007

Disbursal Date:

May 12, 2007

Loan Ended:

Mar 12, 2008

New Innovations: Kiva.org

l

Name: Victor Cisse

Business Name:

1169 -imcec thies

Location: THIES, Senegal

Primary Activity:

Manufacturing

Loan Requested:

$950.00

Repayment Term:

12 months - repaid monthly

Loan Use:Purchase of leather and hides to strengthen stock

Date Posted:

Mar 12, 2008

Date Funded:

Mar 13, 2008

Conclusion:•Can microfinance save the world? No, but it can make it a better place.

•Proper way to view microfinance: As a stepping stone.