There was a lovely article published recently. Concise, and in a single question one can see the fundamental flaws in the presentation of microfinance. BxLConnect interviewed Loïc De Cannière, CEO of microfinance investment fund Incofin. One question from the article is worth examining closely:
Q. Are there any studies on the success rates and effectiveness of microfinance?
A. It is difficult to measure the impact of microfinance in a scientific way because we have no way of knowing what the situation in these communities would have been if microfinancing would have not taken place. However, there are certain cases that clearly show how it can be effective. For example, we have one story of a Kenyan woman who started selling textile in small markets in Nairobi. Through microfinance loans, she grew into a large company and now frequently travels to Dubai to buy and trade in large quantities. In the end, I think the numbers speak for themselves. We invest in 120 microfinance institutions around the world that in turn have made almost 7.5 million loans. Only 1% of those loans have defaulted, which is remarkable and even lower compared to bank loans in western countries.
It’s a valid question and the response of Incofin’s CEO is fascinating. Firstly, he doesn’t actually answer this rather straightforward question (“are there any studies…?”). His argument suggests that the difficulty in measuring impact arises from the inability to know what would have happened had the client not obtained a loan. This ignores a massive array of academic papers that address this specific question, using random controlled trials (RCTs). Such research methods specifically attempt to tease out answers to such questions, by creating control groups, similar to the medical research. RCTs are not perfect, and in fact no trial can ever be perfect, but they have made very convincing progress in addressing this topic. In one single sentence Cannière manages to dismiss the entire academic literature on microfinance impact assessment, and yet remain optimistic about microfinance.
Consider the similarities with the medical profession. When testing a new drug, they apply it to some subjects and not to others, to see how the drug impacts the former compared to the latter. There is no way to also see, on any single subject, what would have happened if they had received the alternative treatment. Thankfully the medical profession has not discarded the practice of drug testing, while Mr. Cannière simply disregards such practices in microfinance. Perhaps we should be pleased that he is running a microfinance fund and not a drug-manufacturer.
Secondly, despite disregarding the academic literature to date, he states that “there are certain cases that clearly show how [microfinance] can be effective”, and then proceeds to tell us about “one story” in Kenya. So, when asked a question explicitly about the broad nature of an entire sector, his defence rests on a single case. To illustrate this clearly, it is like asking a national lottery operator “what is the impact of national lotteries upon the general public” and the response being: “overwhelmingly positive, for example, Mr. Smith won $1 million last week”. Technically true, but what about the other million people who bought a lottery ticket and did not win? A detail the CEO of Incofin conveniently ignores. And there have been countless studies of microfinance actually hurting clients, forcing them to suicide, the microfinance sectors of entire countries collapsing, chronic over-indebtedness etc. and yet Mr. Cannière fails to mention these. This is a standard defence of microfinance: slap a few success stories, ideally with pictures of African women standing next to a goat or a sewing machine, and present this as the norm. Look at any microfinance website for evidence of such practices.
Thirdly, his final comment perhaps best summarises the fallacy of logic that such people depend on:
We invest in 120 microfinance institutions around the world that in turn have made almost 7.5 million loans. Only 1% of those loans have defaulted, which is remarkable and even lower compared to bank loans in western countries.
The low default rates are used as proof that microfinance works. This is one of the classic defences. But loan repayment does not translate to benefit to the client. The evil moneylenders, who break legs and threaten innocent clients, are the bogeyman of microfinance, and also have decent repayment rates. The fact that someone repays a loan says absolutely nothing about the impact of that loan. Indeed, one could argue that the benefit to a client who receives $1.000 and never repays a single dollar and discreetly vanishes could actually be far greater than that of a client who struggles to repay every last cent. In countries such as Nicaragua, where over-indebtedness led to a nationwide collapse, the poor managed to repay loans with very high success rates. They would borrow from Bank A to repay Bank B, and then from Bank C to repay Bank A. While this merry-go round continues repayment rates are healthy, portfolios grow, paper-profit accrues to the banks and their investors, and everything looks fine. Until the music stops, as it did rather abruptly in Nicaragua. Thus even repeat loans to seemingly “loyal” clients could as easily be a sign of damage as a sign of success.
In short, this was a fair journalistic question with a deeply flawed answer. Why do I pick up on this? Because in different guises this is the standard problem in reporting on microfinance. It is pure spin but superficially looks credible, which is what makes it so dangerous. Now, there are only two obvious conclusions I can arrive at regarding this CEO:
- He actually believes his own rhetoric
- He knows this is a flawed response, but said it anyway
Which of these is worse? I am not sure. But the conclusion is the same. This is a deliberate attempt to paint microfinance in a rosy light and ignore the mounting wealth of evidence that challenges the wisdom of indebting poor people. It risks deceiving naïve and well-meaning investors, and it risks harming the lives of the poor. Such companies ought not be allowed to take funds from the general public and institutional investors on the basis of such spin. They should be grilled by astute journalists who push for the real answers rather than settle for meaningless patter in what amounts to little more than a glorified PR exercise thinly disguised as “knowledge”. Such an attitude would be fatal in the medical profession. In the meantime they undermine the efforts of those who are actually trying to harness financial services for the benefit of the poor, who are painted with the same brush as this rhetoric. I find this a great pity.
The rest of the interview is similarly flawed. Cannière states interest rates are typically 20-25% per year, while the Economist recently claimed they were 35% per year (which still appears an under-estimate to me). Alas the rest of the interview subsequently deteriorates into a vain PR exercise.
The underlying problem illustrated clearly here is the so-called principal-agent problem. Microfinance investors must entrust their funds to an intermediary, such as Incofin, to invest on their behalf. Will such intermediaries act in the best interests of the poor, of their investors, or in their own best interests? This is ultimately a question of alignment of interests, and the trustworthiness of the intermediating agent. Do the responses to these simple questions inspire confidence in Incofin? That is for the reader to decide.
In the meantime, don’t believe everything you read in the media.