Is microcredit working?

by : Aijaz Ali Khuwaja

The ‘success’ of microfinance programmes as agent of poverty alleviation is well known. Enthusiasts can point to repayment rates of over 95 per cent, the high participation of women, associated improvements in the health and education of children, and the potential for the macro-credit system to become financially sustainable in the long-term.

In an era of cutbacks in foreign aid budgets, microfinance programmes continue to enjoy strong support across the political spectrum for their capacity to ‘help the poor help themselves’.

But the success of microfinance has been marred by severe criticism of high interest rates, exploitation of women borrowers, unchanging levels of poverty and a failure to cater effectively the target groups. The very poor individuals are often described as high risk as they cannot offer collateral and have no stable source of income.

Loan repayment is one of the major challenges to microfinance, given that a poor repayment culture has plagued numerous microfinance initiatives. The causes of default in microcredit can be divided into four main categories. These are organizational, household/financial, group dynamics, geographical location and environmental degradation/haphazardness.

High repayment rates are insufficient to drive the microfinance revolution. High interest rates are seen as necessary for generation of profitability and for reduced reliance of microfinance institutions (MFIs) on external funding.

The current interest rate on income-generating loans is between 22 to 28 per cent), much higher than the 10-13 per cent rates offered by commercial banks.

All rural support programme networks have government-provided endowment funding, which ranges from Rs500–1500 million. The provincial governments have mostly provided this funding. So the question of sustainability of MFIs does not arise.

Different studies show that the poor are extremely sensitive to increases in interest rates, which results in a reduced demand for financial services. Pakistan Poverty Alleviation Fund provides loans for microcredit to different organizations like the Rural Support Programme networks and other NGOs at six per cent interest rate.

Lending microcredit organizations give loans to the poor at the interest rate of 22-28 per cent. Many organizations are suggesting interest rate hike from 28 to 32 per cent which is not feasible. The total administrative and other costs of Rural Support Programme Networks and other NGOs ranges between 2,4 per cent only. Apart from six per cent interest on microcredit loan, PPAF provides free training and other opportunities including infrastructure facility through the same microcredit lending programmes.

So organizations also save money through infrastructure and other programmes of microcredit. Can poverty be eliminated through such initiatives?

The failure to reduce poverty is another major criticism of microfinance. The current world recession, surging food scarcity, war on terrorism and, political uncertainty have also increased level of poverty. According to the World Bank, another 90 million people all around the world have again become poor. In Pakistan, about 70 per cent live below the poverty line. In the prevailing situation, an increase in the interest rate can be more harmful to borrowers.

Commercial bankers ignore the poor because of the high costs associated with lending of small amounts to borrowers with very little creditworthiness. A flaw of the microcredit lending organizations is a bias towards reporting favorable outcomes on selecting samples overwhelmingly drawn from successful borrowers in large mature programmes.

Given the importance of financial services to the poor and the enormity of the challenge, greater attention to the social mechanisms shaping institutional success and failure is needed to complement the more familiar issues of costs, subsidies, interest rates, lending policies and training. Millions of poor people have used microcredit to fund a new tool, a machine, or a shop in the marketplace.

Studies in India, Kenya and the Philippines have found that the average annual return on investments by micro businesses range from 117 to 847 per cent. If they are so lucrative, why are not businesses sustainable? These and other studies have shown that failures are because of high inflation rate, surging food prices, lack of training and high interest rates.

While there is a place for microcredit and microfinance in efforts to end poverty, there are some fundamental flaws in thinking of this approach as a key one in ending poverty and improving the lives of poor.

Part of the problem with microcredit rests not with the real benefits it provides to a certain segment of the population, but rather with the expectation by some that it is the answer to rural poverty. This belief shows a lack of understanding of the complex nature of poverty.

Capitalizing micro-businesses is one piece of the solution, but without a wider, holistic effort, this kind of credit will mainly benefit the entrepreneurs and slightly less poor who are able to develop business plans and make them work.

Additionally, microcredit models often fail to build borrowers’ capacity to do anything but develop a market analysis and basic business plan. A large number of the poor especially women are marginalized within their communities and even their families, and lack confidence and experience in trying something new.

They have responsibility not only for contributing to family income but to caring for children and the ill, collecting water and fuel wood, preparing their family’s meals, maintaining the home and any number of assorted family responsibilities. If the bigger picture of workload and marginalization is not addressed in a significant way throughout the microcredit lending process, women will continue to struggle with an impossible burden.

Microcredit lending institutions should think about a new approach for improving the microcredit system. Small loans with lower interest rates and surrounding conditions, will give more sustainable help to the poor to start a simple business.

Microcredit unleashes the entrepreneurial spirit. Simply to survive, the poor rely on their own ingenuity. When given an opportunity to succeed, they do it with a determination to break the vicious cycle of inherited misery.

(Mr. AIJAZ AlI KHUWAJA as aProvincial Coordinator Poverty Eradication Initiative (PEI) Pakistan)