The microfinance mega-list

The good, the bad, and the ugly

Microfinance first gained traction in the 1990s with the success of the Grameen Bank in Bangladesh. Since then, the phenomena has spread with over 156 million borrowers worldwide. But, what is microfinance and why is it so controversial? Does it actually work, or is wrong to call it a silver bullet? The answer: it depends. In this week’s post, I review evidence from the “top five” journals in economics, and the American Economic Journal: Applied Economics, to set the record straight.¹

Bangladesh

A 2024 study explores the impact of microloans on farmers’ climate adaptation strategies. By receiving this line of credit, farmers were able to increase the amount of land dedicated to agriculture, improving crop production by almost 20 percent. Not only did this intervention ensure that farmers were less affected when floods did occur, but it also had no adverse spillover effects on recipient households.

Another 2024 field experiment assesses the effect of loan repayment flexibility on business outcomes. Researchers find that offering the option to delay up to 2 monthly repayments can boost business assets and revenues. These effects are driven by entrepreneurial risk-taking, implying that insurance provision is an effective tool for business growth.

India

A 2013 field experiment investigates the impact of debt contracts with immediate loan repayments vs. those with a two-month grace period on the financial performance microenterprises. The study determines that businesses that received the two-month grace period had higher long-run profits, but were also more likely to default. Regardless of the type of debt contract, this study agrees that microfinance provides high returns for small businesses in developing countries.

A 2014 study examines how bundling microfinance with health insurance affects loan renewal. Interestingly, the authors find that bundling loans resulted in a 23 percent decrease in drop-out from microfinance, confirming that clients were willing to give up microloans all together than pay higher interest rates for insurance. The absence of demand for health insurance, however, did eliminate adverse selection in insurance enrollment.

Definition
adverse selection refers to a transaction in which one party has more information than the other
e.g., a reckless driver purchases car insurance, but the insurance company doesn't know that.

A 2015 field experiment explores the impact of a group lending microcredit program. In this context, microfinance had a weak effect on small business investment. The program did, however, improve household spending on durable goods, while decreasing expenditure on temptation goods. This study concludes that microcredit “may not be the ‘miracle’ that it is sometimes claimed to be.”

A 2021 study evaluates what happens when a state government ordered the halting of microfinance activities. This district-level reduction in credit supply adversely impacted daily wages and consequently household consumption, driven by lowered business investment.

Image generated by DALL-E

Pakistan

A 2023 field experiment assesses the impact of asset-based microfinance using hire-purchase contracts, which enables recipients to pay installments towards a business asset worth up to $2,000. For those in the treatment group, this has large and persistent effects; specifically, treated respondents experience a 40 percent increase in business assets, boosting profits by 11 percent. This demonstrates high, sustainable returns to large capital injections for small businesses.

Thailand

Since 2001, the Thai Million Baht Village Fund has provided 80,000 villages with one billion baht (Thai currency) each to start village banks. This improved short-run consumption significantly at the village level, and increased a village’s probability of investing by six percentage points. However, the program costs 30 percent more than its total benefit to households.

A follow-up study on the Fund evaluates the short-term impact of this credit injection on village economies. For every baht injected into a village, consumption increased by an additional 1.7 bahts—the majority of which was spent on house repairs. This also significantly boosted wages across occupations.

Uganda

A 2024 study investigates a novel question: does changing the form of disbursement of a microfinance loan make a difference? The field experiment accomplishes this by comparing loan disbursements that were made in cash to those made to digital accounts of female borrowers. Interestingly, digital account recipients had a 11 percent increase in business capital and 15 percent higher profits, as they experienced less pressure to share money within the household.

Closing thoughts

Though many of the studies above boast the benefits of microfinance, they also point to a system that is financially unsustainable. Providing microloans proves extremely expensive for microfinance institutions, incentivizing lenders towards commercialization via high interest rates. Hence, subsidies will likely continue to play a key role in rolling out microfinance to the world’s poorest.

Moreover, it is important to keep in mind that not everyone is meant to start a business, and that the impact of microfinance is largest for those that are already entrepreneurial. This is the case in Banerjee et al. (2015) and Tarozzi et al. (2015), which provide evidence against the transformative power of microfinance.

1. The microfinance literature extends way beyond the top five. There are hundreds of papers on the topic in development journals alone, and cannot all be covered in one post.