Can microfinance deliver its promise?
A well known problem in developing countries is that the poor, especially in rural areas, do not have access to credit to generate incomes and bridge consumption shortfalls in times of hardship. The reason is that it is costly and adminstratively unattractive for conventional banks to provide such small and fragmented loans. Moreover, information regarding repayment trustworthiness of potential borrowers is largely unavailable and the poor are often too poor to offer collateral. Recent contractual innovations in microfinance institutions based on group pressure as collateral are hoped to mitigate these problems and provide millions of poor farmers access to credit. However, it is not clear to what extent these new methods adress the following issues: (i) how poor people respond to these ‘group loan’ methods; (ii) what type of groups they form; (iii) and to what extent these loans have improved their livelihoods. This study provides answers to these pratical questions by using a rich data set on four-hundered smallholder households, selected from sixteen villages in northern Ethiopia that were visited five times over the last ten years.
This study finds that, first, the type of groups formed do not correspond to those assumed in microfinance theory. Particularly, groups are formed based on exisitng traditional social gatherings and relationships and not necessarily based on similarities in wealth levels as assumed in theory. However, these gatherings still promote loan repayments. Second, although the new methods address the problems from the lender side and help to reduce non-repayments, they still hinder borrowing by introducing additional uncertainities of having to repay for failing group partners. As a result, given the frequent droughts in the study area, poor households tend to avoid borrowings not to risk additional burdens related to the group. This is so because the microfinance institution obliges individual group members to repay for the whole group regardless of whether it is bad or good harvest year. Third, for those who could afford to borrow, credit has improved their welfare. Particularly, borrowering has increased consumption levels and improved housing conditions of participant households over the years. Impact is higher for those that borrowed repeatdely. In sum, this study concludes that microfinance can deliver its promise of reducing poverty around the world but only when the methods in it are re-designed to meet the situations on the ground. A key policy implication in this study is that ‘one-size does not fit all’: existing methods may perfectly fit in some but not in all contexts and context specific innovation of methods is required.