Key message 1 – Traditional microfinance typically has small and uncertain effects on borrower welfare.
The celebration of microfinance 1 as a success in the early 2000s, particularly its success in increasing lending to poor borrowers who were previously ignored and labelled as not creditworthy by traditional lenders, motivated multiple randomised evaluations of microfinance institutions and products. A large number of these studies show little or limited impact of microfinance on household welfare in developing countries.
Banerjee et al. (2015) analysed six studies that expanded microcredit through seven different lenders in six countries – Bosnia, Ethiopia, India, Mexico, Morocco, and Mongolia – during 2003–2012, and found a lack of evidence of microfinance’s transformative effects on the average borrower. Importantly, they find this is not due to lack of investment in microfinance but due to the model itself.
While numerous evaluations of microfinance have been conducted, consensus on the overall effects across different contexts has been limited by concerns about generalisability. Meager (2018) aims to overcome this concern by creating a model that accounts for the variability found across seven major studies and provides estimates of the average impact of microcredit, as well as how much impact differs between different microcredit programmes.
She studies the impact of access to microcredit on six indicators: household business profits, business expenditures, business revenues, consumption, spending on consumer durables (e.g., household appliances), and spending on temptation goods (e.g., alcohol and tobacco). She finds the average effects of access to microcredit on these outcomes are small and uncertain, at around a 5% increase. She also finds moderate to high probability of zero impact, both within and across studies.
Recent literature has suggested several possible reasons for the inability of traditional microfinance to achieve significant income impacts. Fischer (2013) highlights one possible cause: strict peer and institutional monitoring requirements prevent borrowers from using loans to invest in high-return, high-risk investments. Recent studies discussed in this brief explore other weaknesses of the classic microfinance model: short loan duration combined with high-frequency repayment requirements and inability to target productive borrowers.
Hence, an outstanding question: are all of the features of the traditional microfinance model necessary, or can some be relaxed to obtain better outcomes? The next three key messages explore changes that can be made to improve the effectiveness of microfinance loans.