Reading time: 1 – 2 minutes

David Roodman’s latest post excerpts some of Stuart Rutherford’s thoughts on microfinance and its effect on the lives of the poor. Rutherford, founder of Save Safe, skips the marketing speak and gives a more realistic take on microfinance, which I appreciate. Roodman’s summary of Rutherford’s key insights is timely considering the increased scrutiny on microfinance lately. (See my posts on Portfolios of the Poor and on some recent studies from MIT for more information on the debate.)

Rutherford’s bottom line on microfinance is especially pragmatic so I will reproduce it here:

[Microfinance is] a useful service that may not always transform poor people’s lives but rarely fails to help them.

That is probably a good context in which to look at, and judge, microfinance as an aid to the poor. For more of Rutherford’s thoughts please check out Roodman’s post. It is well worth a read for anyone interested in the efficacy of microfinance.

Reading time: 6 – 10 minutes

The Boston Globe released an article on September 20th that took a look at two recent studies on the efficacy of microcredit. The two studies were completed by researchers affiliated with MIT’s Jameel Poverty Action Lab and have not yet been published.  However, according to the Globe the studies are already being called the most thorough and careful studies that have been done on the topic (no sources were cited by the Globe to corroborate that claim). What did the studies find? Here is what the Globe had to say:

What [the studies] find is that, by most measures, microcredit does not offer a way out of poverty. It helps a few of the more entrepreneurial poor to start up businesses, and at the margins it may boost the profits of existing microenterprises, but that doesn’t translate into gains for the borrowers, as measured by indicators like income, spending, health, or education. In fact, most microcredit clients actually spend their borrowed money not on a business, but on household expenses, on paying off other debts or on a relatively big-ticket item like a TV or a daughter’s wedding. And while microcredit champions point to microloans as a tool for empowering women, the studies see no impact on gender roles, and find evidence that if any one group benefits more, it’s male entrepreneurs with existing businesses.

The team that completed the research for “Portfolios of the Poor” also found that a lot of loans aren’t actually used to start, or continue to build, businesses. A lot of the loans are used to pay off debt and to pay for expensive life milestones (like weddings in India and funerals in South Africa) among a myriad of other things. However, even if that is the case, microcredit, with its much lower interest rates, is a much needed alternative to the usurious local moneylenders.

The Globe article goes on to look at the microentrepreneurs that are created through microcredit programs and suggests that we may need to think more macro to solve the poverty issue. That is, we need to think of scale. While building a lot of microbusinesses is a good step toward alleviating poverty we need to recognize that microbusinesses, since they don’t have scale, won’t have as much impact as a growing a scalable business that, over time, will provide many new jobs. That is a completely valid point and one that deserves some more research.

Now that we have taken a look at some of the conclusions of the studies we should take some time to look at the methodology of the studies.  One of the main pieces of information I noticed was the time frame of the studies. The studies were completed over a 1.5 – 2 year time span.  It is debatable whether or not that was a long enough span of time to obtain meaningful results. One of the reasons that I really loved “Portfolios of the Poor” was that the studies were completed over a much longer time span and data was collected at closely spaced intervals. I do believe that to get solid data in the microfinance world you need more data points over a long period of time.  I am not ready to discount anything in the new MIT studies though since I have not even had that chance to read them.

The first study, completed by Dean Karlan (economics professor at Yale) and Jonathan Zinman (associate economics professor at Dartmouth), looked at a single bank in the Phillipines that offered microloans. They asked the bank to institute an algorithm that would approve some borderline people for a loan and deny others.  Then Karlan and Zinman followed up with both sets of subjects to see what the effect of the loans were. It turns out that, in this case, the loans didn’t seem to have much of an effect.

Neither household income nor spending rose for those who got microloans. And borrowers who did put the money into their businesses – instead of using it, as many did, for household expenses – actually shrank rather than grew their businesses. Karlan and Zinman suggest that this might be because the business owners were taking advantage of the loan to fire unproductive workers to whom they owed financial favors, and those firings seemed to explain the very small gains in profit Karlan and Zinman found. In addition, the gains accrued only to male entrepreneurs, not the women usually targeted by microcredit programs.

The second study, authored by Abhijit Banerjee and Esther Duflo (economics professors at MIT) along with Rachel Glennerster (executive director of the Poverty Action Lab) and an MIT economics doctoral student named Cynthia Kinnan, found a larger impact than the first study, albeit a selective one.

Working with a microcredit bank in India that was looking to expand in the city of Hyderabad, the researchers did find some small positive effects. Borrowers who already had a business did see some increase in profit. Households without businesses that the researchers judged more predisposed to start one were found to cut back on spending, suggesting they were saving to augment their loan for a capital business expense like a pushcart or a sewing machine. The researchers also found small but encouraging shifts in household spending across the board, with less money spent on “temptation goods” like alcohol, tobacco, and gambling.

However, overall household spending stayed about the same and the authors found no effect on children’s health or education levels.

Duflo thinks that those results only look disappointing since the expectations for microcredit are so high.  She is probably right. However, it is hard to take too much away from these studies.

The studies were very limited in scope, both of them only looking at one specific bank and then at a subset of the bank’s loan recipients. Because of the limited time frame and scope I am not sure one can rely too heavily on the results of these studies. Of course, I think most rational microcredit enthusiasts and practitioners would agree that microcredit isn’t going to solve the poverty problem by itself. It is simply a new tool in the development arsenal and one that is arguably very potent and sustainable.

Tyler Cowen, an economics professor at George Mason University and one of my favorite bloggers, gave a quote in the Globe piece that lines up with part of my thinking on the issue:

“The fact that [microcredit] has survived commercially, I take that more seriously than any other piece of evidence.”

The commercial viability of microcredit is one of the things that gets me excited about it. Having an effective, and sustainable, development tool is a very powerful thing.

At the end of the day, what these studies do help us understand is that we need to do more. Focusing on building other financial services like savings and insurance will be an important part of the solution going forward. Also, funding enterprises that have graduated from the “micro” level could be another important innovation. It will help bridge the gap between microcredit and working with a standard bank, which, at this point, is quite large.

The Globe article mentions that the Grameen Bank is already looking at an initiative where they will create loans of up to $10,000 for what they call minibusinesses. Other NGOs are even investing in neglected medium-sized businesses and receiving equity stakes in return for their capital.

The future of microfinance and microcredit is bright. Of course there is still a lot we need to learn in order to make better financial products for the poor.  Studies like the ones discussed in this article are very important for that reason. When it comes to development (or really anything) we should always study the efficacy of programs to ensure that they are performing well.  If they aren’t performing well then innovation needs to happen but innovation can only happen when we know the truth.

(via Boston Globe Article by Drake Bennett)

Reading time: 2 – 4 minutes

Forbes India just ran a short interview with Vikram Akula where he talks about how he brings the commercial and social side of microfinance together to help microfinance scale. Akula saw that the three Cs, as he calls them, were hindering the scalability of microfinance and he created SKS Microfinance to address them. Akula’s three Cs are: capital, capacity and cost. SKS has done an incredible job at addressing all three and marrying the commercial and social sides of microfinance together. The result: SKS is on pace to become larger than the Grameen Bank very soon (making SKS the largest MFI in the world with over 8mm customers) and it could be the first MFI to go public in India.

Here is an excerpt from the interview that focuses on how Vikram looks at the social and commercial aspects of SKS:

How do you maintain that social goal, that value addition for your customer when you’re growing at 200 percent? How do you carry that organisational culture across the country? And how do you do that when you also have to show financial profitability for your investors?

We don’t see conflict between the two. Fundamentally our organisation is about creating social value for our customers. I don’t even look at the profit lines. If you ask me the ratios ROE, ROA, I don’t know those things. It doesn’t matter to me what happens — what matters to me is that there’s social value. But I am confident that if we create social value, it will create financial value to our investors and this is the reason why. So first off, how do we create social value? In everything we do, we’re looking at the customers first. Does this work for the member, whether it’s a product, whether it’s a procedure, whether it’s a process?

…

The value for the investors is not the interest on the Rs 2,000 loan — that’s nothing. The value for the investors is when tomorrow she moves from 2 to 10 to 20 to 30 [thousand rupees] and stays with us — that’s when you create financial value. When she moves from one product to four products to five products. The value to the financial investor comes there. In order to create that later value to the investor, I need to have a customer who is extremely loyal to me. How do I make her loyal? By doing what’s right for her.

…

If we don’t treat the customer right today, you undermine long term shareholder value. Every single investor understands that because we are in the fortunate position of being able to pick. There are some investors that don’t understand this, we just haven’t selected them.

Please read the interview if you have a chance. It is worth the time.

Reading time: 3 – 4 minutes

Time.com recently posted an interesting article on insurance for people in the developing world – a.k.a. microinsurance – and why it has been hard to get any meaningful penetration. You might be wondering why gaining traction with an insurance product designed for the world’s poor has been hard. “Why wouldn’t the poor want an insurance product that meets their needs and is financially attainable? Their lives are very risky so it would make a lot of sense for them to insure themselves.” Well, it turns out that, once again, what may work in the first world doesn’t always work the same way in the third world (we learned this from Portfolios of the Poor).

Trust is one of the main reasons why microinsurance has not yet begun to grow like people thought it would. The Time article references a quote by Xavier Giné, a World Bank economist in Malawi, that shows the inherent difference between microcredit, which is growing like wildfire, and microinsurance, which is not nearly growing as fast:

“When we think about credit, lenders need to trust the borrower. But in insurance, it’s the exact opposite. You have to trust that the insurance company will pay the claim.”

That comparison really struck me because it is so simple and yet so true. In the third world people still have a hard time believing that someone will pay them if they run into hard times and, unfortunately, this fear is warranted. According to the Time article, insurers didn’t pay off for the insured in Bangladesh in the 1990s (this was one of the earliest attempts at microinsurance). However, trust is not the only issue the poor have with microinsurance.

In the book Portfolios of the Poor, which I reviewed back on September 8th, other issues with microinsurance are suggested and explored. From the Time article:

“…being poor is not without complications, and that’s part of what makes a loan attractive. Sure, microcredit is typically meant to help build a business, but cash is fungible–if there’s no money for dinner one night, a line of credit, whatever its intent, solves the problem. Not so for insurance, which asks people to decide in advance which of the many risks they face they should hedge.

Plus, even without formal insurance, most people already have some version of a safety net: friends, family and–in truly catastrophic situations–government.”

Robert Morduch, one of the authors of Portfolios of the Poor also adds a bit of wisdom:

“The challenge for insurance is to beat those other mechanisms [i.e. friends, family and government], not to beat nothing.”

Well said. Financiers looking to serve the third world need to remember that they are competing against the status quo and they need to take that status quo, whatever it may be, seriously. They also need to design products that are far better than current alternatives, not just incrementally better.

I have no doubt that MFIs, and others working in the field of microfinance, will figure out how to design microinsurance products that work well. However, we should not expect to see the same outstanding growth trend we saw in microcredit manifest itself in the adoption of microinsurance.

Reading time: 4 – 6 minutes

I recently finished reading “Portfolios of the Poor: How the World’s Poor Live on $2 a Day” by Daryl Collins, Jonathan Morduch, Stuart Rutherford and Orlanda Ruthven. The book was based on a handful of “diary” studies compiled by one of the authors. The diary studies were designed to get to the heart of how the poor manage their money.

Prior to the “diary” studies researchers tended to look at the finances of the poor in an aggregate sense (i.e. using beginning and ending balances for each household and even higher level data). The aggregate view of the finances of the poor, it turns out, does not capture the essence of how the poor manage money.  “Portfolios of the Poor” suggests that one has to look at the cash flows of poor households to really understand how the poor manage their money and what tools they need from the financial sector to improve their lives.

The “diary” studies looked at households in Bangladesh, India and South Africa and took samples of data from the households every two weeks.  This data – the cash flows of the poor – showed that the poor are active money managers and are constantly on the lookout for better financial products that more closely fit their needs.  In fact, the average household in the study turned over multiples of their yearly income each year via a handful of financial tools. For example, the Indian sample turned over 0.75 – 1.75 times their annual incomes on average.

Having spent a lot of time over the past 4 years thinking about microfinance I have to say that I thought I had a firm handle on things but “Portfolios of the Poor” and the data the authors uncovered through their “diary” studies caused me to see microfinance in a new light.  Here are some of the more surprising pieces of information that the “diary” studies revealed:

• The $2/day mark that is often quoted is misleading. The real trouble the poor have is not necessarily the small amount of money they earn (thought that is, of course, a big problem), it is the irregularity (and uncertainty) of their paydays.
• Lower incomes require more, not less, financial management. In other words, the poor do not use financial tools despite their low income, they use them because of their low income.
• The poor do not live hand to mouth (as a lot of people think).
• While microcredit is fantastic, most poor people still prioritize getting food on the table each day, not starting a business. More needs to be done with savings vehicles of different types and more flexible loan offerings to help with this pressing need.
• The most frequent lenders (in the “diary” sample) are still friends and relatives (who tend to loan interest free) showing that there is still a lot of room for microfinance to grow.
• What the poor really need are cash management tools.
• When looking at microfinance and other financial instruments the poor use to manage their cash flow one needs to think in terms of fees, not interest rates. A lot of financial instruments geared toward the poor don’t compound.  Along with that fact, the poor tend to view themselves as paying fees for a service, not interest rates on money borrowed (this is probably why the poor pay for savings in a number of cases, earning what is effectively a negative interest rate).

If you read through the list above I am quite sure you were surprised by at least some of those points.  If you want to learn more about how the researchers arrived at those conclusions please check out the book.

One last note before I conclude: The authors of “Portfolios of the Poor” put together a nice list of three hurdles the poor face in terms of money management.  Here is their list (i.e. “The Triple Whammy”):

• Small income
• Irregular income (or more importantly – an unpredictable income)
• Poor access to financial services that meet their needs

Of course this list is also a set of opportunities for existing banks and microfinance institutions as well as for upstart institutions. Here is the list recast as opportunities:

• Create tools to help poor households manage money on a day-to-day basis (e.g. revolving checking/savings accounts without set deposit or withdrawal terms).
• Create tools that help poor households build savings over the long run (e.g. structured savings accounts with set terms and deposit schedules that can perhaps be borrowed against to add flexibility).
• Create tools that help poor households borrow for all uses, not just to start microenterprises (e.g. loans for emergencies and healthcare needs).

If you are interested in international finance, international development, economics or microfinance I highly recommend reading “Portfolios of the Poor.” It is an engaging read and provides many insights that don’t come to the surface after only a cursory look at microfinance (e.g. the poor are much more financially sophisticated than people think).

Reading time: 4 – 6 minutes

In this post I would like to introduce you to three innovations focused on the bottom of the pyramid.  These three innovations are very exciting and you can get even get involved with any one of them.  First up, The Acumen Fund.

The Acumen Fund: A VC Firm Focused on the Bottom of the Pyramid

I first heard about the Acumen Fund a while back but it was recently brought to the front of my mind via a post on Marginal Revolution (one of my favorite economics blogs). Here is the explanation of Acumen directly from Marginal Revolution:

The idea is to invest patient capital in scalable, for-profit businesses that deliver services to the poor.  The fund, for example, has invested in a firm producing drip irrigation systems in Pakistan, a Tanzanian firm that produces mosquito nets and an Indian firm producing internet-telephone kiosks in small villages.

This is such a fantastic idea.  I can’t believe I had forgotten about Acumen.  I highly recommend checking out their website for more information. I am certainly going to do more homework on these guys.

The one thing I want to know is what their returns look like.  Acumen is a not-for-profit organization but I wonder if this type of investing could be done for-profit.  The one issue I can foresee right away is the liquidity issue.  For example, how do you sell or take public a Pakistani drip irrigation systems company or a Tanzanian mosquito net company?  Even if the companies were big enough I am not sure the capital markets or M&A activity is robust enough to get companies to exit. That said, it may be someday.

Samasource

I just learned about Samasource yesterday via an fbFund related tweet from Mr. Dave McClure.  Samasource was a participant in the fbFund Rev program this summer (the fbFund is a seed fund run by Facebook, the Founders Fund and Accel Partners).

The basic gist of Samasource is this: you can use their site to outsource computer-based work to women, refugees and youth living in poverty.

Samasource is helping to create jobs for the next billion by offering outsourced services ranging from data services and transcription to testing services and virtual assistance.  We have some tasks at TransFS that I am considering using Samasource for so I will report back on its effectiveness in a future post.

Here is a short presentation on Samasource with a few success stories:

Bankers Without Borders

Bankers Without Borders is a Grameen Foundation volunteer initiative. A number of microfinance related volunteer opportunities are listed on their site. When I first started getting into microfinance this site wasn’t around and it was much harder to find places where my skills were needed.  Bankers Without Borders makes volunteering in microfinance simple. If you are at all interested in microfinance I highly recommend checking out their site.

Reading time: 2 – 4 minutes

I wrote a post over two years ago (actually on the eve of FeedBurner’s sale to Google) where I discussed the need for microlending in the U.S. and the issues that U.S. microlending initiatives faced.  I also provided an idea for a possible solution that involved a “Kiva-like” site where organizations could find individuals to contribute to U.S. based microfinance loans.

I had almost forgotten about that post but was reminded of it when I received a comment on it a couple of days ago from Sam at Accion USA.  It turns out that Accion USA and Kiva recently partnered to allow Kiva users to fund U.S. based microloans. I am very excited about this news.  The Accion/Kiva partnership will create more opportunities for microentrepreneurs in the U.S. and it will certainly help us to start gathering the data needed to see if microlending in the U.S. is feasible over the long term.

Sam’s comment was incredible and worthy of a blog post on its own.  I suggest you read it in full if you have a chance.  For those that are short on time I will summarize Sam’s comment below.

• A lot of the concerns I stated in my original post have been addressed over the last two years.
• Microentrepreneurs overseas are limited by scale (this is a problem I am well aware of) but microentrepreneurs here are not since there is more credit available in the U.S. – via standard banks and other institutions – to help microentreprenurs to continue to scale their businesses.
• Microentrepreneurs in the “first” world are more likely to occupy niche industries where they fill gaps in local markets. In contrast, microentrepreneurs in the third world often find themselves in the position of being the main source of income for a community.
• Credit cards are not necessarily direct competition to U.S. microlenders.
• U.S. microloan rates are competitive with private sector loans.
• The greatest struggle for U.S. microlenders will be the fight to achieve sustainability (right now they are dependent on donations).

If you are interested in learning more about Accion USA’s U.S. microlending programs please check out AccionUSA.org or follow Accion USA on twitter (@Accion_USA). You should also check out Kiva.org if you are interested in making your first microloan. For more more general microfinance information you should check out #mifimon (Microfinance Monday) on twitter to follow the real-time microfinance conversation and get insight from experts around the world.

I am excited to see how microfinance develops here at home and to continue to think about how it will evolve and achieve sustainability. Congrats to Accion and Kiva for taking a big step toward a thriving U.S. microfinance sector.