A twist on microfinance delivers new weapon against poverty

The early success of microfinance in many places around the world caused some to praise it as a panacea for economic development. More recently, however, critics have questioned some aspects of the model – their concerns include worries that poorer borrowers can become trapped in a spiral of debt. Moreover, they express concern that entry by for-profit entities has caused microfinance to lose its moral compass.

The truth lies in the middle. While microfinance may not be a cure-all that can eliminate poverty worldwide, it can produce positive – if modest – benefits. And new research from Bangladesh Priorities highlights an innovation in microfinance that promises to boost those benefits even more.

Incorporating flexible repayment models into microfinance can increase benefits, particularly to borrowers, shows a new study by Subir Bairagi, an agricultural economist at the International Rice Research Institute, and Wasel Bin Shadat, an economics lecturer at the University of Manchester. The study found that each taka spent on these aims stands to do more than 2 taka of social good. 

A recent set of reports by MIT’s Abdul Latif Jameel Poverty Action Lab garnered much attention. They studied the effects of microfinance in six countries using randomised evaluations. Such evaluations use random chance to determine if a person participates in, for example, microfinance or not, making it easy to see how well microfinance actually works. The MIT researchers found that the benefits are likely much more modest than some proponents had previously claimed (povertyactionlab.org).

Our experts have used a long-term study to examine Bangladesh specifically. They find that the benefits from traditional microfinance turn out to be 1.7 taka for each taka spent. So while microfinance may not deliver an incredibly high return, there are indeed positive net benefits of 0.7 after having paid off the one taka in costs. The microfinance institution captures about 0.4 taka of that benefit, leaving 0.3 taka in net benefits for the borrower.

One issue with traditional microfinance is that while it has been good for borrowers with continuous and predictable income flows, it can leave behind people whose income is lumpy, like farmers or certain entrepreneurs. Traditional microfinance can also fail to reach people at the most extreme levels of poverty, partly because of rigid repayment options.

So the researchers examined a strategy to overcome these hurdles: flexible repayment schedules that grant borrowers a grace period during the lean season. Introducing this tweak across Bangladesh could grow the microfinance market by approximately 2.5 per cent, providing new opportunities for ultra-poor citizens, many of whom are farmers or labourers. Such a flexible system would mean borrowers wouldn’t have to repay loans until after they’ve received revenues from their harvest or production.

Since 2008, a programme through the Palli Karma-Sahayak Foundation has offered flexible microfinance options in Bangladesh. By June 2013, it had disbursed loans to 512,000 borrowers, totalling more than 9.6 billion taka. A 2012 study showed that under this flexible programme, the benefit to borrowers reflected in their incomes was 8 per cent higher than with traditional microfinance.

Overall, the experts estimate that each taka spent on flexible microfinance does 2.2 taka of good. After having paid off the cost of one taka, the microfinance institution again captures about 0.4 taka, but now the borrower gets 0.8 taka, or almost three times as much in benefits.

Why would microfinance institutions agree to use flexible repayment strategies? Simply because delivering a new product opens a new market, allowing the institutions to reach people who have irregular income flows, while maintaining their profit share. 

Flexible microfinance can do more than 2 units’ worth of social good for each unit spent, improving upon the return from traditional methods. 

 

Bjorn Lomborg is president of the Copenhagen Consensus Centre, ranking the smartest solutions to the world’s biggest problems by cost-benefit. He was named one of the world’s 100 most influential people by Time magazine.