Evidence emerges of a failed model – Milford Bateman

By Milford Bateman

Milford Bateman is a Research Fellow in the Business and Development Programme of the Overseas Development Institute in London. He can be contacted by email at milfordbateman (at the rate) yahoo (dot) com .

milford bateman microfinance india

Milford Bateman - Author of Why Microfinance doesn't Work ?

The views expressed in the below article are those of the authors and do not necessarily reflect the views of IMBN.

The evidence amassed in the past 30 years shows that the basic microfinance model – the use of micro-credit to establish or expand an income-generating activity – simply does not work.

Wherever micro-finance has gained a foothold in the local community, the outcome is an unstable “here today, gone tomorrow” mass of informal micro-enterprises containing almost no transformational power: contrary to microfinance myths and PR, the local economy is generally not steered in the direction of reduced poverty, sustainability, formality and equitable growth but in almost the exact opposite direction.

We can see this outcome today in Jobra, the village in Bangladesh where Dr Muhammad Yunus founded the iconic Grameen Bank back in the late 1970s. Unfortunately, Jobra remains trapped in poverty and, ominously, has begun to experience rising individual indebtedness. A Jobra-style outcome is also the emerging norm in many other locations that have achieved microfinance saturation – notably in Bosnia, Bolivia, Mexico, Nicaragua and Morocco.

It is widely accepted that the crisis in Andhra Pradesh is the most serious challenge to microfinance to date. After four years of unsuccessful intervention by official agencies and the Reserve Bank of India, the government of this southern Indian state stepped in last October with a special law to curtail aggressive lending practices and other client abuses. But the damage had been done. Poor clients took advantage of the confusion to default on their bundles of expensive micro-loans, which in turn caused the commercial banks to begin to cut off the main microfinance institutions (MFIs) from further funding. It is likely that a considerable part of the microfinance sector will not survive for much longer.

To most experts, including Vijay Mahajan, founder of BASIX, the Indian microfinance and livelihood institution, the crisis is a result of the main MFIs’ pursuit of growth, market share and profit: it is overwhelmingly a market-driven crisis. Only diehard market fundamentalists deny this, claiming it is “a crisis born of government intervention”.

Where will the next microfinance crisis occur? Similarly destructive dynamics have been playing out in Bangladesh. There are high numbers of multiple loans per poor household and pressure on existing clients to accept a top-up micro-loan, irrespective of whether or not they can use it productively. Several of the major MFIs are engaged in “extending and pretending” to maintain the fiction of 98 per cent repayment rates. The rapid expansion of Peru’s microfinance sector has raised concern that a boom-to-bust scenario is underway there too. We can learn from previous “boom-to-bust” episodes.

In 1999, Bolivia was one of the first to experience a commercialisation-driven crisis in microfinance. Having made little progress in reducing poverty, the leftist government of Evo Morales, which took power in 2006, recognised that there would have to be change. For a long time, a significant proportion of Bolivia’s scarce financial resources had been intermediated through commercialised MFIs. But this achieved nothing other than to turn Bolivia’s urban areas into giant open bazaars.

Meanwhile, the country’s subsistence farmers could not use expensive microfinance to invest their way out of poverty, and remained trapped. Commercialised microfinance was thus viewed as a primary cause of Bolivia’s deep poverty.

The Morales government needed to make fundamental changes. It negotiated agreements with the main MFI’s to set lower interest rates and insisted that they offer more support for potentially sustainable businesses (including cooperatives) and the scaling-up of family farms. It set up its own small and medium enterprise (SME) bank, offering low interest loans to small industrial and agro-processing businesses typically ignored by the microfinance sector.

The wisdom of these changes was confirmed when, for the first time in 30 years, poverty in Bolivia began to fall quite rapidly, at least partly thanks to new SMEs. Further confirmation of the soundness of the approach came in 2010 when the Inter-American Development Bank released The Age of Productivity, which attributed Latin America’s poverty to the misallocation of its scarce financial resources into micro-enterprises and self-employment, effectively starving the SME sector of the funds with which it would otherwise have built scale economies.

With far more potential to realise productivity growth, the decline in funding for the SME sector in the past 30 years has been a catastrophe for Latin America. There is much that La Paz can teach Hyderabad – and Dhaka, Sarajevo and the international development agencies.

Reproduced from the Financial World with the permission of the The Financial World Online

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