Microfinance: Issue 3

This is latest version (Issue 3) of this VoxDevLit, previous versions can be downloaded at the top of this page. Senior Editors discussed what we have learned about microfinance from this living literature review on our podcast.

Academic research has deepened our collective understanding of the benefits and challenges of microfinance. New models of lending have been developed and the more nuanced elements of microfinance have added to the accumulated pool of knowledge. In this review, we highlight key contributions to that work, and summarise the state of knowledge. 

While evaluations of earlier microfinance interventions acknowledge improvements in borrowing and investment, they convene around a lack of transformational impacts on important outcomes such as business profits and labour supply. However, the demand- and supply-side barriers in studying the causal effects of microfinance that were identified in early evaluations have led to more creative assessments around their features and benefits. Reviews of such work have highlighted significant heterogeneity in impacts, based on key indicators such as gender and prior business experience of entrepreneurs.

Group lending was a prominent feature in early microfinance interventions, designed to mitigate adverse selection and moral hazard through joint liability for borrowers. However, empirical evidence has found joint liability not to be a prerequisite for high repayment rates compared to alternative incentives for borrowers.

Incentives for borrowers have been proven useful in improving repayment and default rates. Making access to future loans conditional on successful repayment of previous loans, for example, has been shown to increase repayment and reduce risky behaviour of borrowers.

Microfinance loans are subject to intra-household dynamics, and interventions targeting women specifically need to be sensitive to gender norms and inequalities that favour aggregation of resources into male hands.

Frequent repayment periods are often desired by microfinance institutions for their assumed benefit of providing financial discipline for borrowers. Following the evidence, however, highlights that spacing out repayments doesn’t increase default rates, and allowing sensitivity to seasonal liquidity constraints can improve outcomes for borrowers.

Likewise, flexibility in contracting and repayment timelines can yield significant benefits for borrowers in terms of profits and income. Instituting ‘grace periods’ or allowing short-term deferrals in borrowers’ repayment plans allows them to better allocate loans towards bulky investments or in case of external shocks.

Asset-based microfinance shows promise in yielding high returns across settings. Borrowers are able to acquire more expensive assets that can be used immediately compared to traditional microfinance loans, with built-in collateral for microfinance institutions in the assets provided.

At a broader macroeconomic level, microfinance can have positive impacts on wages and consumption; although the long-run impacts are small on average, the vast majority of the population experiences welfare gains, including poor and marginal entrepreneurs.

Looking ahead, microfinance is an ever-expanding field that is significantly heterogeneous across programme design, contracting, contexts, and beneficiaries. Further research is needed to explore which adaptations prove effective, in which contexts, and for whom.

This review will be updated as new information becomes available. Our hope is that by facilitating a dialogue between governments, practitioners, and researchers, these reviews will generate new research that helps fill knowledge gaps.

Microfinance (Issue 2): Presentation of key takeaways

For our launch event in 2023, Jing Cai, Muhammad Meki and Simon Quinn joined us to present the key takeaways from the previous issue of this VoxDevLit, highlighting policy relevant results from recent research on the economics of microfinance.