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5 Things You Never Knew About Microfinancing

5 Things You Never Knew About Microfinancing


The following is an excerpt from “Confessions of a Microfinance Heretic” by Hugh Sinclair. Please share your comments about microfinancing below for a chance to win a copy of this enlightening book. We will choose 5 commenters at random to receive the book. Good luck!

“I’m a dodgy moneylender, exploiting the poor with useless, overpriced loans, ideally obliging their children into forced labor in the process.”

This did not go down well. I had been introduced to yet another gath­ering of bright-eyed microfinance experts at yet another microfinance conference, and I had incorrectly assumed that irony and sarcasm were within their grasp. They were not. I attempted to redeem myself.

“Guys, I’m joking … it was a joke. I’m a microfinance consultant, we’re all cool … sorry.”

I had broken the golden rule of microfinance, the unwritten code that bonds its practitioners together. I had criticized microfinance and, per­haps worse, I had implicitly challenged the developmental claims the sector proclaims so vehemently. This is unacceptable from an insider. But none of the experts offered a defense or rebuked my confession.

There is actually surprisingly little evidence supporting microfinance as a practical tool of poverty reduction, but this rather critical detail is ignored within the microfinance sector for one simple reason. Microfi­nance does not apparently require evidence to prove it works—since, on the face of it, it seems to work. It works because the poor repay loans, and this is all the proof the sector requires. Some 200 million people now receive microfinance loans, most of whom repay the loans. Therefore they miraculously became better off in the process. So the argument goes.

The fact that crippling poverty persists unabated in countries like Bangladesh, India, Nicaragua, Nigeria, and Bolivia is an irrelevant detail. The persistence of poverty means that we need more microfinance. Even when Indian women started poisoning themselves under the burden and shame of chronic over indebtedness, or when the citizens of an entire country refused to repay their microfinance loans claiming unfair treat­ment. This had nothing to do with those who provided the loans. Ap­parently.

Microfinance is a $70 billion industry, employing tens of thousands of people, predominantly managed by a closed group of funds based in the USA and Europe acting as gatekeepers of the private capital avail­able, and increasingly some of the public funding as well. The industry is largely unregulated, opaque, and hard to investigate in practice. A tireless PR machine recruits spokespeople, advertises on television, and holds endless promotional events. An almost cult-like aurora surrounds the sec­tor. Insiders are expected to tow the party line. It’s to all of our advantage to belong to such an epistemic community with a common set of broadly held beliefs.

Microfinance touches on the core values of entrepreneurial vision, of teaching a man how to fish rather than handing him a fish on a plate. It appears to be such an excellent idea. It appeals to the positive aspects of capitalism and economic development, and it leverages the positive desire to work hard and provide for one’s family. Everyone’s a winner. So how dare anyone ever criticize it?

To cite a selection of the flaws of the romanticized image of the female microfinance client living in the hut with the sewing machine:

  • Such cases are surprisingly hard to find in practice. Men often send their wives to get loans because they know they are more likely to be approved.
  • Loans are almost invariably not spent on the productive sewing machine or goat, but on a TV, repaying another loan to a very simi­lar bank, paying other bills, or generally consumed
  • Interest rates on loans, when all the various hidden charges are considered, are substantially higher than those stated. Interest rates under 30 percent a year are disappointingly rare, and rates of 100 percent or higher are common.
  • The small business is rarely able to generate sufficiently massive returns over prolonged periods to cover these interest payments. When Wal-Mart opens in a town in America, many smaller shops are driven out of business. According to the microfinance sector this phenomenon does not occur in developing countries. We ignore the businesses that fail.
  • It is assumed that every poor person is a budding Bill Gates. A quick glance at the overwhelming majority of businesses that re­ceive microloans hardly suggests cutting-edge innovation—most market traders sell precisely the same products as everyone else in the market place. Not everyone in Europe or the USA is a budding entrepreneur, so why would we expect anything different in devel­oping countries?

The average person on the street has been spoon-fed a deliberately na­ive view of microfinance. Most individuals who have invested in microfi­nance have little idea how their funds are deployed in reality, and many would presumably be disturbed to find out the truth. They cannot board a flight to Burkina Faso to check whether their $25 investment is being used wisely or not, so they entrust their money to a fund or a website that offers assurances of incredible impact. Little do they know that these institutions are largely unregu­lated in practice and have a rather different view of microfinance from that presented in their magazines, littered with photos of poor women in action poses, bouncing out of poverty every second of the day thanks to $25 loans.

Meanwhile the poor largely remain poor, even as billions of dollars in interest payments are extracted from their pockets justified by a few iso­lated but celebrated cases of successful tomato vendors splashed across the promotional materials of the companies leading the sector. An article in Time World summarized it succinctly: “On current evidence, the best estimate of the average impact of microcredit on the poverty of clients is zero.”

Excerpted with permission from Berett-Koehler Publishers, San Francisco CA Copyright Hugh Sinclair 2012.

Check out these launch events for the book:

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7:58PM PDT on Jul 16, 2012

The first time I ever read about micro-finance I thought what a bunch of bogus BS, Just give these poor people enough money to live on every month and let them decide what to do with it.Poverty ending does not depend on making stuff to sell and paying back loans +interest so those who already have plenty can get just a little more.No matter how anyone tries to dress it up as something noble, the old teach a man to fish nonsense, lending and expecting pay back from the poorest of the poor is disgusting.They need a means of exchange that stays in circulation at their own level .

8:33PM PDT on Jul 14, 2012

I have a question for Hugh Sinclair. I have a high school classmate who graduated from MIT and taught at the Univerisity of Washington. We met for dinner one night and we were discussing micro finance. He mentioned that it was not the cure all that many had hoped it would be. I must admit that he is much more educated and knowledgeable than I and he expressed his disillusionment with micro finance. On the other hand he discussed his hope of one day starting a charitable foundation and from his world travels explained how a small amount of money could accomplish a great deal more progress in the third world than it could in the developed world. I have loaned money at microplace and have found myself wondering how my local savings bank is paying me 0.25 % interest on my passbook and the money that I invested in Haiti after the earhtquake, hurricane, cholera epidemic and poitical upheaval is apying a higher interst rate. So the problem does not appear to be in the concept of micro finance but in the implementation and the integrity of the lending institutions and the honesty of those borrowing . The problems appear to be in transparency and finding quality lending institutions. Am I interpreting this correctly? It is a case of buyer or rather lender beware.

7:20PM PDT on Jul 13, 2012

sorry about the typo... "
I rather believe this claim carries a subconscious prejudice against the poor, and a reluctance to believe they are HONEST. In my dealings with them I find them to be so"

7:17PM PDT on Jul 13, 2012

@ Hugh I won't give up on helping the working poor, because if I can help someone get on their feet I believe it is the right thing to do. Nothing to do with Bill or Melinda Gates. Much to do with a sharing of compassion - and to correct a misconception/assumption - I was born, grew up and have lived my life in a third world country. I understand that people need and deserve a helping hand.
You may not be, but I'm satisfied with what Kiva has posted of what the Portfolio Yield is and why they use that: "Kiva uses a calculation called “Portfolio Yield” to express the average interest rate and fees that Kiva borrowers pay to the Kiva Field Partner administering their loan. Portfolio Yield is defined as all interest and fees paid by borrowers to the Field Partner divided by the average portfolio outstanding during any given year.

The Portfolio Yield is generally based on audited financial information and is a better indication of the cost of borrowing money from a Kiva Field Partner than the simple interest rates reported by our Field Partners because it:
a) Includes any fees associated with loans and
b) Is expressed in one-year increments (similar to the way an APR works) "
If the evidence for diverting loans to consumer goods is so rare to find, then where did the research you cited find it? I rather believe this claim carries a subconscious prejudice against the poor, and a reluctance to believe they are hoest. In my dealings with them I find them to be

4:54PM PDT on Jul 12, 2012

A final word: to those disillusioned by microfinance, do not throw the baby out with the bathwater. Good microfinance does exist but it is rare. It looks much the same as flawed microfinance, but if you know what you're looking for, the right questions to ask, and how to spot the alarm bells, you can have a positive impact. But hold your intermediaries to account, do not just believe a glossy brochure and some nice stories about goats and sewing machines. You are entering into a murky and unregualted world here, where neither you nor the poor are afforded much regulatory protection in practice, so take care. I dedicate a decent part of the concluding chapter on this precise topic.

For example, ask Kiva why it is that they can show you photos, little stories, family details, loan amount, loan purpose, how many kids the client has, all manner of information, but they cannot tell you what the interest rate is? They will tell you the historic interest rate of the overall institution. They cite the so-called "portfolio yield", which is a poor proxy for the interest rate (obtained from the Mix Market website). This data is self-reported, unreliable, easily manipulated and does not necessarily contain all the fees, expenses, forced savings etc. that the poor have to pay. Why can't Kiva just tell you the interest rate? Demand a good explanation. And this is just the first question....

Do not dspair, but be aware that this is not quite as simple as it looks, and a lot of individ

4:25PM PDT on Jul 12, 2012

[cut off] poor, if they make people in developed countries feel fulfilled, perhaps that is still a service? Marg H wondered about the evidence for consumption lending accounting for much of microfinance. Evidence is hard to obtain as, naturally, many microfinance practitioners are hesitant to publish such data. However, John Hatch, founder of Finca, estimated consumption accounted for 90% of all lending, see the Harvard Business Review September 2007 "Beware of Bad Microcredit". The article goes on to cite two noted academics:

"Abhijit Banerjee and Esther Duflo, of MIT’s Poverty Action Lab, recently evaluated dozens of rigorous studies on the economic lives of the poor, finding that regardless of country or continent, very little of each additional dollar of disposable income is spent on any form of investment, or even on food and shelter"

Even I was taken aback by this. I privately estimated consumption to be closer to 75%, but that is only from my own direct experience, and I am not an academic.

Were more evidence required, the latest industry report on the state of the microfinance sector, Banana Skins 2012 (both this and the HBR are available on-line) lists over-indebtedness as the number one risk facing the sector. So, in addition to consumption loans we must also consider loans used simply to repay loans at other banks - a common phenomenon that has led to microfinance crises in a number of countries. The one I explore in detail in the book is Nicaragua.

3:09PM PDT on Jul 12, 2012

@Edo and JT S its sad that you are cynical and distrust something that CAN and does help people who the big banking system won't even look at. Your mistrust may stem from the Big Banking system and how it operates, but I suspect your cynicism there hasn't stopped you from using them! And yes, JT a mere $25 loan (which is paid back) can be offered to US borrowers many of whom are helped at Kiva! It would be good if you overcome your distrust enough to just go and see... "Free, no obligation" lol as the tv ads say. You may well be surprised at what you will find, and how you will feel about the existence of these micro funding organisations. Best wishes.

3:07PM PDT on Jul 12, 2012

I am enthused to see so many responses. Betsy M summarises the situation succinctly - a nice idea hijacked by "parasites". I use the word "vulture" in the book, but I think this gets the message across either way. I cannot go through each comment, but Jt. S raised a valid point about the lack of journalistic rigour - I agree. Most microfinance funds, institutions and websites present little more than spin. To this end I placed 250 footnotes in the book, each of which has supporting evidence on the website, This includes removed webpages, full audio recordings, transcripts, documents, court rulings, emails, video footage and academic papers. I did this precisely so that every claim and reference can be verified by the reader to form his or her own opinion. Transparency is the name of the game, and this is what is so chronically lacking in the sector. It was also great to see Laura H., with first-hand experience from Tanzania, observing similar findings.

To those lending via Kiva, all I can suggest is that you read chapter 11 of the book, which specifically examines this institution. Marg. H made an interesting observation: "I find it very fulfilling". This is a more astute observation than it initially appears. Who is the beneficiary of a Kiva loan - the borrower, or the lender? The evidence of poverty reduction is minimal. But hundreds of Kivans feel like a "mini Bill Gates", as Kiva describe it. Even if these loans have zero impact on the

10:03AM PDT on Jul 12, 2012

Sounds just about as dodgy as those emails you get in your spam box of people supposedly despearte for a loan, and can you "please send me your back account details"!!

10:03AM PDT on Jul 12, 2012

Sounds just about as dodgy as those emails you get in your spam box of people supposedly despearte for a loan, and can you "please send me your back account details"!!

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