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Taking a Closer Look: The Images of Microfinance

Hugh Sinclair Posted by Hugh Sinclair, COO - Economist - Author, Alliance Microfinance.

Hugh Sinclair works in turnaround management, helping ailing Microfinance Institutions in accounting, software automation, rescue strategy, and doing due diligence.

Taking a Closer Look: The Images of Microfinance

India Microfinance

The image: a local, smiling woman sitting in her hut with a newly-purchased sewing machine, surrounded by her grateful children and her friendly next-door neighbors.

Unfortunately this picture is a myth. Here’s why:

  • Such cases are surprisingly hard to find in practice.
  • The clients are not always female, and quite often men deliberately send their wives to get loans because they know they are more likely to be approved.
  • Loans are invariably not spent on the productive sewing machine, but on a new TV, repaying another loan to a similar bank, paying other bills, or generally consumed. The microfinance institution does not generally ask what the loan is going to be used for, and even if they do, they don't much care. All they want to know is that it will be repaid. The benefits of the cash quickly disappear, but the debt remains while accumulating interest at an alarming rate, often encouraging the ‚“micro-entrepreneur ‚” to obtain another loan elsewhere to meet the repayments, and often from the very moneylenders the microfinance community claim to replace.
  • Interest rates on loans, when all the various hidden charges are considered, are substantially higher than those stated. Interest rates under 30% a year are disappointingly rare, and rates approaching 100% or higher are disappointingly common.
  • The small business, if one exists at all, is rarely able to generate sufficiently massive returns over prolonged periods of time to cover all its costs including interest payments. Even if it does offer some genuine improvement to the life of the individual entrepreneur, it is quite possible that this is at the expense of other people in the marketplace. When a superstore opens in a small town in America, many smaller shops are driven out of business. According to the microfinance sector this phenomenon does not occur in developing countries. Microfinance has somehow managed to defy the basic laws of economics.
  • The supposedly abundant supply of entrepreneurs in developing countries has not actually been demonstrated. It is assumed that every poor person is a budding Steve Jobs, one business idea away from a big break-through. A quick glance at the overwhelming majority of businesses that receive microloans hardly suggest cutting-edge innovation -- most market traders sell precisely the same trinkets as everyone else in the marketplace, while the number of people buying these trinkets remains unchanged.
  • The impact of child labor is a carefully avoided question. The reality is that many micro-enterprises employ their own children, and no one really knows the impact of such labor long-term. As universal education becomes a reality in more and more countries each year, it is likely that some proportion of these children are stacking shelves or selling cellphone credit at the expense of an education. Conveniently, few microfinance banks and only one microfinance fund have policies on child labor. Even the self-regulatory watchdogs avoid discussion of the child labor in their so-called ‚“Client Protection Principles. ‚”
  • The majority of the microfinance clients are not at the bottom of the pyramid, or the ‚“extreme poor ‚” as the sector prefers to call it. In fact, quite a few are perhaps best described as lower middle-class, and while it is a pity that their own commercial banks won't lend them money on reasonable terms, it does not follow that a microfinance bank offering them a loan at 60% interest a year is necessarily contributing to development.
  • To a large extent, the clients of most microfinance bankers are not protected by the regulatory protection afforded to people in more developed countries, and are rarely applied even where such regulation does exist.
  • By joining groups of borrowers who guarantee one another's portion of the loan, the defaulting client not only incurs the wrath of the bank, but they also their colleagues, who are obliged to step in and meet the shortfall.