Research News

Can Microfinance Save the Poor?

Findings by IPR economist Cynthia Kinnan question its role in poverty reduction

Does microfinance reduce poverty and transform households?

Microfinance institutions (MFIs)—which extend small loans to impoverished households in developing countries—have exploded over the past 10–15 years; the number of poor families with a microloan grew from 7.6 million to 137.5 million from 1997–2010.  Yet do MFIs actually spur business growth, empower women, and lift families out of poverty?

IPR economist Cynthia Kinnan, with Abhijit Banerjee, Esther Duflo, and Rachel Glennerster—all affiliates of MIT’s Abdul Latif Jameel Poverty Action Lab—undertook the first randomized evaluation of a microcredit lending model. The results, published in American Economic Journal: Applied Economics, are overturning widely held notions about microfinance and its role in poverty reduction.

Kinnan and her colleagues assessed the effects of loans offered by Spandana, a MFI serving poor women in Hyderabad, India. The researchers studied impacts on consumption patterns, business creation and business income, and women’s empowerment, as measured by a woman’s ability to participate in household decisions about spending, saving, and other factors, for up to 3.5 years after Spandana began lending.

The first striking finding was that instead of the predicted near-universal demand for microloans, only around 33 percent of eligible households borrowed from Spandana, indicating either that interest rates were too high or households preferred other sources of credit.

Cynthia Kinnan

Second, the loans did not lead to large amounts of business creation—“something that is often part of the narrative of how microfinance will affect households,” Kinnan said.

Also part of that narrative: the notion that MFIs increase women’s empowerment. “It’s natural to think that if this source of credit is flowing to women, that may allow women to start or scale up a business, and that may give them more autonomy,” Kinnan explained. However, in their evaluation of Spandana, she and her colleagues did not “see any detectable evidence of a change in women’s bargaining power.”

Where microfinance did produce “significant and detectable impacts” was changing the composition of household spending: spending more on durable goods, such as a new sewing machine for a tailor; scaling up existing businesses; and spending less on “temptation” goods such as alcohol, tobacco, and gambling. The need to make regular, weekly payments on a microloan might help households stick to their budgetary priorities.

Though these monetary effects could add up over time,  “Our takeaway is that microfinance was not the transformational product many hoped it would be,” Kinnan concluded. Five other evaluations of MFIs published in the same issue reached similar conclusions.

The results of these studies “should perhaps prompt a rethinking of whether microfinance—at least, the current microfinance model—deserves a large amount of public and private subsidy,” Kinnan said.

Cynthia Kinnan is assistant professor of economics and an IPR fellow.

Photo credit: Lauren Mitchell