Banking can do more good for the poor than only helping entrepreneurs.
- By Timothy OgdenJonathan Morduch is an economist at New York University’s Wagner Graduate School of Public Service and the executive director of NYU’s Financial Access Initiative. Tim Ogden is managing director of FAI. , Jonathan MorduchJonathan Morduch is co-author, with Daryl Collins, Stuart Rutherford, and Orlanda Ruthven, of Portfolios of the Poor: How the World's Poor Live on $2 a Day. He is professor of public policy and economics at New York University's Wagner Graduate School of Public Service and managing director of the Financial Access Initiative.
In just 30 years, the microfinance movement has reached 200 million people who had been deemed "unbankable." That’s a stunning success. But the narrative that drove this success has implicitly shut the vast majority of the unbanked out of the system. That’s why it’s time to change the story, and our minds, on how microfinance works.
The rise of the microfinance industry has been driven by a simple narrative, most closely associated with Muhammad Yunus and the Grameen Bank, joint recipients of the Nobel Peace Prize in 2006: Get capital into the hands of competent but cash-starved entrepreneurs, who would need loans of just a few hundred dollars to start shops and other micro-enterprises. While this sort of lending is more complicated than that, microfinance has certainly worked in the sense that most loans in most countries are repaid on time, most lenders have steadily grown, and most investors have been happy with the results.
By keeping the focus on small businesses, this microfinance narrative keeps us in our comfort zone. We can intuit how small loans can make a big difference for tiny enterprises that would otherwise depend on local loan sharks or never start in the first place. More important, we can imagine how such loans could be repaid with interest, yet still benefit the poor. The problem is, by clinging to this concept, we have kept ourselves from seeing what a more inclusive approach could mean for the world’s poor — and what it is that actually makes the micro-loan model work reasonably well today.
Consider Selco, an Indian company that sells solar-powered lighting to people unable to connect to the grid, or for whom power outages are way too common. The aim of Harish Hande, the engineer who founded Selco,, was to give households an alternative to expensive, non-renewable power sources.
Customers liked the Selco lanterns, but many balked at the price — about $140 for the cheapest system. Hande saw that customers would only be interested if they could make payments over time. So Selco built partnerships with banks, and customers can now acquire lanterns and solar panels by taking out loans payable in installments over 3-5 years. Since 1995, about 150,000 customers have received such financing to purchase solar-powered systems. As a result, their children can do their homework at night, the air in their houses is cleaner, and their businesses (if they have them) can stay open later.
A similar story can be told about WaterCredit, a non-profit organization dedicated to financing improvements in household sanitation. To date, WaterCredit has made 65,000+ loans that have brought access to clean water and safe sanitation to close to 400,000 people in India, Bangladesh, Kenya, and Uganda. The loans fund household water and sewerage connections, toilets and pit latrines, tubewells, and rainwater harvesting tanks.
Finance is the key to making Selco and WaterCredit work, but not the sort we associate with microfinance. Rather, it is that most basic of consumer banking services: Loans that break up payments for large purchases into small installments. Indeed, recent studies of microcredit from sites as diverse as Mongolia, Peru, Indonesia, and Bangladesh show that in a substantial proportion of cases, micro-loans are being used to meet goals other than business investment — health care, school fees, housing improvements, or simply keeping food on the table in periods of financial drought. And while those of us in the banked half of the world take this sort of thing for granted, the lack of reasonably-priced services to smooth out volatile and uncertain household cash flows represents a huge problem for poor households.
Microfinance thus turns out to do for the poor much of what credit cards do for the banked half of the world. Your card allows you to make purchases even if you don’t have the cash in hand. The card allows you to stretch out expenditures so that they become more manageable. It allows you to build up a credit profile, so that the more successful you are at repaying now, the more you will be able to borrow later. Your credit card also allows you to pay for things remotely, perhaps online or even in a foreign currency, thereby getting maximum value for your cash.
Yet the traditional microfinance story casts poor households as a class apart — as frustrated entrepreneurs whose concerns about meeting household needs are left unspoken. If you view the financial needs of the poor through the wider lens of money management, a new world opens up. The potential customer base for finance is no longer limited to the self-employed. It now includes those who work for others — agricultural laborers, maids, construction workers, and the like. In other words, it allows us to focus on the majority of the world’s unbanked half, not just the comparatively small slice targeted by traditional microfinance.
Market-driven microfinance has not completely ignored these needs. Yunus’ Grameen Bank, which (like many micro-lenders) has consistently maintained the narrative centered on loans for business investment, has nonetheless stretched the concept to include loans for education and for housing improvements. Recently, it even introduced loan products that explicitly provide ready cash for emergencies, like health crises and food shortages.
Still, the industry remains leery of seeking customers who are not self-employed, and for an understandable reason: Microfinance’s success has only been possible because socially conscious investors opened their pocketbooks in response to the narrative of financing entrepreneurs. Most microfinance banks, even those that are nominally profitable, have been implicitly subsidized by investors happy to trade financial returns for presumed social ones.
That was, and still is, necessary: Delivering services to poor households is expensive, even with the cost-saving operational innovations introduced by micro-financiers such as meeting with village customers in groups rather than in brick-and-mortar branches. Serving poor customers well requires as much (or more) effort and oversight as serving much wealthier ones — there is simply no way around that.
The change required to reach the unbanked half of the world is thus less about transforming current practice than about transforming how we think and talk about the financial needs of the poor. At the most fundamental level, those needs are centered on money management — ways to borrow for a wide variety of purposes, ways to save, ways to manage risk, ways to transfer funds quickly and securely.
The good news is that progress has been made on all those fronts, with the introduction of innovative products along with the research to show they are viable. Mobile banking, made practical by the surprisingly rapid penetration of cell phones in developing countries, is especially promising as a financial platform that reduces costs and offers a wider range of services. The big question is whether social investors will prove as willing to help low-income households spread the payments for, say, electric lighting (or, as important, to manage the complicated task of making ends meet each day) as they have been to fund boot-strapping female entrepreneurs. For this is always going to be a business in which doing good is as important as doing well.