Rethinking Microloans: How helpful are they actually?
A local leader counts money to be distributed as microloans to women who are raising cows or opening village tea stalls in Sadasivpet, India. (The Wall Street Journal)
By Emma Monson
Everyone interested in social impact has at some point heard an inspiring story about a woman in a developing country who starts a business, lifting herself and her family out of poverty. Many of these stories attribute these successes to a relatively new financial tool: microloans. What exactly is a microloan though? Microloans, in this context, are very small loans usually less than $3,000 and many of them being only hundreds of dollars. Microloans are mainly used in developing countries where people do not have credit history to receive a traditional loan from a bank. The idea is that you give a small amount of money to someone and they can use it to create a business or make lucrative investments into their existing means of income. Since the money is a loan not a gift, it can be reused to help other people. While microloans were created with the intent to solve an important issue, are they truly effective at combating cyclical poverty?
Microloans have the capacity to be powerful tools of financial inclusion. Various segments of society that have historically been underserved can be integrated into the microloan market. In 2018, 80 percent of microloan recipients were female. This is significant considering that financial independence is one of the major obstacles to gender equality in developing nations. In addition to women, microfinance is bringing in other populations into the banking system. 65 percent of microloan borrowers live in rural areas where traditional loans are almost impossible to receive. Microloans are circulating money in areas where it otherwise would not reach.
Since microloans have such an expansive clientele, with 139.9 million borrowers in 2018 alone, the impact on standards of living should be substantial, however, the data doesn’t quite reflect this assumption. Six randomized controlled studies of microloans conducted in different countries were examined in American Economic Journal. Out of all six studies, not one showed a statistically significant increase in household income. Another way of testing microloans’ success was to look at household food consumption, but out of these studies household food consumption stayed relatively similar to pre-microloan consumption levels. Overall, the results were not anywhere near what some predicted they would be. Some even argue that microloans put more stress on individuals in poverty. Critics claim that clients are given loans without the necessary guidance needed to generate returns, leaving them unable to repay their debts. In 2010, microloans were even links to suicide when 80 borrowers in India took their lives after defaulting on their loans.
Many people are optimistic that microfinance will prove to be a solution to global poverty. Muhammad Yunus, Bangladeshi social entrepreneur and Nobel Peace Prize winner who devleoped concepts for microfinance, said that with microloans “The poor themselves can create a poverty-free world. All we have to do is free them from the chains that we have put around them!” While I wish this notion were true, this is not the reality we live in. The evidence points away from microloans everyday, but with it projected to have been a 129.4 billion dollar industry in 2019 banks and companies are not ready to give up yet.
Te Creemos, a Mexican financial institution, charges up to 125 percent interest rates. With high interest rates like this, it can be almost impossible for borrowers to pay back loans. This begs the question “Why would people take microloans with extremely high rates?” Some borrowers have no other option as they are not able to receive loans elsewhere. While there have been certain instances of success with microloans, predatory lending practices threaten the viability of this success. Microloans are a good attempt, but they offer “micro-help” where there needs to be major change to combat cyclical poverty.
