Microfinance: A Help or Hindrance to the Poor?

Last week, David Roodman of the Center for Global Development published Due Diligence: An Impertinent Inquiry into Microfinance. He challenges the success of microfinance institutions overseas, arguing clients of such institutions may be worse-off with the assistance of microloans. Roodman suggests we prematurely celebrated the successes of microfinance; however, his claims highlight problems that affect only a small minority and don’t outweigh the benefits. Microfinance has the potential to continue to provide significant aid to many individuals in developing areas; Roodman’s claims only encapsulate minor hazards associated with the microfinance sector and are not sufficient enough to curb its practices.

Microfinance institutions provide small loans, typically less than $500, to marginalized individuals in developing regions and help elevate them out of poverty. Millions have utilized these loans to start self-employed businesses, send their children to school, and feed their families. Microfinance institutions boast near-perfect repayment rates of loans and keep their practices sustainable. Many institutions target women to receive microloans; successful repayment of loans has socially empowered many women to take greater leadership within their families and communities. 

Although microfinance institutions have successfully created financial opportunities in impoverished communities, boast of high repayment rates, and continue to provide successful loans to many people, Roodman suggests that these success stories are merely anecdotal and mask the problems of microfinance. Primarily, the majority of microfinance institutions organize clients into groups who are collectively responsible for the loans of each group member, in the event that one member may struggle with repayment. Roodman believes the immense social pressure created by this contract encourages those struggling with repayment to borrow money from equally poor relatives. Therefore, entire families spiral further downward into worse levels of poverty than they were in before accepting a microloan. Alternatively, other group members might loot their homes to obtain collateral for the defaulted loan, which presents a physical and social risk for microfinance clients. While these situations represent legitimate fears associated with the social contract that microfinance clients must adhere to, they should not be sufficient enough to deter potential clients from accepting microcredit.

Roodman also criticizes the structure of donor lending to MFIs. Because the loans are given in small amounts, many donors are willing to give monetary support to fund additional microloans. Furthermore, many organizations are subjected to laws that dictate the percentage of donations that must be appropriated for loans. In order to meet these regulations in the wake of unprecedented donation rates, organizations are forced to offer loans to people who are less likely to successfully repay.

While insufficient to outweigh the proven successes of microfinance, perhaps Roodman’s criticisms issue a warning to the industry. Microfinance institutions are still developing and evolving, and may need to reevaluate lending practices and implement alternatives to group loan absorption. Additionally, they may benefit from more closely examining the costs and benefits of regulating the percentage of budgets allocated for loans. Instead, institutions could use surplus funds and expand their services to include savings and insurance plans. With added savings and insurance options, clients would have a greater support system to prevent a relapse into severe poverty.

Despite the social risk of peer pressure associated with potentially defaulted loans, microfinance has empowered people worldwide by providing financial opportunity. Impoverished communities deserve financial opportunity as much as they deserve clean water and basic sanitation. However, addressing the issues raised by Roodman could benefit the industry by encouraging continued refinement of microfinance institutions and loan practices. In turn, the industry can maximize the efficiency of their practices and lessen the struggles of many impoverished people.

Photo Credit: Wikimedia Commons