Microfinance promise

Journal of Economic Literature
Vol. XXXVII (Decmber 1999), pp. 1569–1614

Morduch:ofThe Microfinance (December 1999)
Journal Economic Literature, Vol. XXXVII Promise

The Microfinance Promise
Jonathan Morduch1

1. Introduction increasingly fractured, offering a fragile
foundation on which to build.
A BOUT ONE billion people globally
live in households with per capita in-
comes of under one dollar per day. The
Amid the dispiriting news, excite-
ment is building about a set of unusual
financial institutions prospering in dis-
policymakers and practitioners who have tant corners of the world—especially
been trying to improve the lives of that Bolivia, Bangladesh, and Indonesia. The
billion face an uphill battle. Reports of hope is that much poverty can be allevi-
bureaucratic sprawl and unchecked cor- ated—and that economic and social
ruption abound. And many now believe structures can be transformed funda-
that government assistance to the poor mentally—by providing financial ser-
often creates dependency and disincen- vices to low-income households. These
tives that make matters worse, not bet- institutions, united under the banner of
ter. Moreover, despite decades of aid, microfinance, share a commitment to
communities and families appear to be serving clients that have been excluded
1 Princeton University. JMorduch@Princeton.
from the formal banking sector. Almost
Edu. I have benefited from comments from all of the borrowers do so to finance
Harold Alderman, Anne Case, Jonathan Conning, self-employment activities, and many
Peter Fidler, Karla Hoff, Margaret Madajewicz, start by taking loans as small as $75, re-
John Pencavel, Mark Schreiner, Jay Rosengard,
J.D. von Pischke, and three anonymous referees. I paid over several months or a year. Only
have also benefited from discussions with Abhijit a few programs require borrowers to
Banerjee, David Cutler, Don Johnston, Albert put up collateral, enabling would-be en-
Park, Mark Pitt, Marguerite Robinson, Scott
Rozelle, Michael Woolcock, and seminar partici- trepreneurs with few assets to escape
pants at Brown University, HIID, and the Ohio positions as poorly paid wage laborers
State University. Aimee Chin and Milissa Day pro- or farmers.
vided excellent research assistance. Part of the re-
search was funded by the Harvard Institute for Some of the programs serve just a
International Development, and I appreciate the handful of borrowers while others serve
support of Jeffrey Sachs and David Bloom. I also millions. In the past two decades, a di-
appreciate the hospitality of the Bank Rakyat In-
donesia in Jakarta in August 1996 and of Grameen, verse assortment of new programs has
BRAC, and ASA staff in Bangladesh in the sum- been set up in Africa, Asia, Latin Amer-
mer of 1997. The paper was largely completed ica, Canada, and roughly 300 U.S. sites
during a year as a National Fellow at the Hoover
Institution, Stanford University. The revision from New York to San Diego (The Econo-
was completed with support from the Mac- mist 1997). Globally, there are now
Arthur Foundation. An earlier version of the pa- about 8 to 10 million households served
per was circulated under the title “The Microfi-
nance Revolution.” The paper reflects my views by microfinance programs, and some
only. practitioners are pushing to expand to
1569

1570 Journal of Economic Literature, Vol. XXXVII (December 1999)

100 million poor households by 2005. furniture maker in Northern California.
As James Wolfensohn, the president of The story continues:
the World Bank, has been quick to From ancient slums and impoverished vil-
point out, helping 100 million house- lages in the developing world to the tired in-
holds means that as many as 500–600 ner cities and frayed suburbs of America’s
million poor people could benefit. In- economic fringes, these and millions of other
creasing activity in the United States women are all part of a revolution. Some
might call it a capitalist revolution . . . As
can be expected as banks turn to mi- little as $25 or $50 in the developing world,
crofinance encouraged by new teeth perhaps $500 or $5000 in the United States,
added to the Community Reinvestment these microloans make huge differences in
Act of 1977 (Timothy O’Brien 1998). people’s lives . . . Many Third World bank-
The programs point to innovations ers are finding that lending to the poor is not
just a good thing to do but is also profitable.
like “group-lending” contracts and new (Brill 1999)
attitudes about subsidies as the keys to
their successes. Group-lending con- Advocates who lean left highlight the
tracts effectively make a borrower’s “bottom-up” aspects, attention to com-
neighbors co-signers to loans, mitigat- munity, focus on women, and, most im-
ing problems created by informational portantly, the aim to help the under-
asymmetries between lender and bor- served. It is no coincidence that the rise
rower. Neighbors now have incentives of microfinance parallels the rise of non-
to monitor each other and to exclude governmental organizations (NGOs) in
risky borrowers from participation, pro- policy circles and the newfound attention
moting repayments even in the absence to “social capital” by academics (e.g.,
of collateral requirements. The con- Robert Putnam 1993). Those who lean
tracts have caught the attention of eco- right highlight the prospect of alleviat-
nomic theorists, and they have brought ing poverty while providing incentives
global recognition to the group-lending to work, the nongovernmental leadership,
model of Bangladesh’s Grameen Bank. 2 the use of mechanisms disciplined by
The lack of public discord is striking. market forces, and the general suspicion
Microfinance appears to offer a “win- of ongoing subsidization.
win” solution, where both financial in- There are good reasons for excite-
stitutions and poor clients profit. The ment about the promise of microfi-
first installment of a recent five-part se- nance, especially given the political
ries in the San Francisco Examiner, for context, but there are also good reasons
example, begins with stories about four for caution. Alleviating poverty through
women helped by microfinance: a tex- banking is an old idea with a checkered
tile distributor in Ahmedabad, India; a past. Poverty alleviation through the
street vendor in Cairo, Egypt; an artist provision of subsidized credit was a cen-
in Albuquerque, New Mexico; and a terpiece of many countries’ develop-
2 Recent theoretical studies of microfinance in-
ment strategies from the early 1950s
clude Joseph Stiglitz 1990; Hal Varian 1990; Timo- through the 1980s, but these experi-
thy Besley and Stephen Coate 1995; Abhijit ences were nearly all disasters. Loan re-
Banerjee, Besley, and Timothy Guinnane 1992; payment rates often dropped well below
Maitreesh Ghatak 1998; Mansoora Rashid and
Robert Townsend 1993; Beatriz Armendariz de 50 percent; costs of subsidies ballooned;
Aghion and Morduch 1998; Armendariz and Chris- and much credit was diverted to the po-
tian Gollier 1997; Margaret Madajewicz 1998; litically powerful, away from the in-
Aliou Diagne 1998; Bruce Wydick 1999; Jonathan
Conning 1997; Edward S. Prescott 1997; and Loïc tended recipients (Dale Adams, Douglas
Sadoulet 1997. Graham, and J. D. von Pischke 1984).

Morduch: The Microfinance Promise 1571

What is new? Although very few pro- through soft terms on loans from do-
grams require collateral, the major new nors. Moreover, the programs that are
programs report loan repayment rates breaking even financially are not those
that are in almost all cases above 95 celebrated for serving the poorest cli-
percent. The programs have also proven ents. A recent survey shows that even
able to reach poor individuals, particu- poverty-focused programs with a “com-
larly women, that have been difficult to mitment” to achieving financial sustain-
reach through alternative approaches. ability cover only about 70 percent of
Nowhere is this more striking than in their full costs (MicroBanking Bulletin
Bangladesh, a predominantly Muslim 1998). While many hope that weak fi-
country traditionally viewed as cultur- nancial performances will improve over
ally conservative and male-dominated. time, even established poverty-focused
The programs there together serve programs like the Grameen Bank would
close to five million borrowers, the vast have trouble making ends meet without
majority of whom are women, and, in ongoing subsidies.
addition to providing loans, some of the The continuing dependence on subsi-
programs also offer education on health dies has given donors a strong voice,
issues, gender roles, and legal rights. but, ironically, they have used it to
The new programs also break from the preach against ongoing subsidization.
past by eschewing heavy government in- The fear of repeating past mistakes has
volvement and by paying close attention pushed donors to argue that subsidiza-
to the incentives that drive efficient tion should be used only to cover start-
performance. up costs. But if money spent to support
But things are happening fast—and microfinance helps to meet social objec-
getting much faster. In 1997, a high tives in ways not possible through alter-
profile consortium of policymakers, native programs like workfare or direct
charitable foundations, and practitioners food aid, why not continue subsidizing
started a drive to raise over $20 billion microfinance? Would the world be bet-
for microfinance start-ups in the next ten ter off if programs like the Grameen
years (Microcredit Summit Report 1997). Bank were forced to shut their doors?
Most of those funds are being mobi- Answering the questions requires
lized and channeled to new, untested studies of social impacts and informa-
institutions, and existing resources are tion on client profiles by income and
being reallocated from traditional pov- occupation. Those arguing from the
erty alleviation programs to microfi- anti-subsidy (“win-win”) position have
nance. With donor funding pouring in, shown little interest in collecting these
practitioners have limited incentives to data, however. One defense is that, as-
step back and question exactly how and suming that the “win-win” position is
where monies will be best spent. correct (i.e., that raising real interest
The evidence described below, how- rates to levels approaching 40 percent
ever, suggests that the greatest promise per year will not seriously undermine
of microfinance is so far unmet, and the the depth of outreach), financial viabil-
boldest claims do not withstand close ity should be sufficient to show social
scrutiny. High repayment rates have impact. But the assertion is strong, and
seldom translated into profits as adver- the broader argument packs little punch
tised. As Section 4 shows, most pro- without evidence to back it up.
grams continue to be subsidized di- Poverty-focused programs counter
rectly through grants and indirectly that shifting all costs onto clients would


likely undermine social objectives, but by practitioners and researchers who
by the same token there is not yet di- are moving beyond the terms of early
rect evidence on this either. Anecdotes conversations (e.g., Gary Woller, Chris-
abound about dramatic social and eco- topher Dunford, and Warner Wood-
nomic impacts, but there have been few worth 1999). The promise of microfi-
impact evaluations with carefully cho- nance was founded on innovation: new
sen treatment and control groups (or management structures, new contracts,
with control groups of any sort), and and new attitudes. The leading pro-
those that exist yield a mixed picture of grams came about by trial and error.
impacts. Nor has there been much solid Once the mechanisms worked reason-
empirical work on the sensitivity of ably well, standardization and replica-
credit demand to the interest rate, nor tion became top priorities, with contin-
on the extent to which subsidized pro- ued innovation only around the edges.
grams generate externalities for non- As a result, most programs are not opti-
borrowers. Part of the problem is that mally designed nor necessarily offering
the programs themselves also have little the most desirable financial products.
incentive to complete impact studies. While the group-lending contract is the
Data collection efforts can be costly and most celebrated innovation in microfi-
distracting, and results threaten to un- nance, all programs use a variety of
dermine the rhetorical strength of the other innovations that may well be as
anecdotal evidence. important, especially various forms of
The indirect evidence at least lends dynamic incentives and repayment
support to those wary of the anti-sub- schedules. In this sense, economic the-
sidy argument. Without better data, av- ory on microfinance (which focuses
erage loan size is typically used to proxy nearly exclusively on group contracts) is
for poverty levels (under the assump- also ahead of the evidence. A portion of
tion that only poorer households will be donor money would be well spent quan-
willing to take the smallest loans). The tifying the roles of these overlapping
typical borrower from financially self- mechanisms and supporting efforts to
sufficient programs has a loan balance determine less expensive combinations
of around $430—with loan sizes often of mechanisms to serve poor clients in
much higher (MicroBanking Bulletin varying contexts. New management
1998). In low-income countries, bor- structures, like the stripped-down struc-
rowers at that level tend to be among ture of Bangladesh’s Association for So-
the “better off” poor or are even slightly cial Advancement, may allow sharp cost-
above the poverty line. Expanding fi- cutting. New products, like the flexible
nancial services in this way can foster savings plan of Bangladesh’s SafeSave,
economic efficiency—and, perhaps, may provide an alternative route to fi-
economic growth along the lines of nancial sustainability while helping poor
Valerie Bencivenga and Bruce D. Smith households. The enduring lesson of mi-
(1991)—but it will do little directly to crofinance is that mechanisms matter:
affect the vast majority of poor house- the full promise of microfinance can
holds. In contrast, Section 4.1 shows only be realized by returning to the
that the typical client from (subsidized) early commitments to experimentation,
programs focused sharply on poverty al- innovation, and evaluation.
leviation has a loan balance close to just The next section describes leading
$100. programs. Section 3 considers theoret-
Important next steps are being taken ical perspectives. Section 4 turns to


financial sustainability, and Section 5 failures appeared to confirm suspicions
takes up issues surrounding the costs and that poor households are neither credit-
benefits of subsidization. Section 6 de- worthy nor able to save much. More-
scribes econometric evaluations of im- over, subsidized credit was often di-
pacts, and Section 7 turns from credit verted to politically-favored non-poor
to saving. The final section concludes households (Adams and von Pischke
with consideration of microfinance 1992). Despite good intentions, many
in the broader context of economic programs proved costly and did little to
development. help the intended beneficiaries.
The experience of Bangladesh’s Gra-
2. New Approaches meen Bank turned this around, and now
a broad range of financial institutions
Received wisdom has long been that offer alternative microfinance models
lending to poor households is doomed with varying philosophies and target
to failure: costs are too high, risks are groups. Other pioneers described below
too great, savings propensities are too include BancoSol of Bolivia, the Bank
low, and few households have much to Rakyat Indonesia, the Bank Kredit Deas
put up as collateral. Not long ago, the of Indonesia, and the village banks
norm was heavily subsidized credit pro- started by the Foundation for Interna-
vided by government banks with repay- tional Community Assistance (FINCA).
ment rates of 70–80 percent at best. In The programs below were chosen with
Bangladesh, for example, loans targeted an eye to illustrating the diversity of
to poor households by traditional banks mechanisms in use, and Table 1 high-
had repayment rates of 51.6 percent in lights particular mechanisms. The func-
1980. By 1988–89, a year of bad flood- tioning of the mechanisms is described
ing, the repayment rate had fallen to further in Section 3. 3
18.8 percent (M. A. Khalily and Richard
Meyer 1993). Similarly, by 1986 repay- 2.1 The Grameen Bank, Bangladesh
ment rates sank to 41 percent for subsi- The idea for the Grameen Bank did
dized credit delivered as part of India’s not come down from the academy, nor
high-profile Integrated Rural Develop- from ideas that started in high-income
ment Program (Robert Pulley 1989). countries and then spread broadly. 4
These programs offered heavily subsi-
3 Sections 4.1 and 5.1 describe summary statis-
dized credit on the premise that poor
tics on a broad variety of programs. See also Maria
households cannot afford to borrow at Otero and Elisabeth Rhyne (1994); MicroBanking
high interest rates. Bulletin (1998); Ernst Brugger and Sarath Rajapa-
But the costs quickly mounted and tirana (1995); David Hulme and Paul Mosley
(1996); and Elaine Edgcomb, Joyce Klein, and
the programs soon bogged down gov- Peggy Clark (1996).
ernment budgets, giving little incentive 4 Part of the inspiration came from observing

for banks to expand. Moreover, many credit cooperatives in Bangladesh, and, interest-
ingly, these had European roots. The late nine-
bank managers were forced to reduce teenth century in Europe saw the blossoming of
interest rates on deposits in order to credit cooperatives designed to help low-income
compensate for the low rates on loans. households save and get credit. The cooperatives
started by Frederick Raiffeisen grew to serve 1.4
In equilibrium, little in the way of sav- million in Germany by 1910, with replications in
ings was collected, little credit was de- Ireland and northern Italy (Guinnane 1994 and
livered, and default rates accelerated as 1997; Aidan Hollis and Arthur Sweetman 1997). In
the 1880s the government of Madras in South In-
borrowers began to perceive that the dia, then under British rule, looked to the German
banks would not last long. The repeated experiences for solutions in addressing poverty in


TABLE 1
CHARACTERISTICS OF SELECTED LEADING MICROFINANCE PROGRAMS

Bank Badan
Grameen Banco- Rakyat Kredit FINCA
Bank, Sol, Indonesia Desa, Village
Bangladesh Bolivia Unit Desa Indonesia banks
2 million
borrowers;
Membership 2.4 million 81,503 16 million 765,586 89,986
depositors
Average loan balance $134 $909 $1007 $71 $191
Typical loan term 1 year 4–12 3–24 3 months 4 months
months months
Percent female members 95% 61% 23% — 95%
Mostly rural? Urban? rural urban mostly rural mostly
rural rural
Group-lending contracts? yes yes no no no
Collateral required? no no yes no no
Voluntary savings
emphasized? no yes yes no yes
Progressive lending? yes yes yes yes yes
Regular repayment
schedules weekly flexible flexible flexible weekly
Target clients for lending poor largely non-poor poor poor
non-poor
Currently financially
sustainable? no yes yes yes no
Nominal interest rate on 20% 47.5– 32–43% 55% 36–48%
loans (per year) 50.5%
Annual consumer price
inflation, 1996 2.7% 12.4% 8.0% 8.0% —

Sources: Grameen Bank: through August 1998, www.grameen.com; loan size is from December 1996, calculated
by author. BancoSol: through December 1998, from Jean Steege, ACCION International, personal communica-
tion. Interest rates include commission and are for loans denominated in bolivianos; base rates on dollar loans
are 25–31%. BRI and BKD: through December 1994 (BKD) and December 1996 (BRI), from BRI annual data
and Don Johnston, personal communication. BRI interest rates are effective rates. FINCA: through July 1998,
www.villagebanking.org. Inflation rate: World Bank World Development Indicators 1998.

Programs that have been set up in tion, Grameen’s group lending model
North Carolina, New York City, Chi- has been replicated in Bolivia, Chile,
cago, Boston, and Washington, D.C. China, Ethiopia, Honduras, India, Ma-
cite Grameen as an inspiration. In addi- laysia, Mali, the Philippines, Sri Lanka,

India. By 1912, over four hundred thousand poor ton merchant whose department stores still bear
Indians belonged to the new credit cooperatives, his name, spent time in India, learning about the
and by 1946 membership exceeded 9 million (R. cooperatives in order to later set up similar pro-
Bedi 1992, cited in Michael Woolcock 1998). The grams in Boston, New York, and Providence
cooperatives took hold in the State of Bengal, the (Shelly Tenenbaum 1993). The credit cooperatives
eastern part of which became East Pakistan at in- eventually lost steam in Bangladesh, but the no-
dependence in 1947 and is now Bangladesh. In tion of group-lending had established itself and,
the early 1900s, the credit cooperatives of Bengal after experimentation and modification, became
were so well-known that Edward Filene, the Bos- one basis for the Grameen model.


Tanzania, Thailand, the U.S., and Viet- rely on informal insurance relationships
nam. When Bill Clinton was still gover- and threats, ranging from social isola-
nor, it was Muhammad Yunus, founder tion to physical retribution, that facili-
of the Grameen Bank (and a Vander- tate borrowing for households lacking
bilt-trained economist), who was called collateral (Besley and Coate 1995). The
on to help set up the Good Faith Fund programs thus combine the scale advan-
in Arkansas, one of the early microfi- tages of a standard bank with mecha-
nance organizations in the U.S. As nisms long used in traditional, group-
Yunus (1995) describes the beginning: based modes of informal finance, such
as rotating savings and credit associa-
Bangladesh had a terrible famine in 1974. I
tions (Besley, Coate, and Glenn Loury
was teaching economics in a Bangladesh uni-
versity at that time. You can guess how diffi- 1993). 5
cult it is to teach the elegant theories of eco- The Grameen Bank now has over two
nomics when people are dying of hunger all million borrowers, 95 percent of whom
around you. Those theories appeared like are women, receiving loans that total
cruel jokes. I became a drop-out from formal
$30–40 million per month. Reported re-
economics. I wanted to learn economics
from the poor in the village next door to the cent repayment rates average 97–98
university campus. percent, but as Section 4.2 describes,
relevant rates average about 92 percent
Yunus found that most villagers were and have been substantially lower in
unable to obtain credit at reasonable recent years.
rates, so he began by lending them Most loans are for one year with a
money from his own pocket, allowing nominal interest rate of 20 percent
the villagers to buy materials for proj- (roughly a 15–16 percent real rate).
ects like weaving bamboo stools and Calculations described in Section 4.2
making pots (New York Times 1997). suggest, however, that Grameen would
Ten years later, Yunus had set up the have had to charge a nominal rate of
bank, drawing on lessons from informal around 32 percent in order to become
financial institutions to lend exclusively fully financially sustainable (holding the
to groups of poor households. Common current cost structure constant). The
loan uses include rice processing, management argues that such an in-
livestock raising, and traditional crafts. crease would undermine the bank’s so-
The groups form voluntarily, and, cial mission (Shahidur Khandker 1998),
while loans are made to individuals, all
in the group are held responsible for 5 In a rotating savings and credit association, a
loan repayment. The groups consist of group of participants puts contributions into a pot
five borrowers each, with lending first that is given to a single member. This is repeated
over time until each member has had a turn, with
to two, then to the next two, and then order determined by list, lottery, or auction. Most
to the fifth. These groups of five meet microfinance contracts build on the use of groups
together weekly with seven other but mobilize capital from outside the area.
ROSCA participants are often women, and in the
groups, so that bank staff meet with U.S. involvement is active in new immigrant com-
forty clients at a time. According to the munities, including among Koreans, Vietnamese,
rules, if one member ever defaults, all Mexicans, Salvadorans, Guatemalans, Trinidadi-
ans, Jamaicans, Barbadans, and Ethiopians. In-
in the group are denied subsequent volvement had been active earlier in the century
loans. The contracts take advantage of among Japanese and Chinese Americans, but it
local information and the “social assets” is not common now (Light and Pham 1998).
Rutherford (1998) and Armendariz and Morduch
that are at the heart of local enforce- (1998) describe links of ROSCAs and microfinance
ment mechanisms. Those mechanisms mechanisms.


but there is little solid evidence that loans are denominated in dollars, how-
speaks to the issue. ever, and these loans cost clients 24–30
Grameen figures prominently as an percent per year, with a 1 percent fee
early innovator in microfinance and has up front.
been particularly well studied. Assess- Fourth, as a result of these rates, the
ments of its financial performance are bank does not rely on subsidies, mak-
described below in Section 4.2, of its ing a respectable return on lending.
costs and benefits in Section 5.1, and BancoSol reports returns on equity of
of its social and economic impacts in nearly 30 percent at the end of 1998
Section 6.3. and returns on assets of about 4.5 per-
cent, figures that are impressive relative
2.2 BancoSol, Bolivia to Wall Street investments—although
adjustments for risk will alter the pic-
Banco Solidario (BancoSol) of urban ture. Fifth, repayment schedules are
Bolivia also lends to groups but differs flexible, allowing some borrowers to
in many ways from Grameen. 6 First, its make weekly repayments and others to
focus is sharply on banking, not on so- do so only monthly. Sixth, loan dura-
cial service. Second, loans are made to tions are also flexible. At the end of
all group members simultaneously, and 1998, about 10 percent had durations
the “solidarity groups” can be formed of between one and four months, 24 per-
three to seven members. The bank, cent had durations of four to seven
though, is constantly evolving, and it months, 23 percent had durations of
has started lending to individuals as seven to ten months, 19 percent had
well. By the end of 1998, 92 percent of durations of ten to thirteen months,
the portfolio was in loans made to soli- and the balance stretched toward two
darity groups and 98 percent of clients years.
were in solidarity groups, but it is likely Seventh, borrowers are better off
that those ratios will fall over time. By than in Bangladesh and loans are larger,
the end of 1998, 28 percent of the port- with average loan balances exceeding
folio had some kind of guarantee beyond $900, roughly nine times larger than for
just a solidarity group. Grameen (although first loans may start
Third, interest rates are relatively as low as $100). Thus while BancoSol
high. While 1998 inflation was below 5 serves poor clients, a recent study finds
percent, loans denominated in bolivi- that typical clients are among the “rich-
anos were made at an annual base rate est of the poor” and are clustered just
of 48 percent, plus a 2.5 percent com- above the poverty line (where poverty
mission charged up front. Clients with is based on access to a set of basic
solid performance records are offered needs like shelter and education; Sergio
loans at 45 percent per year, but this is Navajas et al. 1998). Partly this may be
still steep relative to Grameen (but not due to the “maturation” of clients from
relative to the typical moneylender, poor borrowers into less poor borrow-
who may charge as much as 10 percent ers, but the profile of clients also looks
per month). About 70–80 percent of very different from that of the ma-
ture clients of typical South Asian
6 The financial information is from Jean Steege, programs.
ACCION International, personal communication, The stress on the financial side has
January 1999. Claudio Gonzalez-Vega et al. (1997)
provide more detail on BancoSol. Further infor- made BancoSol one of the key forces
mation can also be found at http://www.accion.org. in the Bolivian banking system. The


institution started as an NGO 32.3 percent in New Mexico.7 ACCION’s
(PRODEM) in 1987, became a bank in other affiliates, including six in the United
1992, and, by the end of 1998, served States, have not, however, achieved fi-
81,503 low-income clients. That scale nancial sustainability. The largest im-
gives it about 40 percent of borrowers pediments for U.S. programs appear to
in the entire Bolivian banking system. be a mixed record of repayment, and
Part of the success is due to impres- usury laws that prevent microfinance in-
sive repayment performance, although stitutions from charging interest rates
difficulties are beginning to emerge. that cover costs (Pham 1996).
Unlike most other microfinance institu-
2.3 Rakyat Indonesia
tions, BancoSol reports overdues using
conservative standards: if a loan repay- Like BancoSol, the Bank Rakyat In-
ment is overdue for one day, the entire donesia unit desa system is financially
unpaid balance is considered at risk self-sufficient and also lends to “better
(even when the planned payment was off” poor and nonpoor households, with
only scheduled to be a partial repay- average loan sizes of $1007 during
ment). By these standards, 2.03 percent 1996. Unlike BancoSol and Grameen,
of the portfolio was at risk at the end of however, BRI does not use a group
1997. But by the end of 1998, the frac- lending mechanism. And, unlike nearly
tion increased to 4.89 percent, a trend all other programs, the bank requires
that parallels a general weakening individual borrowers to put up collat-
throughout the Bolivian banking system eral, so the very poorest borrowers are
and which may signal the negative excluded, but operations remain small-
effects of increasing competition. scale and “collateral” is often defined
BancoSol’s successes have spawned loosely, allowing staff some discretion to
competition from NGOs, new nonbank increase loan size for reliable borrowers
financial institutions, and even formal who may not be able to fully back loans
banks with new loan windows for low- with assets. Even in the wake of the re-
income clients. The effect has been a cent financial crisis in Indonesia, repay-
rapid increase in credit supply, and a ment rates for BRI were 97.8 percent in
weakening of repayment incentives that March 1998 (Paul McGuire 1998).
may foreshadow problems to come The bank has centered on achieving
elsewhere (see Section 3.3). cost reductions by setting up a network
Still, BancoSol stands as a financial 7 Data are from ACCION (1997) and hold as of
success, and the model has been repli- December 1996. Five of the six U.S. affiliates have
cated—profitably—by nine of the eigh- only been operating since 1994, and the group as a
teen other Latin American affiliates of whole serves only 1,695 clients (but with capital
secured for expansion). A range of microfinance
ACCION International, an NGO based institutions operate in the U.S. Among the oldest
in Somerville, Massachusetts. ACCION and best-established are Chicago’s South Shore
also serves over one thousand clients in Bank and Boston’s Working Capital. The Cal-
Meadow Foundation has recently provided fund-
the U.S., spread over the six programs. ing for several microfinance programs in Canada.
Average loan sizes range from $1366 in Microfinance participation in the U.S. is heavily
New Mexico to $3883 in Chicago, and minority-based, with a high ethnic concentration.
For example, 90 percent of the urban clients of
overall nearly 40 percent of the clients Boston’s Working Capital are minorities (and 66
are female. As of December 1996, pay- percent are female). Loans start at $500. Clients
ments past due by at least thirty days tend to be better educated and have more job ex-
perience than average welfare recipients, and just
averaged 15.5 percent but ranged as 29 percent of Working Capital’s borrowers were
high as 21.2 percent in New York and below the poverty line (Working Capital 1997).


of branches and posts (with an average of 1994, the BKDs generated profits of
of five staff members each) and now $4.73 million on $30 million of net loans
serves about 2 million borrowers and 16 outstanding to 765,586 borrowers. 8
million depositors. (The importance of Like Grameen-style programs, the
savings to BRI is highlighted below in BKDs lend to the poorest households,
Section 7.) Loan officers get to know and scale is small, with an emphasis on
clients over time, starting borrowers off petty traders and an average loan size of
with small loans and increasing loan $71 in 1994. The term of loans is gener-
size conditional on repayment perfor- ally 10–12 weeks with weekly repay-
mance. Annualized interest rates are 34 ment and interest of 10 percent on the
percent in general and 24 percent if principal. Christen et al. (1995) calcu-
loans are paid with no delay (roughly 25 late that this translates to a 55 percent
percent and 15 percent in real terms— nominal annual rate and a 46 percent
before the recent financial crisis). real rate in 1993. Loan losses in 1994
Like BancoSol, BRI also does not see were just under 4 percent of loans
itself as a social service organization, outstanding (Johnston 1996).
and it does not provide clients with Also as in most microfinance programs,
training or guidance—it aims to earn a loans do not require collateral. The in-
profit and sees microfinance as good novation of the BKDs is to allocate
business (Marguerite Robinson 1992). funds through village-level management
Indeed, in 1995, the unit desa program commissions led by village heads. This
of the Bank Rakyat Indonesia earned works in Indonesia since there is a clear
$175 million in profits on their loans to system of authority that stretches from
low-income households. More striking, Jakarta down to the villages. The BKDs
the program’s repayment rates—and piggy-back on this structure, and the
profits—on loans to poor households management commissions thus build in
have exceeded the performance of loans many of the advantages of group lend-
made to corporate clients by other parts ing (most importantly, exploiting local
of the bank. A recent calculation sug- information and enforcement mecha-
gests that if the BRI unit desa program nisms) while retaining an individual-
did not have to cross-subsidize the rest lending approach. The commissions are
of the bank, they could have broken able to exclude the worst credit risks
even in 1995 while charging a nominal but appear to be relatively democratic
interest rate of just 17.5 percent per in their allocations. Through the late
year on loans (around a 7 percent real 1990s, most BKDs have had excess
rate; Jacob Yaron, McDonald Benjamin, capital for lending and hold balances in
and Stephanie Charitonenko 1998). BRI accounts. The BKDs are now su-
pervised by BRI, and successful BKD
2.4 Kredit Desa, Indonesia
borrowers can graduate naturally to
The Bank Kredit Desa system larger-scale lending from BRI units.
(BKDs) in rural Indonesia, a sister insti-
tution to BRI, is much less well-known. 2.5 Village Banks
The program dates back to 1929, al-
though much of the capital was wiped Prospects for replicating the BKDs
out by the hyper-inflation of the middle outside of Indonesia are limited, how-
1960s (Don Johnston 1996). Like BRI, ever. A more promising, exportable
loans are made to individuals and the 8 Figures are calculated from Johnston (1996)
operation is financially viable. At the end and data provided by BRI in August 1996.


village-based structure is provided by mulation have limited those aspirations
the network of village banks started in (Candace Nelson et al. 1995).
the mid-1980s in Latin America by Like the Indonesian BKDs, the vil-
John Hatch and his associates at the lage banks successfully harness local in-
Foundation for International Commu- formation and peer pressure without us-
nity Assistance (FINCA). The village ing small groups along BancoSol or
banking model has now been replicated Grameen lines. And, as with the BKDs,
in over 3000 sites in 25 countries by sustainability is an aim, with nominal in-
NGOs like CARE, Catholic Relief Ser- terest rates as high as 4 percent per
vices, Freedom from Hunger, and Save month. Most village banks, however,
the Children. FINCA programs alone still require substantial subsidies to
serve nearly 90,000 clients in countries cover capital costs. Section 4.1 shows
as diverse as Peru, Haiti, Malawi, evidence that village banks as a group
Uganda, and Kyrgyzstan, as well as in cover just 70 percent of total costs on
Maryland, Virginia, and Washington, average. Partly, this is because many vil-
D.C. lage banks have been set up in areas
The NGOs help set up village finan- that are particularly difficult to serve
cial institutions in partnership with lo- (e.g., rural Mali and Burkina Faso), and
cal groups, allowing substantial local the focus has been on outreach rather
autonomy over loan decisions and man- than scale. Worldwide, the number of
agement. Freedom from Hunger, for clients is measured in the tens of thou-
example, then facilitates a relationship sands, rather than the millions served
between the village banks and local com- by the Grameen Bank and BRI.
mercial banks with the aim to create
sustainable institutional structures. 3. Microfinance Mechanisms
The village banks tend to serve a
The five programs above highlight
poor, predominantly female clientele
the diversity of approaches spawned by
similar to that served by the Grameen
the common idea of lending to low-
Bank. In the standard model, the spon-
income households. Group lending has
soring agency makes an initial loan to
taken most of the spotlight, and the
the village bank and its 30–50 members.
idea has had immediate appeal for eco-
Loans are then made to members, start-
nomic theorists and for policymakers
ing at around $50 with a four month
with a vision of building programs
term, with subsequent loan sizes tied to
around households’ “social” assets, even
the amount that members have on de-
when physical assets are few. But its
posit with the bank (they must typically
role has been exaggerated: group lend-
have saved at least 20 percent of the
ing is not the only mechanism that dif-
loan value). The initial loan from the
ferentiates microfinance contracts from
sponsoring agency is kept in an “exter-
standard loan contracts. 9 The programs
nal account,” and interest income is
described above also use dynamic in-
used to cover costs. The deposits of
centives, regular repayment schedules,
members are held in an “internal ac-
and collateral substitutes to help main-
count” that can be drawn down as de-
tain high repayment rates. Lending to
positors need. The original aim was to
build up internal accounts so that exter- 9 Ghatak and Guinnane (1999) provide an excel-

nal funding could be withdrawn within lent review of group-lending contracts. Monica
Huppi and Gershon Feder (1990) provide an early
three years, but in practice growing perspective. Armendariz and Morduch (1998) de-
credit demands and slow savings accu- scribe the functioning of alternative mechanisms.


women can also be a benefit from a each type in the population, but it is
financial perspective. unable to determine which specific in-
As shown in Table 1, just two of the vestors are of which type. Investors,
five use explicit group-lending con- though, have perfect information about
tracts, but all lend in increasing each other.
amounts over time (“progressive” lend- Both types want to invest in a project
ing), offer terms that are substantially with an uncertain outcome that requires
better than alternative credit sources, one unit of capital. If they choose not to
and cut off borrowers in default. Most undertake the project, they can earn
also require weekly or semi-weekly re- wage income m. The risky investors have
payments, beginning soon after loan re- a probability of success p r and net re-
ceipt. While we lack good evidence on turn R r. The safe investors have a prob-
the relative importance of these mecha- ability of success p s and net return R s.
nisms, there is increasing anecdotal evi- When either type fails, the return is zero.
dence on limits to group lending per se Returns are statistically independent.
(e.g., the village studies from Bangla- Risky types are less likely to be suc-
desh in Aminur Rahman 1998; Imran cessful (pr < ps), but they have higher re-
Matin 1997; Woolcock 1999; Sanae Ito turns when they succeed. For simplic-
1998; and Pankaj Jain 1996). This sec- ity, assume that the expected net
tion highlights what is known (or ought returns are equal for both safe and risky
__
to be known) about the diversity of types: prRr = psRs ≡ R. The projects of
technologies that underlie repayment both types are socially profitable in that
rates and screening mechanisms. expected returns net of the cost of capi-
tal, ρ, exceed earnings from wage labor:
_
_
3.1 Peer Selection R − ρ > m.
Neither type has assets to put up as
Group lending has many advantages, collateral, so the investors pay the bank
beginning with mitigation of problems nothing if the projects fail. To break
created by adverse selection. The key is even, the bank must set the interest
that group-lending schemes provide in- rate high enough to cover its per-loan
centives for similar types to group to- capital cost, ρ. If both types borrow, the
gether. Ghatak (1999) shows how this equilibrium interest rate under compe-
sorting process can be instrumental in –
tition will then be set so that rp = ρ,
improving repayment rates, allowing for where p – is the average probability of
lower interest rates, and raising social success in the population. Since the
welfare. His insight is that a group- bank can’t distinguish between borrow-
lending contract provides a way to price ers, all investors will face interest rate,
discriminate that is impossible with an r. As a result, safe types have lower ex-
individual-lending contract. 10 pected returns than risky types—since
_
_ _
_
To see this, imagine two types of po- R − rps < R − rpr —and the safe types will
tential investors. Both types are risk enter the market only if their expected
neutral, but one type is “risky” and the net return exceeds their fallback posi-
__
other is “safe”; the risky type fails more tion: R − rps > m. If the safe types enter,
often than the safe type, but the risky the risky types will too.
types have higher returns when success- But the safe types will stay out of the
__
ful. The bank knows the fraction of market if R − rps < m, and only risky
10 Armendariz and Gollier (1997) also describe types might be left in the market. In
this mechanism in parallel work. that case, the equilibrium interest rate


will rise so that rpr = ρ. Risky types drive pected net gain from joining with a safe
out the safe. The risky types lose the type is as much as pr(ps − pr)c∗. But since
implicit cross-subsidization by the safe pr < ps, the expected gains to risky types
types, while the safe types lose access to are always smaller than the expected
capital. This second-best scenario is in- losses to safe types. Thus, there is no
efficient since only the risky types bor- mutually beneficial way for risky and
row, even though the safe types also safe types to group together. Group
have socially valuable projects. lending thus leads to assortative match-
Can a group-lending scheme improve ing: all types group with like types
on this outcome? If it does, it must (Gary Becker 1991). 12
bring the safe types back into the mar- How does this affect the functioning
ket. For simplicity, consider groups of of the credit market? Ghatak (1999)
two people, with each group formed demonstrates that the group-lending
voluntarily. Individuals invest indepen- contract provides a way to charge dif-
dently, but the contract is written to ferent effective fees to risky and safe
create joint liability. Imagine a contract types—even though all groups face ex-
such that each borrower pays nothing if actly the same contract with exactly the
her project fails, and an amount r∗ if same nominal charges, r∗ and c∗. The
her project is successful. In addition, result arises because risky types will be
the successful borrower pays a joint- teamed with other risky types, while
liability payment c∗ if the other mem- safe types team with safe types. Risky
ber of the group fails. 11 The expected types then receive expected net returns
__
net return of a safe_type teamed with a
_ of R − pr(r∗ + (1 − pr)c∗), while safe types
risky type is then R − ps(r∗ + (1 − pr)c∗), receive expected net returns of
_
_
with similar calculations for exclusively R − ps(r∗ + (1 − ps)c∗). Thus, a successful
safe and exclusively risky groups. risky type is more likely to have to pay
Will the groups be homogeneous or the joint-liability payment c∗ than a
mixed? Since safe types are always pre- successful safe type. If r∗ and c∗ are set
ferred as partners (since their prob- appropriately, the group-lending con-
ability of failure is lower), the question tract can provide an effective way to
becomes: will the risky types be willing price discriminate that is impossible
to make a large enough transfer to the under the standard second-best indi-
safe types such that both risky and safe vidual-lending contract. If p s = 0.9 and
types do better together? By comparing p r = 0.8, for example, the safer types
expected returns under alternative sce- can expect to pay less than the riskier
narios, we can calculate that a safe type types as long as the joint liability
will require a transfer of at least payment is set so that c∗ > 1.4r∗.
ps(ps − pr)c∗ to agree to form a partner- Efficiency gains result if the difference
ship with a risky type. Will risky types is large enough to induce the safe types
be willing to pay that much? Their ex- back into the market. When this hap-
pens, average repayment rates rise, and
11 In typical contracts, group members are re- the bank can afford to maintain a lower
sponsible for helping to pay off the loan in diffi- interest rate r∗ while not losing money.
culty, rather than having to pay a fixed penalty for
a group member’s default. While clients lack col-
lateral, they are assumed to have a large enough 12 Ghatak (1998) extends the results to groups
income flow to cover these costs if needed. In larger than 2, a continuum of types, and prefer-
practice this may impose a constraint on loan size ences against risk. See also Varian (1990) and Ar-
since individuals may have increasing difficulty mendariz and Gollier (1997) on related issues of
paying c∗ + r∗ when loan sizes grow large. efficiency and sorting.


3.2 Peer Monitoring How can a group-lending contract
improve matters? The key is that it can
Group lending may also provide create a mechanism that gives borrow-
benefits by inducing borrowers not to ers an incentive to choose the safe ac-
take risks that undermine the bank’s tivity. Again consider groups of two bor-
profitability (Stiglitz 1990; Besley and rowers and group-lending contracts like
Coate 1995). This can be seen by those in Section 3.1 above. The borrow-
slightly modifying the framework in ers in each group have the ability to
Section 3.1 to consider moral hazard. enforce contracts between each other,
Instead, consider identical risk averse and they jointly decide which types
borrowers with utility functions u(x). of activities to undertake. Now their
Each borrower may do either risky or problem is to choose between both do-
safe activities, and each activity again ing the safe activity, yielding each bor-
requires the same capital cost. The rower expected utility of p2u(Rs − r∗) +
s
bank, as above, has imperfect informa- ps(1 − ps)u(Rs − r∗ − c∗), or doing the
tion about borrowers—in particular, risky activity with expected utility
here it cannot tell whether the borrow- p2u(Rr − r∗) + pr(1 − pr)u(Rr − r∗ − c∗). If
r
ers have done the safe or risky activity. the joint-liability payment c∗ is set high
Moral hazard is thus a prime concern. enough, borrowers will always choose to
When projects fail, borrowers have a re- do the safe activity (Stiglitz 1990).
turn of zero, and a borrower’s utility This is good for the bank, but it sad-
level when projects fail is normalized to dles borrowers with extra risk. The
zero as well. bank, though, knows borrowers will now
We start with the standard individual- do the safe activity, and it earns extra
lending contract. Borrowers either have income from the joint-liability pay-
expected utility psu(Rs − r) or pru(Rr − r), ments. The bank can thus afford to
depending on whether they do the safe lower the interest rate to offset the
or risky activity. If everyone did the burden.
safe activity, the bank could charge an Thus, through exploiting the ability
interest rate of r = ρ/p s and break even. of neighbors to enforce contracts and
But, since the bank cannot see which monitor each other—even when the
activity is chosen (and thus cannot con- bank can do neither—the group-lending
tract on it), borrowers may fare better contract again offers a way to lower
doing the risky activity and getting ex- equilibrium interest rates, raise expected
pected utility E[U sr] = pru(Rr − ρ/ps). The utility, and raise expected repayment
bank then loses money. Thus, the bank rates.
raises interest rates to r = ρ/p r. Now the
3.3 Dynamic Incentives
borrower gets expected utility of
E[U rr] = pru(Rr − ρ/pr), and she is clearly A third mechanism for securing high
worse off than with a lower interest repayment rates with high monitoring
rate. In fact, if the borrower could costs involves exploiting dynamic incen-
somehow commit to doing the safe ac- tives (Besley 1995, p. 2187). Programs
tivity, she could be better off—with ex- typically begin by lending just small
pected utility E[U ss] = psu(Rs − ρ/ps). Thus amounts and then increasing loan size
the borrower prefers E[U sr] to E[U ss] to upon satisfactory repayment. The re-
E[U rr], but the information problem peated nature of the interactions—and
and inability to commit means that she the credible threat to cut off any future
always gets the worst outcome, E[U rr]. lending when loans are not repaid—can


be exploited to overcome information Relying on dynamic incentives also
problems and improve efficiency, runs into problems common to all finite
whether lending is group-based or repeated games. If the lending relation-
individual-based. 13 ship has a clear end, borrowers have in-
Incentives are enhanced further if centives to default in the final period.
borrowers can anticipate a stream of in- Anticipating that, the lender will not
creasingly larger loans. (Hulme and lend in the final period, giving borrow-
Mosley 1996 term this “progressive ers incentives to default in the penulti-
lending,” and the ACCION network mate period—and so forth until the en-
calls it “step lending.”) As above, keep- tire mechanism unravels. Thus, unless
ing interest rates relatively low is criti- there is substantial uncertainty about
cal, since the advantage of microfinance the end date—or if “graduation” from one
programs lies in their offering services program to the next is well-established
at rates that are more attractive than (ad infinitum), dynamic incentives have
competitors’ rates. Thus, the Bank Rak- limited scope on their own.
yat Indonesia (BRI) and BancoSol One quite different advantage of pro-
charge high rates, but they keep levels gressive lending is the ability to test
well below rates that moneylenders borrowers with small loans at the start.
traditionally charge. This feature allows lenders to develop
However, competition will diminish relationships with clients over time and
the power of the dynamic incentives to screen out the worst prospects before
against moral hazard—a problem that expanding loan scale (Parikshit Ghosh
both the Bank Rakyat Indonesia and and Debraj Ray 1997).
BancoSol are starting to feel as other Dynamic incentives can also help to
commercial banks see the potential explain advantages found in lending to
profitability of their model. In practice, women. Credit programs like those of
though, real competition has yet to be the Grameen Bank and the Bangladesh
felt by most microfinance institutions Rural Advancement Committee (BRAC)
(perhaps because so few are actually did not begin with a focus on women.
turning a profit). As competition grows, In 1980–83, women made up 39 percent
the need for a centralized credit rating and 34 percent of their respective mem-
agency will also grow. berships, but by 1991–92, BRAC’s
Dynamic incentives will also work membership was 74 percent female and
better in areas with relatively low mo- Grameen’s was 94 percent female (Anne
bility. In urban areas, for example, Marie Goetz and Rina Sen Gupta 1995).
where households come and go, it may As Table 2 shows, many other programs
not be easy to catch defaulters who also focus on lending to women, and it
move across town and start borrowing appears to confer financial advantages
again with a clean slate at a different on the programs. At Grameen, for ex-
branch or program. BRI has faced ample, 15.3 percent of male borrowers
greater trouble securing repayments in were “struggling” in 1991 (i.e., missing
their urban programs than in their rural some payments before the final due
ones, which may be due to greater date) while this was true for just 1.3
urban mobility. percent of women (Khandker, Baqui
Khalily, and Zahed Kahn 1995).
13 See the general theoretical treatment in Bol- The decision to focus on women has
ton and Scharfstein (1990) and the application to
microfinance contracts in Armendariz and Mor- some obvious advantages. The lower
duch (1998). mobility of women may be a plus where


TABLE 2
PERFORMANCE INDICATORS OF MICROFINANCE PROGRAMS

Avg. loan as Average Average
Average loan % of GNP operational financial
Observations balance ($) per capita sustainability sustainability
Sustainability
All microfinance institutions 72 415 34 105 83
Fully sustainable 34 428 39 139 113
Lending method
Individual lending 30 842 76 120 92
Solidarity groups 20 451 35 103 89
Village bank 22 94 11 91 69
Target Group
Low end 37 133 13 88 72
Broad 28 564 48 122 100
High end 7 2971 359 121 76
Age
3 to 6 years 15 301 44 98 84
7 or more years 40 374 27 123 98

Source: Statistical appendix to MicroBanking Bulletin (1998). Village banks have a “B” data quality; all others are
graded “A”. Portfolio at risk is the amount in arrears for 90 days or more as a percentage of the loan portfolio.
Averages exclude data for the top and bottom deciles.

ex post moral hazard is a problem (i.e., 3.4 Regular Repayment Schedules
where there is a fear that clients will
“take the money and run”). Also, where One of the least remarked upon—but
women have fewer alternative borrow- most unusual—features of most microfi-
ing possibilities than men, dynamic nance credit contracts is that repay-
incentives will be heightened. 14 ments must start nearly immediately af-
Thus, ironically, the financial success ter disbursement. In a traditional loan
of many programs with a focus on contract, the borrower gets the money,
women may spring partly from the lack invests it, and then repays in full with
of economic access of women, while, at interest at the end of the term. But at
the same time, promotion of economic Grameen-style banks, terms for a year-
access is a principal social objective long loan are likely to be determined by
(Syed Hashemi, Sidney Ruth Schuler, adding up the principal and interest due
and Ann P. Riley 1996). in total, dividing by 50, and starting
weekly collections a couple of weeks af-
14 Rahman (1998) describes complementary cul- ter the disbursement. Programs like
tural forces based on women’s “culturally pat- BancoSol and BRI tend to be more flex-
terned behavior.” Female Grameen Bank borrow-
ers in Rahman’s study area, for example, are found ible in the formula, but even they do
to be much more sensitive to verbal hostility not stray far from the idea of collecting
heaped on by fellow members and bank workers regular repayments in small amounts.
when repayment difficulties arise. The stigma is
exacerbated by the public collection of payments The advantages are several. Regular
at weekly group meetings. According to Rahman repayment schedules screen out undis-
(1998), women are especially sensitive since their ciplined borrowers. They give early
misfortune reflects poorly on the entire household
(and lineage), while men have an easier time shak- warning to loan officers and peer group
ing it off. members about emerging problems.


TABLE 2 (Cont.)

Avg. return Avg. percent of Avg. percent Avg. number of
on equity portfolio at risk female clients active borrowers
Sustainability
All microfinance institutions –8.5 3.3 65 9,035
Fully sustainable 9.3 2.6 61 12,926
Lending method
Individual lending –5.0 3.1 53 15,226
Solidarity groups –3.0 4.1 49 7,252
Village bank –17.4 2.8 92 7,833
Target Group
Low end –16.2 3.8 74 7,953
Broad 1.2 3.0 60 12,282
High end –6.2 1.9 34 1,891
Age
3 to 6 years –6.8 2.2 71 9,921
7 or more years –2.4 4.1 63 16,557

And they allow the bank to get hold of 3.5 Collateral Substitutes
cash flows before they are consumed or
otherwise diverted, a point developed While few programs require collat-
by Stuart Rutherford (1998). eral, many have substitutes. For exam-
More striking, because the repayment ple, programs following the Grameen
process begins before investments bear model require that borrowers contrib-
fruit, weekly repayments necessitate ute to an “emergency fund” in the
that the household has an additional in- amount of 0.5 percent of every unit bor-
come source on which to rely. Thus, in- rowed (beyond a given scale). The
sisting on weekly repayments means emergency fund provides insurance in
that the bank is effectively lending cases of default, death, disability, etc.,
partly against the household’s steady, in amounts proportional to the length of
diversified income stream, not just the membership. An additional 5 percent of
risky project. This confers advantages the loan is taken out as a “group tax”
for the bank and for diversified house- that goes into a group fund account. Up
holds. But it means that microfinance to half of the fund can be used by group
has yet to make real inroads in areas fo- members (with unanimous consent).
cused sharply on highly seasonal occu- Typically, it is disbursed among the
pations like agricultural cultivation. group as zero-interest loans with fixed
Seasonality thus poses one of the largest terms. Until October 1995, Grameen
challenges to the spread of microfi- Bank members could not withdraw
nance in areas centered on rainfed these funds from the bank, even upon
agriculture, areas that include some of leaving. These “forced savings” can now
the poorest regions of South Asia and be withdrawn upon leaving, but only af-
Africa. ter the banks have taken out what they


are owed. Thus, in effect, the funds borrowers in growing businesses and
serve as a form of partial collateral. those that outstrip the pace of their
The Bank Rakyat Indonesia’s unit peers (Madajewicz 1997; Woolcock
desa program is one of the few pro- 1998)? Are weekly meetings particularly
grams to require collateral explicitly. Its costly (for both borrowers and bank
advocates, however, emphasize instead staff) in areas of low population density
the role of dynamic incentives in gener- and at busy agricultural seasons? Do so-
ating repayments (Richard Patten and cial programs enhance economic perfor-
Jay Rosengard 1991; Robinson 1992). It mance? When default occurs, do bank
is impossible, though, to determine eas- staff follow the letter of the law and cut
ily which incentive mechanism is most off good clients with the misfortune to
important in driving repayment rates. be in groups with unlucky neighbors?
While bank officials point out that col- Or is renegotiation common (Hashemi
lateral is almost never collected, this and Sidney Schuler 1997; Matin 1997;
does not signal its lack of importance as Armendariz and Morduch 1998)?
an incentive device. If the threat of col- Most of the theoretical propositions
lection is believable, there should be are supported with anecdotes from par-
few instances when collateral is actually ticular programs, but they have not
collected. been established as empirical regulari-
BancoSol also stresses the role of ties. Better research is needed to sharpen
solidarity groups in assuring repay- both the growing body of microfinance
ments, but as its clients have prospered theory and ongoing policy dialogues.
at varying rates, lending approaches Empirical understandings of microfi-
have diversified as well. As noted in nance will also be aided by studies that
Section 2.2, by the end of 1998, 28 per- quantify the roles of the various mecha-
cent of its portfolio had some kind of nisms in driving microfinance perfor-
guarantee beyond the solidarity group. mance. The difficulty in these inquiries is
that most programs use the same lend-
3.6 Empirical Research Agenda
ing model in all branches. Thus, there is
Do the mechanisms above function as no variation off of which to estimate the
advertised? Is there evidence of assorta- efficacy of particular mechanisms. Well-
tive matching through group lending as designed experiments would help (e.g.,
postulated by Ghatak (1999)? Are fu- individual-lending contracts to some of
ture loan terms predicted by lagged the sample, group-lending contracts to
performance, as suggested by the the- others; weekly repayments for some,
ory of dynamic incentives? Extending monthly or quarterly schedules for others).
the theory further, does the group-lend- Lacking well-designed experiments, a
ing contract heighten default prob- collection of studies instead presents
abilities for the entire group when some regressions in which repayment rates
members run into difficulties, as pre- are explained by proxies for forces be-
dicted by Besley and Coate (1995)? hind particular mechanisms. The vari-
Does group lending lead to excessive ation thus arises from features of the
monitoring and excessive pressure to economic environment that affect the
undertake “safe” projects rather than efficacy of particular program features:
riskier and more lucrative projects How good are information flows? How
(Banerjee, Besley, and Guinnane competitive are credit markets? How
1992)? Is the group-lending structure strong are informal enforcement mech-
less flexible than individual lending for anisms? The variation in answers to


these questions allows econometric esti- opposite in considering other Bangla-
mation, but the evidence is indirect and desh banks (including Grameen). Both
subject to multiple interpretations since drop-out rates and repayment rates in-
the strength of information flows, mar- crease in better-developed villages.
kets, and enforcement mechanisms is This may be a product of improved li-
unlikely to matter only through the quidity and better business opportuni-
form of credit contract. In addition, se- ties in better-off villages, but it might
lection biases of the sort raised in Sec- also reflect selection bias.
tion 6.1 are likely to apply. Still, some These bits of evidence show that
results are provocative. group lending is a varied enterprise and
For example, Wydick (1999) reports that there is much to microfinance be-
on a survey of an ACCION Interna- yond group lending. Narrowing the gap
tional affiliate in western Guatemala between theory and evidence will be an
tailored to elicit information about important step toward improving and
groups. He finds that improvements in evaluating programs.
repayment rates are associated with
variables that proxy for the ability to 4. Profitability and Financial
monitor and enforce group relation- Sustainability
ships, such as knowledge of the weekly
sales of fellow group members. He Microfinance discussions pay surpris-
finds little impact, though, of social ties ingly little attention to particular mech-
per se: friends do not make more reli- anisms relative to how much attention
able group members than others. In fact, is paid to purely financial matters. Ac-
members are sometimes softer on their cordingly, this section considers fi-
friends, worsening average repayment nances, and social issues are taken up
rates. again in Section 5.
Mark Wenner (1995) investigates re- How well in the end have microfi-
payment rates in 25 village banks in nance programs met their financial
Costa Rica affiliated with FINCA. He promise? A recent survey finds 34 prof-
finds active screening that successfully itable programs among a group of 72
excludes the worst credit risks, working with a “commitment” to financial sus-
in a more straightforward way than in tainability (MicroBanking Bulletin
the simple model of peer selection in 1998). This does not imply, however,
Section 3.1 above. He also finds that that half of all programs worldwide are
delinquency rates are higher in better self-sufficient. The hundreds of pro-
off towns. This lends support to the the- grams outside the base 72 continue to
ory of dynamic incentives: where bor- depend on the generosity of donors
rowers have better alternatives, they are (e.g., Grameen Bank and most of its
likely to value the programs less, and replicators do not make the list of 72,
this drives up default rates. although BancoSol and BRI do). Some
The result is echoed by Manohar experts estimate that no more than 1
Sharma and Manfred Zeller (1996) in their percent of NGO programs worldwide
study of three programs in Bangladesh are currently financially sustainable—
(but not Grameen). They find that re- and perhaps another 5 percent of NGO
payment rates are higher in remote programs will ever cross the hurdle. 15
communities—i.e., those with fewer al- 15 The figures are based on an informal poll
ternative credit programs. Khandker et taken by Richard Rosenberg at a microfinance
al. (1995, Table 7.2), however, find the conference (personal communication, Nov. 1998).


The other 95 percent of programs in with average loan balances varying from
operation will either fold or continue $133 to $2971. Averages for the 34 fully
requiring subsidies, either because their sustainable institutions are not, how-
costs are high or because they choose to ever, substantially different from the
cap interest rates rather than to pass overall sample in terms of average loan
costs on to their clients. Although subsi- balance or the percentage of female
dies remain integral, donors and practi- clients.
tioners have been reluctant to discuss Sustainability is generally considered
optimal subsidies to alleviate poverty, at two levels. The first is operational
perhaps for fear of appearing retro- sustainability. This refers to the ability
grade in light of the disastrous experi- of institutions to generate enough reve-
ences with subsidized government-run nue to cover operating costs—but not
programs. Instead, rhetoric privileges necessarily the full cost of capital. If
financial sustainability. unable to do this, capital holdings are
depleted over time. The second level of
4.1 International Evidence
concern is financial sustainability. This
Table 2 gives financial indicators for is defined by whether or not the in-
the 72 programs in the MicroBanking stitution requires subsidized inputs in
Bulletin survey. 16 The 72 programs have order to operate. If the institution is
been divided into non-exclusive catego- not financially sustainable, it cannot
ries by age, lending method, target survive if it has to obtain all inputs (es-
group, and level of sustainability. 17 pecially capital) at market, rather than
(There is considerable overlap, for ex- concessional, rates.
ample, between the village bank cate- Most of the programs in the survey
gory and the group targeting “low end” have crossed the operational sustain-
borrowers.) ability hurdle. The only exceptions are
The groups, divided by lending the village banks and those with low
method and target group, demonstrate end targets, both of which generate
the diversity of programs marching be- about 90 percent of the required
hind the microfinance banner. Average income. 18
loan balances range from $94 to $842 Many fewer, however, can cover full
when comparing village banks to those capital costs as well. Overall, programs
that lend exclusively to individuals. The generate 83 percent of the required in-
focus on women varies from 92 percent come and the village bank/low end tar-
to 53 percent. The target group cate- get groups generate about 70 percent.
gory makes the comparison starker, Strikingly, the handful of programs that
16 The project started as a collaboration with the
focus on “high end” clients are just as
American Economic Association’s Economics In- heavily subsidized as those on the low
stitute in Boulder, Colorado. end. Similarly, the financial perfor-
17 Those with low end target groups have aver-
mance of programs with individual
age loan balances under $150 or loans as a per-
centage of GNP per capita under 20 percent (they
include, for example, FINCA programs). Those 18 See Mark Schreiner (1997) and Khandker
with broad targets have average balances that are (1998) for discussions of alternative views of sus-
20–85 percent of GNP per capita (and include tainability. Unlike other reported figures, those
BancoSol and the BRI unit desa system). The high here make adjustments to account for subsidies on
end programs make average loans greater than 120 capital costs, the erosion of the value of equity due
percent of GNP per capita. The solidarity group to inflation, and adequate provisioning for non-re-
methodology is based on groups with 3–5 borrow- coverable loans. To the extent possible, the figures
ers (like BancoSol). The village banks have groups are comparable to data for standard commercial
with over five borrowers. enterprises.


loans is roughly equivalent to that of If donors tire of footing the bill for
programs using solidarity groups, even microfinance, achieving financial sus-
though the former serve a clientele that tainability and increasing returns to eq-
is more than twice as rich. uity is the only game to play. The issue is:
The greatest financial progress has will donors tire if social returns can be
been made by broad-based programs proven to justify the costs? Answering
like BancoSol and BRI that serve cli- the question puts impact studies and cost–
ents across the range. Financial pro- benefit analyses high on the research
gress also improves with age (although agenda. It also requires paying close at-
comparisons of young and old groups tention to the basis of self-reported
can only be suggestive as their orienta- claims about financial performance.
tions tend to differ). 19
4.2 The Grameen Bank Example
The returns to equity echo the data
on financial sustainability. The numbers The data above have been adjusted to
give profits relative to the equity put bring them into rough conformity with
into the programs. The table shows that standard accounting practices. This is
this is not a place to make big bucks. not typical: microfinance statistics are
While average returns to equity of 9.3 often calculated in idiosyncratic ways
percent for the financially-sustainable and are vulnerable to misinterpretation.
programs are respectable, they do not The Grameen Bank has been relatively
compete well with alternative invest- open with its data, and it provides a full
ments and often carry considerable risk. set of accounts in its annual reports.
At the same time, social returns may Table 3 provides evidence on the
well be high even if financial returns Grameen Bank’s performance between
are modest (or negative). On average, 1985 and 1996. 20 The table shows Gra-
the broad-based programs, for example, meen’s rapid increase in scale, with the
cover all costs and serve a large pool of size of the average annual loan portfolio
clients with modest incomes, most of increasing from $10 million in 1985 to
whom are women. Wall Street would $271 million by 1996. Membership has
surely pass by the investment opportu- expanded 12 times over the same
nity, but socially-minded investors period, reaching 2.06 million by 1996.
might find the trade-off favorable. The bank reports repayment rates
If returns to equity could be in- above 98 percent and steady profits—
creased through more effective leverag- and this is widely reported (e.g., New
ing of equity, however, Wall Street might York Times 1997). All accounting defi-
eventually be willing to take a look. In- nitions are not standard, however. The
creasing leverage is thus the cutting reported overdue rates are calculated
edge for financially-minded microfinance by Grameen as the value of loans over-
advocates, and it has taken microfi- due greater than one year, divided by
nance discussions to places far from 20 The base data are drawn from Grameen Bank
their original focus on how to make annual reports. This section draws on Morduch
$100 loans to Bolivian street vendors. (1999). Summaries of Grameen’s financial perfor-
mance through 1994 can be found in Hashemi and
Schuler (1997) and Khandker, Khalily, and Kahn
19 None of the U.S. programs that I know of are (1995). Schreiner (1997) provides alternative cal-
profitable, and some are very far from financial culations of subsidy dependence with illustrations
sustainability, held back by legal caps on interest from Grameen. The adjustments here capture the
rates (Michael Chu 1996). None of the U.S. pro- most critical issues, but they are not comprehen-
grams are included in the MicroBanking Bulletin sive—for example, no adjustment is made for the
survey. erosion of equity due to inflation.


TABLE 3
GRAMEEN BANK: SELECTED FINANCIAL INDICATORS
(Millions of 1996 U.S. dollars)

1985–
1996
1985 1990 1992 1994 1996 average
Size
Average annual loans outstanding 10.0 58.3 83.8 211.5 271.3 108
Members (thousands) 172 870 1,424 2,013 2,060 1,101
Overdues rates (%)
Reported overdues rate 2.8 3.3 2.5 0.8 13.9 1.6A
Adjusted overdues rate 3.8 6.2 1.9 15.0 — 7.8A
Profits
Reported profits 0.02 0.09 –0.15 0.56 0.46 1.5B
Adjusted profits –0.33 –1.51 –3.06 –0.93 –2.28 –17.8B
Subsidies
Direct grants 0.0 2.3 1.7 2.0 2.1 16.4B
Value of access to soft loans 1.1 7.0 5.8 9.0 12.7 80.5B
Value of access to equity 0.0 0.4 2.7 8.0 8.8 47.3B
Subsidy per 100 units outstanding 11 21 16 7 9 11
Interest rates (%)
Average nominal on-lending rate 16.8 11.1 15.8 16.7 15.9 15.9
Average real on-lending rate 5.9 3.0 11.6 13.1 10.1 10.1
Benchmark cost of capital 15.0 15.0 13.5 9.4 10.3 11.3
Average nominal cost of capital 7.9 2.2 2.1 5.5 3.4 3.7
Subsidy dependence index 80 263 106 45 65 74
Avg. nominal “break-even” rate 30.2 40.2 32.6 24.2 26.2 25.7

Source: Morduch (1999) based on data from various years of the Grameen Bank Annual Report.
Notes: A: average for 1985–94, weighted by portfolio size. B: Sum for 1985–96.

the current portfolio. A problem is that it is high enough to start creating finan-
the current portfolio tends to be much cial difficulties. More dramatically, the
larger than the portfolio that existed bank reported an overdue rate of 0.8
when the overdue loans were first percent in 1994, while at the same time
made. With the portfolio expanding 27 I estimate that 15 percent of the loans
times between 1985 and 1996, reported made that year were unrecovered.
default rates are considerably lower Similarly, reported profits differ con-
than standard calculation of arrears siderably from adjusted profits in Table
(which instead immediately captures 3. The main adjustment is to make ade-
the share of the portfolio “at risk”). The quate provision for loan losses. Until re-
adjusted rates replace the denominator cently, the bank had been slow to write
with the size of the portfolio at the time off losses, and the adjusted rates ensure
that the loans were made. that in each year the bank writes off a
Doing so can make a big difference: modest 3.5 percent of its portfolio (still,
overall, overdues averaged 7.8 percent considerably less than the 7.8 percent
between 1985 and 1996, rather than the average overdue rate). The result is
reported 1.6 percent. The rate is still losses of nearly $18 million between
impressive relative to the performance 1985 and 1996, rather than the bank’s
of government development banks, but reported $1.5 million in profits.

Microfinance promise

Recomendados

Recomendados

Más contenido relacionado

La actualidad más candente

La actualidad más candente (20)

Similar a Microfinance promise

Similar a Microfinance promise (20)

Microfinance promise