Microfinance: Issue 3

Nineteen years ago, the Norwegian Nobel Committee awarded the Nobel Peace Prize to Muhammad Yunus and the Grameen Bank for their work in providing microcredit. The Committee declared, in doing so, that microcredit “must play a major part” in the fight against poverty.[1]1.See https://www.nobelprize.org/prizes/peace/2006/press-release/.  The period since that momentous occasion has been transformational for research on microfinance; since the 2006 award, a large body of academic work has deepened our collective understanding of every aspect on the topic.

In this VoxDevLit, we review some of the key contributions in that work. This review comprises seven sections. In Section 2, we discuss the ‘first generation’ of microcredit field experiments, with an emphasis both on the headline results as well as the findings of heterogeneous treatment effects. Section 3 seeks to ‘unpack’ some of the key features of the classic microcredit model; we respectively consider results on: (i) group lending, (ii) dynamic incentives, (iii) targeting of female borrowers, (iv) timing of loans and repayment, and (v) repayment flexibility and inflexibility. Section 4 looks at asset-based microfinance, Section 5 focuses on the role of microfinance institutions, and Section 6 discusses the general equilibrium impacts of microcredit. We conclude in Section 7 with some general lessons and some thoughts around directions for future research.

Throughout this review, we use the term ‘microfinance’ to refer to the provision of formal financial services to poor and low-income individuals, as well as other people systematically excluded from the financial system (CGAP 2012). While microfinance is often targeted at microentrepreneurs, it is also commonly used for non-business purposes, such as consumption smoothing or for financing household expenses. Microfinance is a broad concept; in this review, we focus throughout on microcredit, leaving for another day the other various forms of microfinance (in particular, microsaving, microinsurance, and microequity). There are a range of institutions that provide microcredit, including non-government organisations (NGOs), non-bank microfinance companies, microfinance banks, financial cooperatives, rural banks, as well as state-owned institutions.[2]2.See CGAP (2012) for a description of the different providers of microfinance services, and a detailed analysis of the regulation of the different types of institution. In this review, we do not cover lending services that are built upon mobile money platforms provided by telecommunications companies (such as Safaricom or M-PESA in Kenya), which are covered in the associated VoxDevLit on mobile money. Mobile money is different from the loans that we discuss in this review in many ways. Specifically, it often sits outside the formal banking system since the accounts are linked to a phone number rather than to a bank account. Moreover, in most countries mobile money operates under a different regulatory framework than lending institutions. Mobile money loans are also quite different from the programmes that we discuss here in terms of application and decision process, scale, and duration.[3]3.Mobile money loans are often disbursed instantly, and without the close personal contact between lender and borrower that is one of the distinguishing characteristics of traditional microcredit. They are also typically very small in scale (as little as a few dollars in loan amount), and with a very short duration (most are due within a month, and often after only a week or two). The lending decision process is also quite different to that used by traditional MFIs, with decisions often being based on credit scoring rules or algorithms using administrative data on the applicant’s phone usage, call and SMS logs, or contact and network data., [4]4.Nonetheless, there are undoubtedly conceptual ideas that are relevant to the design of both types of lending, and – in the spirit of VoxDev dynamic literature reviews – we will continue to update the two pieces in line with the fast-moving changes in the industry and the evolving regulatory environment. 

This is the third release of the VoxDevLit on microfinance; as a dynamic literature review, this document will be updated on a regular basis as this exciting body of academic work continues to evolve. We look forward to readers’ feedback on the review, and to ongoing discussions on this fascinating topic. The latest version of this review can be found at https://voxdev.org/voxdevlit/microfinance.

References

CGAP (Consultative Group to Assist the Poor) (2012), “A guide to regulation and supervision of microfinance.” Available here.