After Microcredit Loans, Businesses Owners Are Worse Off, Study Finds

By Veronique Greenwood | June 10, 2011 4:20 pm


What’s the News: Making loans to small business owners in developing countries has quite the positive reputation. It has given people in poverty, especially women, a chance to bootstrap themselves up the economic ladder despite having marginal or no credit history and little work experience, as people have used the tiny loans to start businesses, purchase herds of animals, or invest in improvements to their shops or inventory. The Nobel Peace Prize was awarded to the economists who developed the practice in the 1970s at Bangladesh’s Grameen Bank.

But does microcredit really pay off? In a study published today in Science, economists have taken a rigorous look at it and concluded that in many or its modern implementations, it’s not having the touted benefits.

What’s the Context:

  • The problem with studying the effects of microcredit is that there tend to be a lot of factors at play in addition to the money. Lenders might provide counseling to business owners—as part of a broader category of services called microfinance—or decide to give credit to only those they think most likely to succeed. This makes it hard to tell whether the money, all on its own, can have the positive effect that people generally observe: more successful businesses and happier businesspeople.
  • The distinction isn’t just academic. While the earlier generation of microlenders were non-profits that tended to loan to collectives or cooperatives, 50% of microlenders now loan just to individuals, and 25% are for-profit businesses. They are acting more like traditional lenders, and their loans aren’t cheap, with 10–100% annualized interest. Because microcredit continues to be praised as a development strategy, discerning whether such loans can have positive effects without the bells and whistles that sometimes accompany it is key.

How the Heck:

  • To get around this compounding effect, the economists randomly selected 1272 loan applicants who were approved to receive loans of $100–$500. All had received a “marginal” rating in a credit check—the usual category of individuals who receive such loans—with First Macro Bank, a lender near Manila that is typical of Filipino microlending operations, making 3-month loans with 60% annualized interest. But the researchers also randomly rejected some applicants, yielding a control group of 329 applicants.
  • Then, 11–22 months after the loans were made, the recipients and controls were surveyed. They found that in general, businesses that had received loans were not larger than those in the control group, nor had the owners seen a boost in well-being.
  • They also discovered that the money was often used to deal with unexpected expenses, almost as a kind of household insurance policy. Perhaps the right marketplace for microcredit is as insurance, rather than as capital for investing in business, they write.

The Future Holds: Microcredit is already established in the eyes of many, especially NGOs and the United Nations, as a route to development. But before pressing forward with this strategy, the researchers say, economists should undertake more rigorously controlled studies to suss out exactly what microcredit can accomplish, what situations yield the best results, and what’s an unreasonable expectation.

Reference: Dean Karlan, Jonathan Zinman. Microcredit in Theory and Practice: Using Randomized Credit Scoring for Impact Evaluation. Science, 10 June 2011: Vol. 332 no. 6035 pp. 1278-1284 DOI: 10.1126/science.1200138

Image credit: Tjook/flickr

  • tmsa

    ok wait so if I understand correctly all the loans in the study were from the same bank that charges a huge 60% interest rate? How about a broader survey of banks? If my understanding is correct this seems to be an incredibly weak study. The banks that developed microcredit do not charge at a 60% interest rate, maybe the conclusion of this report should read more like “Business owners who take loans from First Macro Bank are much worse off than before”, and should be published in the papers there, not in science here. 60% interest rate on payments used for insurance rather than capital improvement is analogous to pawnshops and loansharking. It’s not micro-credit as designed.

  • Rabidmob

    I would be in worse shape if I too took a lone out that was sever times the amount I regularly earn annually at a 60% interest rate.

  • Doug

    This headline is very misleading. The problem isn’t microcredit, it’s exorbitant interest. This is like calling payday lenders in the US “microcredit.”

  • Salim

    I completely agree with the tmsa #1. In most developing countries, especially where Grameen Banks are operating, the rates of interest are much lower than 60%. I cannot imagine any industry thriving having loans with over 60% interest rate. The usual rates of co-operative bank micro loans in Kerala, India (the one I know) is around 6-8% and a maximum of 14% or so. The completely unrepresentative sample bias makes one wonder what the real intention of the researchers!

    On the other hand, I couldnt find any good study that proves otherwise. So, it could very well be true that the overall result of micro-credit is not significant, but this study does not prove that.


  • karlkorsh

    at 19:45

    Does microlending really work? Every year billions of dollars are ploughed into this sort of lending, and part of that is supplied through aid money, from donor governments. But is it money well spent?

    Dean Karlan, professor of economics at Yale University, has studied how it works – and made the study rigorous by comparing groups with a control group in the Philippines.

    A control group is a group identical to the one being observed except that it doesn’t have what is being tested for.

    As Professor Karlan told Lesley Curwen, the results raised serious questions about the effectiveness of microcredit in reducing poverty

  • julius estoesta

    I’m from the Philippines. I think that bank that they mentioned in this study does not represent the majority of the poor lenders in the Philippines. the researchers should have expanded thier sampling not only covering banks but other lending entities such as cooperatives and NGO. Did it cover both rural and urban clients?

    I appeal to whoever has a copy of the original study to publish it in public for discussion.

    thank you

  • Praedor

    A 60% interest rate is, plain and simple, URSURY and should be legally banned and punished. There needs to be a best practices set of rules that maximizes the chances of the recipient actually making good (in business and paying back the loan). As such, interest rates should be minimal, merely enough to cover the loan plus a little extra to increase the pool of money available for other microloans. NO one at the loaning institution should be getting rich off the backs of the poor.

    I believe another term used for someone who loans money with a 60% (or higher) interest rate is “loan shark”.


  • Dr. Xylem Galadhon

    I have to agree with all the above also — charging interest makes it very different than zero interest, which is what, e.g. Kiva.Org is based around, a “business-model” for helping the developing world that I have come to feel very positive about in recent years, and support heartily. I’d like to see the numbers on *their* work, see if the clients fare better several years later.. I am guessing they do, once they get on their feet with their businesses.

    Interesting points, though…


  • Sieben Stern

    debt money isn’t wealth. the only person who benefits is the lender.

  • James

    ??? I can charge 60% interest by moving my “investments” to third world countries and hiring a legal debt collection department (read:thugs) to keep the bottom-line tight???
    F my RRSP.

    Where do I sign up?

    So sad really. Some things never change.

  • H.C.

    About the 60% interest. You are working with risky businesses here. If e.g. half of the businesses go bankrupt after one year, and you want 0% (zero) interest, you have to charge 100% interest rate on your customers – just to brake even. In principle, the small part of the businesses succeeding should cover this, so, instead of lending, a better approach might be to invest, where the 10% top earners could foot the bill of the 50% going bankrupt.

  • Andrew Zimmerman Jones

    First, in reference to Dr. Galadhon, I loan through Kiva, and I’m pretty sure that the lending partners they work through do charge interest (or at least some of them do). It’s all in the bottom left of the loan profiles. Of the four loans I’ve been involved with, the field partner’s yield ranges from 9% to 49%. Granted, this information might be for their business in general, and maybe the rates for the Kiva-funded loans might be less, but they do have to pay their employees somehow.

    Also, one of the benefits of micro-credit, as it was originally envisioned, was that it was a communal practice that had a very low default rate. The loans were only made to GROUPS of women, so there was a social support (and pressure) network in place to be sure that the loans got paid back. The default rate was very low, so an interest rate of only a few percent should have allowed for a break-even rate overall.

  • Brian Too

    Another giant hole in this study. The microcredit programs I have heard about had support and business counselling, with a specific business plan in place for the money.

    Since these are very small and relatively unsophisticated business owners, sometimes it is as simple as “I will buy a sewing machine with this money and sell the production to X”.

    Therefore, where is the oversight that allowed “…the money was often used to deal with unexpected expenses…” to happen? This makes me think that there was no guidance and assistance to keep the business plan on track.

    In a larger sense, this would be recipe for drift and loss of focus in almost any business, practically anywhere in the world.

  • Veronique Greenwood

    @folks discussing the 60% annualized interest, the rate, while it sounds shocking, isn’t that different from what a lot of microcredit lenders use–it’s 2.5% per month over several months, plus taking into account fees that lift the rate. Also, as stated, while groups of women were the recipients of loans from many early microcredit programs, many lenders are now lending to individuals of either sex. For more, check out this Asia Development Bank note to policymakers: It specifically deals with why interest rates are high and comparisons one might make with loan sharks.

    @Brian Too, actually, that’s not a hole in the study–that’s a feature. Microfinance, as stated above, is different from microcredit, which is often a component of microfinance. This study wanted to see if *just the money* would make a difference. Turns out, that doesn’t seem to be enough.

    Basically, the idea is, if we’re going to keep using this as a development strategy, it seems prudent to figure out what situations do and don’t work.

  • Will Woodlief

    Isn’t this completely different from the original micro-loan idea? There is a huge difference between lending at high interest to an individual, and lending at low interest to an established social network. It sounds like the only thing in common is the size of the loan.

  • Dr. Xylem Galadhon

    In response to Andrew Jones above- I appreciate this info, thanks, i hadn’t realized the intermediary agencies that Kiva works with charge interest, but on second thought, of course they do have to stay afloat somehow. As does Kiva, which i believe itself does *not* charge any interest — certainly lenders don’t make any money off their loans, that i know.

    Also — the borrowers have a very high rate of payback (i’ve certainly gotten paid back fine through several, including one where there was huge political volatility in Kenya, the pay back was just delayed a bit).

    So.. i’m still interested in whether Kiva’s clients fare better than the average small businessperson in these countries, and assume that at some point someone will publish data on this..

    thx much-

  • John T

    Microcredit run as ripoffs of the poor of course don’t work. It’s the nonprofits, govt agencies, not g*dd*mned bankers, who should make microloans.

  • Bonsai King

    Thanks for the ADB article. I advise everyone to read it.

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