Microfinance – A way for developing countries to escape poverty?

Dialogue forum entitled “World in flux – The forgotten billions” held on 25 February 2010

Microloans have increasingly grown in popularity in recent years, not least because the Nobel Peace Prize awarded to Muhammad Yunus in 2006 helped bring about the breakthrough. There is no doubt that microloans enable people in developing countries lead more independent lives. But is a loan with an interest rate of 20% or more really a social instrument? That was one of the issues discussed at the third in the series of dialogue forums entitled “World in flux – The forgotten billions?” held in Munich on 25 February.

Sources variously estimate that microloans are granted by some 10,000 microfinance institutions to over 100 million borrowers. Loans can even be arranged online these days, thanks to websites like that of kiva.org, which have granted microloans to small business in the developing world since 2004. However, the microfinancing reality may be nowhere near as rosy as the picture the media tend to paint. These are hard-nosed banking transactions, involving major challenges for all those involved.  
 
Dr. Bernd Balkenhol, Head of the Social Finance Programme of the International Labour Organization, Geneva, acknowledged: “Spectacular successes may not be the rule. However, the vast majority of people are able to better manage their personal circumstances thanks to microloans.” There is not much room for social romanticism. “We tread the fine line between business and social concerns”, was how Martin Godemann, Group Finance Manager with ProCredit Holding AG, Frankfurt, described the business model of his company, a microloan provider. 
  
In order to survive, you have to make a profit. At the same time, ProCredit does not aim to maximise profits. “Loans are debts, not social transfers, and they have to be repaid”, Godemann emphasised. Microfinancing is most successful at combating poverty when the money is invested, creating new jobs. Business is ultimately transacted in much the same way as in Germany. The client goes to a branch to ask for a loan. Once his application has been considered, the loan is granted or refused, and the money is repaid in instalments. 
  
Johannes Majewski, a financial systems consultant with the German Association for Technical Cooperation (GTZ), warned that we should not regard microfinancing as a means of redistribution. “Banks ought to concentrate on what they do best – providing financial services in a way that ensures they remain viable.” 
   
He added that the increasingly widespread use of modern technology in developing countries is opening up a cost-effective distribution channel. “On current reckoning, by 2012 some 1.7 billion people without access to financial services will have mobile phones, so that potentially you will be able to tap into a market of around 360 million people.” That is three times the present figure. The GTZ is working with the private sector to explore ways of offering such services. However, Majewski points out that more transparency is required: “Clients need to understand how loans function and how interest is calculated. Otherwise, there’s a risk of misappropriation.” 
   
ILO expert Balkenhol thinks it goes without saying that microloans are no real substitute for social security systems. However: “We can’t wait until countries like Mali or Burkina Faso have the means to set up such systems.” In the meantime, microfinancing fills the gap, for instance by providing loans that enable people to pay for a doctor or ambulance in an emergency. He does not think subsidised microfinancing systems work: “They destroy traditional business.” 
    
Godemann referred to problems encountered with microloans. “In our experience, particularly during the financial crisis, ordinary people run up debts because there are lots of microfinancing institutions around and they take out a number of loans.” The danger is that people will fail to escape the poverty trap, leaving nothing but scorched earth behind. The ProCredit manager therefore believes it is important to foster a savings culture as well. 
  
Balkenhol: “Microfinance alone will not alter the fundamental balance of power in the developing countries but, combined with other tools, it can have a liberating effect.” He illustrated the point by describing how landowners in remote parts of Nepal and Pakistan often subject people to a form of debt bondage. Microloans, legal advice and local self-help groups have gone some way towards solving, if not yet eradicating, the problem. Balkenhol continued: “I can’t think of any way other than microfinance of tackling poverty in the long term.”
   
Nevertheless, only about 50% of microfinance institutions are able to survive without subsidies because the costs of providing microloans are high and cannot always be covered, despite average interest rates of 24%. Although high interest rates prevent the widespread use of this financial tool, there is no shortage of profitable projects. For instance, one lady, who used to sew clothes by hand, has now boosted her output by acquiring a sewing machine. Whilst she is still far from rich and continues to live in very modest circumstances, the loan she used to pay for the sewing machine has brought enormous returns. 
   
By the end of the discussion, it was clear to the large audience attending the forum that microfinance is not a poverty cure-all. But without it, helping the developing world would be far more difficult. 
    
The next dialogue forum "Consuming at the expense of others – Growth at any cost?" will be on 18 March 2010.