Bureau for Research and Economic Analysis of Development, Working Paper No. 278, June, Abhijit Banerjee, Esther Duflo, Rachel Glennerster, and Cynthia Kinnan (2010)

This randomized evaluation brings new data to bear in the debate concerning the effectiveness of microfinance. The authors find that microfinance in Hyderabad, India had no effect on health, education, female decision making, or household per capita expenditure.  However, microfinance did have an interesting heterogeneous impact on household investment decisions.  Households considering starting a business took advantage of microfinance to increase their investment in durable goods, while households not considering doing so used microfinance to increase their investment in nondurable goods.

Microfinance has grown rapidly since its emergence in the late 1970s.  Over 150 million people had accessed microfinance services as of 2007, according to a Microcredit Summit Campaign estimate.  Microfinance organizations such as CGAP cite “eradication of poverty and hunger, universal primary education, the promotion of gender equality and empowerment of women, reduction in child mortality and improvement in maternal health as contributions of microfinance for which there is already evidence”.  However, Banerjee, Duflo, Glennerster, and Kinnan caution that “whether and how much it helps the poor is the subject of intense debate” . 

Microfinance could potentially crowd out more effective development interventions or encourage over-borrowing.  A 2009 Wall Street Journal article reported that the wide availability of microloans in India is leading households into extreme debt, for example.  This debate rages in part because microfinance evaluation is extraordinarily difficult from an econometric and statistical standpoint.  The authors explain that:

“Even representative data about microfinance clients and non-clients cannot identify the causal effect of microfinance access, because clients are self-selected and therefore not comparable to non-clients. Microfinance organizations also purposely choose some villages and not others, and some households purposely choose to borrow while other do not. Difference in difference estimates can control for fixed differences between clients and non-clients, but it is likely that those who choose join MFIs would be on different trajectories even absent microfinance. This invalidates comparisons over time between clients and non clients”.

Therefore, one of the few ways to rigorously assess the causal impact of microfinance is through randomization.  If access to credit is randomly assigned, the effect of credit access on outcomes can be estimated without the above sources of bias.

The authors evaluate a randomized microcredit program in Hyderabad, India.  They report that to the best of their knowledge, “to date… there have not been any large-scale randomized trials with the potential to examine what happens when ‘first generation’ microcredit (i.e., very small, joint-liability, female-directed loans) becomes available in a new market”.

Microfinance lending offices were opened in 52 slums randomly selected from Hyderabad’s 104.  Microfinance was not previously available in these areas.  The offices were operated by Spandana, one of India’s largest microfinance organizations.  Standard, Grameen-type group loans were offered, under which six to ten women were responsible for a Rs. 10,000 (US$200) loan at a 12% interest rate for 50 weeks.  If the first loan was repaid, the group was eligible for subsequent loans of up to Rs. 20,000.  To be eligible, group members had to be female, aged 18 to 59, resident for at least one year, have identification and proof of residence, and 80% of members were required to be home owners.

15 to 18 months after lending began, a survey of 65 households per neighbourhood assessed the impact of credit access.  Compared to the control group, access to credit had no detectable effect on average monthly per capita expenditure.  There was no effect on health, education, or female decision making.  However, credit access did increase expenditure on durable goods and new business ventures.  An important finding is that microfinance had heterogeneous effects.  Existing businesses invested more in durables, households on the brink of starting businesses borrowed money to invest in durables and dipped into their nondurable spending as well, and households with no business aspirations increased their spending on nondurables.  One of the few “social effects” findings was that increased spending on durable goods was associated with decreased spending on “temptation goods” such as alcohol, tobacco, betel leaves, gambling, and dining out.

The authors’ conclusions are cautionary and worth quoting at length:

“Our results suggest that microcredit is an important financial tool for some households: for households already engaged in entrepreneurship, it allows expansion of the household business; for those with high returns to entrepreneurship, but rates of time preference high enough that they did not become entrepreneurs in the absence of microcredit, access to microcredit makes it possible to pay the fixed cost of starting a business; and for households with low returns to entrepreneurship and high rates of time preference, microcredit facilitates borrowing against future income to finance current consumption. For all of these groups, the welfare impact is ambiguous: existing businesses may or may not become more profitable when they scale up; new businesses may or may not generate future profits that compensate their owners for the drop in consumption that partially financed their creation; households who borrow to finance current consumption may be more-efficiently timing their consumption, raising welfare, or they may be borrowing unsustainably, leading to eventual lower consumption. Finally, even in treated areas, over 70% of households do not take microloans, preferring to borrow from other sources. In short, microcredit is not for every household, or even most households, in Hyderabad, and it does not lead to the miraculous social transformation some proponents have claimed. But for some households it has precisely the types of impacts we would expect of a new source of credit”.

Though microfinance may have a long term impact on education, health, and female empowerment, at least in the 15 to 18 month context studied here it did not.  It did, however, have predictable effects on business formation.