Building off a Financial Times article written by Tim Harford last week that criticizes our lack of understanding of how microfinance impacts clients’ livelihoods (which my colleague Sushmita highlighted here), Professor Milford Bateman goes a step further by arguing that heavy investments in microfinance actually hurts local economies.
Bateman starts by discussing the growing microfinance portfolios of commercial banks in Serbia:
“I have recently been working as a consultant in Serbia. Here the foreign-owned commercial banks since 2001 have massively discovered microfinance. From almost zero in 2001, the commercial banks now channel 22 per cent of their total loan portfolio through highly profitable microfinance (household microloans) programmes amounting to almost 12 per cent of gross domestic product.”
From there, Bateman discusses the negative effects that he feels stem from this growing concentration on microfinance, specifically:
• Shortage of funds for small and medium-sized enterprises (SMEs), which can be
damaging because SMEs are a proven route to sustained growth and development
• Accelerated proliferation of informal-sector microenterprises (e.g., kiosks,
shops, subsistence farms) instead of industrial ventures
Bateman extends this argument to other countries, where he feels similar problems arise from overinvestment in microfinance, to the neglect of SMEs and other engines of sustained growth (e.g., Mexico, Bangladesh).
I don’t agree with all of Bateman’s points, but the idea that there could be over-concentration and investment in microfinance makes sense. As Bateman concludes,
“Economics 101 shows conclusively how critical savings are to development, but only if intermediated into growth- and productivity-enhancing projects. If it all goes into rickshaws, kiosks, 30 chicken farms, traders, and so on, then that country simply will not develop and sustainably reduce poverty.”
Bateman’s full article can be found here. Any good arguments against Bateman’s points?
9 comments:
Mr Bateman makes some interesting observations such as the criticality of savings. But I am not sure about microfinance being a major part of bank's portfolio. Some disaggregation of the microfinance portfolio referred to by Mr Bateman is needed. I would surmise that microfinance is defined generously in Bosnia and a significant part of it went for consumer credit as in some Latin American countries. It is difficult to envisage a situation where more than 20% of loans flow to microfinance clients which means that a very large number of such accounts are with banks to the exclusion of more profitable avenues of lending for larger clients.
In India even with large numbers of clients available and with large numbers being acquired by the MFIs and banks, the credit flow in fiscal 2008 was less than 0.5% of total bank credit.
Even granting a large part of loans go to micro clients, it generates local economic activity, puts incomes in hands of a large number of people and stimulates demand for goods and services. If the SME sector is viable and profitable, Banks would not prioritise other sectors. There is more to the asset allocation policies. The assumption in Batesman argument is that resources are so limited in some of these economies, that microfinance could exhaust supply of credit. In a globalised financial sector this does not seem likely unless the banking sector is very weak and as a consequence unable to access external funds.
N.Srinivasan
Consultant and author,
State of the sector report Microfinance India 2008
Just came across this reference to my letter, so maybe I can help. Microfinance is indeed a major and growing part of many banks' portfolios in South East Europe. In fact, Serbia is one of the least problematic in this regard. I mentioned it only because when I was invited to write the letter to the FT, I was coincidentally on assignment in Serbia so had much data to hand. Croatia and Bosnia are probably even more exposed to a massive overhang of household microloans. And if you go to the Baltic states you will find even more dramatic increases in the total of household microloans disbursed as part of the loan portfolio of most banks, a fact that is now exposing these countries to serious risks. All that money loaned out, with just a few hundred thousand more kiosks, taxis, petty traders is not much of a development return. As to your next point - yes, it is best to consider microfinance and consumer credit as inter-changeable. A high proportion of microfinance is used for consumption purposes, on the one hand, and if you do want to start a microenterprise it is perfectly possible to use consumer credit, on the other. Next, the reason commercial banks prefer microloans to anything else? This is easy - household microloans are highly profitable and much less risky. No doubt about this. PR aside, the banks are not remotely interested in the longer run impact on the local economy, anymore than junk food or tobacco producers are concerned about the longer run health implications of their products. As to your point about microloans 'generating economic activity, etc', I hear this a lot but never see any real evidence. However, I don't deny some microloans might have some seemingly temporary effect. But displacement effects in already saturated local markets for non-tradeable goods ensure that very few net jobs or additional income are really created, if indeed the local economy is not made much worse off directly thanks to the promotion of destructive competition. Also, policymakers make choices, and if microloans are worse than everything else on offer, particularly SME lending, then the fact that they have a small positive impact logically means nothing. You could make the same argument in favour of coal-powered cars - yes, they can propel a car a little way, but because they are not nearly as good as all other engine types, this is why we don't have coal-powered cars. Finally, the scarce resources argument - yes, resources are scarce everywhere, so there is bound to be an opportunity cost to using savings for microloans. SME lending is in critically short supply in South East Europe, especially for new starts, so anything that encourages even more resources to be channelled into microloans and then into trivial activities makes no development sense whatsoever. If it means SME lending is reduced, which is indeed what is happening, then this is particularly bad.
I observed only one small microfinance programme (total amount about two lakh rupees and fifty families) with no name run by a pastor and he expressed similar misgivings to Bateman's. Possibly some scale production like making paper plates (a second hand machine was available for 15,000 rupees last year)etc can be organized. But at the moment, it seems to be a question of making a living for some and improving a bit for others. There is no doubt that it is helpful and the amount involved could not have been used for more productive purposes. I would 'guess' that the processes involved would depend very much on the region, type of clients and the government. Perhaps when necessary, governments can limit the number of banks involved (using their track records if necessary), or have limits on the percentage of their lending to microfinance projects.
An interesting aside. The pastor has been running the program for two years and so far all the loans are returned in time. The interest is only one percent for month and on the amount still owed and so comes to about 6 percent an year which is enough to cover the paper work and other expenses like travel.
I do not have any expertise or knowledge in the area apart from observing this one organization from a distance. Just trying to learn.
Mr. Srinivasan and Mr. Bateman,
Thanks so much for your very insightful comments. I have learned a lot through your discussion, which in my mind, has raised a lot of questions about the differences in microfinance in Eastern Europe and here in India.
Specifically, are clientele similar in both regions? If not, what are the main differences and what would this for this how microcredit is, and should be, deployed, in these regions?
I did a little research, and found an interesting benchmarking report on microfinance in Eastern Europe. Page 3 in the report details average loan sizes, which seem to be about US$700 - $800 (http://www.mfc.org.pl/doc/Publication/ECA_Benchmarking.pdf). In India, most MFIs start by providing loans of about Rs 5000 (~US$100), and increase to a maximum of about Rs 15000 (~$300). This is a huge difference, and the fact that about 50% of adults in India do not have access to formal finance (i.e., no bank account)also opens a space for microfinance beyond providing consumer credit. I am not sure, but am guessing the percentage of adults without a bank account in Eastern Europe is a lot smaller.
Basically, I think the differences in clientele attributes and the size of loans may mean that microfinance in India can play a more basic role in integrating clients into the formal financial system and would have less of an impact on the SME sector than microfinance in Eastern Europe.
As Mr. Bateman points out in his article, microcredit accounts for 22% of commercial banks' loan portfolio in Bosnia. Compare that to the information provided by Mr. Srinivasan; in 2008 microcredit only accounts for .5% of the bank credit flow in India. Differences in accounting aside, Bosnia's microfinance market may be saturated while India's microfinance institutions increasingly fill a void in the formal financial services system.
I would agree that high quality lending to SMEs, in addition to providing microloans has many-many beneficial effects both for the provider and for the economy (see Huang 2007 for a more recent treatment of the impact of this on the Chinese growth miracle -- I have provided a link to a McKinsey article on this book, in the "Access to Finance is a Fundamental Right" group on facebook).
I do not however agree that micro-loans are the "problem" or that liquidity is even the right metric of "systemic lending capacity". I feel that the challenges for SME lending are many and unless we address them systematically, merely directing money away from microfinance is not going to help. For example a large proportion of rural based SMEs face systemic risks that far exceed idiosyncratic risks that they can deal with at the village level. Even for those enterprises that have their supply chains begin and end in the village itself there is a need to improve credit underwriting capacity well beyond what is currently available at a rural financial institution.
The IFMR Trust (www.ifmrtrust.co.in) has sought to address both these issues in their strategy (please see the presentations and videos on www.nachiketmor.net if you want to know more). It is my view that if they are right they may well be able to produce a Chinese style growth impact in the regions in which they operate.
There is nothing wrong with microfinance if you only borrow what you can pay for. For example, auto loans are very affordable.
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Do auto loans even count as microfinance? Cars aren't very cheap at all, so I don't see the "micro" part there.
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"Do auto loans even count as microfinance?" They do count as microfinance for the mere fact that you pay your loans off in small increments. Obviously, this doesn't apply to short-term loans.
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