Microfinance: Why Care About Institution Building?

Rather than complaining that microloans aren't enough, those who support microfinance can work on figuring out how to use these great institutional resources to accomplish more.
This post was published on the now-closed HuffPost Contributor platform. Contributors control their own work and posted freely to our site. If you need to flag this entry as abusive, send us an email.

David Roodman's book, Due Diligence, shapes today's public conversation about microfinance. Time magazine, The Washington Post and others, have picked up on the book and its message. With, as his subtitle says, an impertinent but serious, approach, Roodman's book attempts to answer a basic question: Does microfinance work?

His answer begins with a necessary pre-question: What, actually, is microfinance trying to do? Roodman sets out three possibilities, which then provide a framework for his investigation of the Big Question. First, lifting people out of poverty, second, increasing their freedom and ability to manage their lives (also called agency), and third, contributing to development through building institutions. Most of the of the commentary about the book and 100 percent of the headlines focus on poverty alleviation. Once they latch on to the poverty question, most reviewers look up only to announce that in the handful of studies Roodman considers methodologically rigorous, evidence has not shown that microcredit increases incomes on average. As important and discussion-worthy as that question may be, today I'd like to explore microfinance from a different angle.

I want to explore Roodman's third question, the contribution of microfinance to institutional development. Although this goal of microfinance is often shrugged off, Roodman claims it as an area in which microfinance has had great success. I agree.

Roodman refers to two kinds of institutions - the concrete (actual organizations) and the abstract (ways of operating that make societies or economies work - like property rights). Microfinance boasts some extremely impressive contributions in both respects.

On creating organizations: there are now several thousand microfinance institutions around the world serving at last count about 200 million people. When microfinance began to grow, as recently as 1990, only a tiny fraction of those people (or their younger counterparts) had any access to formal financial services. They were ignored by banks, and it was especially hard for them to get credit. What's more, most of today's clients are served by institutions operating on a break even or better basis, so they don't require public subsidies to keep going. As Roodman points out, microfinance may be the only industry that started out as a grant-funded development and philanthropic effort, and migrated into the mainstream private sector.

Microfinance hasn't done too badly on the soft kind of institution creation, either. Most fundamentally, it has developed a body of knowledge about how to lend to low income people that has spread globally. Perhaps more interestingly, it has developed supporting frameworks, like regulatory regimes in many countries for specialized institutions serving the poor, and transparency standards that allow investors to identify investment-worthy microfinance institutions and incentivize sound governance and responsible operation.

To my thinking, the most important soft institutional achievement is the creation of an organizational framework that genuinely marries both social and financial objectives. By blending the best elements of charities and businesses, microfinance institutions take on a distinctive and different character. The most prominent microfinance institutions were founded with the social aims foremost, and while many of them have migrated in a more commercial direction (and some have perhaps gone too far), their fundamental commitment remains.

In the landscape of organizations in developing countries, a private, for-profit company with a strong social orientation, is something to celebrate and to look to as an agent of future positive change in society. So is a non-profit with business-like finances and delivery. I suspect there are not many social purpose organizations in these countries that are neither part of the public sector (and hence financed from taxes), nor part of the charity sector (financed by philanthropy), but are anchored in the business world. Wouldn't it be great if there were more?

The social side of this unique blend means that these institutions can be counted on to stay focused on the low income clients they came to serve. Their social missions are touchstones for the owners and managers, continually challenging them to improve their existing products, develop new products, and keep client welfare in the front of their minds. I see this in action whenever I visit microfinance institutions or talk with their leaders.

These institutions are also special in their connections to enormous numbers of the poor. They have direct client-provider relationships with millions of people, presence in low income villages and neighborhoods, deep knowledge and understanding about the poor and their lives, and, quite often, the trust of their clients. And because they are financially self-sufficient or profitable, they have means to act on their ideas. All told, microfinance institutions represent an enormous potential resource for doing good in the world.

And the leaders of microfinance institutions know this. But what they don't yet know in full is how to apply that wonderful positioning to make a greater difference to their clients. They are not immune to the research showing that microcredit alone is not enough, and in fact for some time they have been searching for more and better ways to use a platform built around microcredit to add greater value.

Nearly all MFIs are broadening their offer of financial services, if they are in a legal position to do so, recognizing that people need savings, payment services, and insurance, not just credit. Some of the best MFIs, like Mibanco in Peru, have become full-service banks. Many institutions are experimenting with "microfinance plus" - combining access to finance with other services. This encompasses a very wide range of activities, from ProMujer's offer of simple health services in Latin America, to Equity Bank Foundation's secondary school scholarship programs in Kenya, to BRAC's "ultra poor" program for the destitute in Bangladesh. These examples only hint at the creative ferment that is now underway. We need to know more about which models are succeeding, an area that has received far too little exploration.

Through its success at institution building, microfinance has constructed platforms with enormous potential to provide socially valuable services to low income people. Rather than complaining that microloans aren't enough, those who support microfinance can work on figuring out how to use these great institutional resources to accomplish more.

Go To Homepage

Popular in the Community