by David Whitehouse
Microcredit, pioneered in Bangladesh by Muhammad Yunus through Grameen Bank in the 1980s, was embraced by an unlikely coalition of Western development institutions, multinational banks, liberal altruists and self-help libertarians as a panacea for extreme poverty.
The original development goals of small loans for the poor were displaced as the prospect of a profitable new financial services industry beckoned. Early beneficiaries notably included women, some of whom were able to use the loans to achieve greater financial independence. But today, microcredit often feeds on the poor rather than helping them.
The costs of achieving scale in the microcredit industry are borne by the poor. There may not be any other way for scale to be achieved. But the burden of proof that extending microcredit at scale is beneficial to borrowers lies squarely with lenders. That burden of proof has not been met. Most statistical studies of the impact of microcredit on poverty do not produce strong evidence either way. Based on the limited evidence that statisticians accept as being robust, the average impact is about zero.(1)
Microcredit, the provision of loans, needs to be distinguished from microfinance, which also includes insurance and savings products for the poor. Selling insurance and savings products to the poor is harder work than offering loans, and much less profitable. Microcredit, which I’m writing about here, is the only industry which claims to help poor people while asking them through interest rates of 20% or 30% a year to not only cover the cost of creating an industry from scratch, but provide a quick profit as well.
Across the Global South, the aim of reducing poverty through microcredit has been quietly replaced by the soft, vague goal of “financial inclusion.” But making a transition from being a charity to being a profit-driven industry does not mean that the charity has been successful. It just means that the aims have changed and the profit motive has taken over.
Most Westerners would not use borrowed money to invest in the stock market, even to buy shares in large, reliable companies. Yet microcredit institutions lend to the poor to invest in their vastly more risky individual enterprises. An affluent Westerner who borrows too much or wastes the money is unlikely to meet financial disaster on that basis alone. For poor people, especially in the global South, such a miscalculation is a catastrophe. Microcredit does not provide an increase in freedom, but simply an accumulation of risk among the world’s poorest.
The contradiction inherent in the idea that there is no trade-off between microcredit profitability and poverty reduction is skirted with the notion of a “double bottom line.” The industry wants to make a profit and it wants to have an impact. But there can be only one bottom line, not two. The microfinance industry has grown faster and more profitably than even its most optimistic founders imaged, but the impacts on poor populations have been at best moderate and at worst damaging.
One estimate is that there is a small minority of microcredit winners of about 5% while at least 10% of borrowers become worse off, with that percentage much higher in markets where there is an oversupply of microcredit.(2) The losers are concentrated among those who can least afford the blow.
Microfinance institutions (MFIs) in the early days received most of their funding from public international financial institutions, aid organizations and governments. The sources of funding were gradually diversified to include private-sector banks. The presence of these large institutions meant that microfinance became skewed towards microcredit rather than savings. As David Roodman has argued, the reckless overlending which took place, for example, in India and Bosnia would probably not have happened if the MFIs had been using the savings of the poor to lend, rather than funds from banks and aid agencies.(3)
A report published by the World Bank describes the rapid growth in microcredit in Cambodia as a “flight to quality” as a result of the 2008 global financial crisis.(4) The truth is more unsettling. At the start of 2019, around 2.4 million Cambodians out of a population of 16 million had at least $8 billion in outstanding microloans. The average loan was around $3,400, the highest in the world for such loans.(5)
With effective annual interest rates of up to 30%, nearly one in three of the households had monthly loan repayments that they could not make.(6) That was before Covid-19, which killed the tourism industry and has now led for the first time to a full lockdown in the capital Phnom Penh.
Some have argued that microfinance can contribute to the advance of democracy through economic empowerment.(7) This is simply naive in the context of an authoritarian system such as that of Cambodia. Property rights in Cambodia were abolished by the Khmer Rouge in the 1970s and today, a clear, legally predictable system of hard property rights does not exist. Most property rights are “soft” and thus open to being revoked by central or local authorities whenever convenient.
Local commune and village authorities, the foundation of the national power structure, issue many of the land titles that microcredit lenders require as collateral. Microcredit providers are more likely to turn to these authorities in case of dispute with a borrower than to the courts. The scope for local power structures to use their discretion over unpaid loans as a means to further the ongoing crackdown against the country’s banned opposition is clear.(8)
The reality of trying to service these loans is often effective slavery. In Cambodia, children and adults alike work as brick factory slaves to try to pay their debts.(9) Research from Cambodian human rights organisation LICADHO has found that microcredit is a driver of migration to Thailand and a contributor to human trafficking. Lenders were found to directly encourage migration by only giving loans if a family could prove they had a member working abroad.
A telling detail of this research is that the name of the village where the fieldwork was done was withheld to protect inhabitants from reprisals. In a context of authoritarian rule, microcredit is part of the problem, not part of the solution. Cambodia’s lack of hard land rights resulting from the Khmer Rouge years makes it perhaps the most obvious example, yet microcredit has the potential to be used to quash dissent wherever authoritarianism exists.
The author: David Whitehouse, PhD (@whitehouse789) was the co-author of We Didn’t Start the Fire: My Struggle for Democracy in Cambodia, the English-language autobiography of opposition leader Sam Rainsy which appeared in 2013. He is currently completing a book about missionary activity in colonial Rwanda and Burundi. He is business editor of The Africa Report published by Jeune Afrique in Paris.
Notes and Sources
Top photo by David Whitehouse shows small-scale Cambodian farmers. Agriculture is the type of activity that microcredit is often used to expand.
1. David Roodman, Due Diligence: An Impertinent Inquiry into Microfinance, (Washington: Brookings Institution Press, 2012), 141.
2. Lesley Sherratt, Can Microfinance Work? How to Improve Its Ethical Balance and Effectiveness, (Oxford: Oxford University Press, 2016), 122.
3. Roodman, Due Diligence, 263.
4. Pasquale Di Benedetta, Ira W. Lieberman, Laura Ard, Corporate Governance in Microfinance Institutions, (Washington: World Bank, 2015), 11.
5. LICADHO, Collateral Damage: Land loss and abuses in Cambodia’s microfinance sector, August 2019, 1.
6. W. Nathan Green, “Regulating Over-indebtedness: Local State Power in Cambodia’s Microfinance Market,” Development and Change, October 2020.
7. Miriam Ronzoni and Laura Valentini, “Microfinance, poverty relief, and political justice,” in Tom Sorell, Luis Cabrera, (eds) Microfinance, Rights and Global Justice (Cambridge: Cambridge University Press, 2015, 84-104.
8. Green, “Regulating Over-indebtedness”.
9. LICADHO, Built on Slavery: Debt Bondage and Child Labour in Cambodia’s Brick Factories, December 2016.
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