Kiva announced last week that it has passed the $400 million milestone in microloans, a landmark achievement for an organization that relies on private donors to finance loans as small as $25 in developing countries.
This field, known as “microfinance,” has recently become immensely popular, inspiring similar movements across the nation. In 2009, New York Times journalist Nicholas Kristof famously said, “Microcredit is undoubtedly the most visible innovation in anti-poverty policy in the last half century.”
For a business student, especially, it’s easy to want to believe that typically capitalistic fields like banking and finance can cause a positive social impact. But unless combined with other efforts, microfinance is unlikely to enact sustainable progress for those in developing countries.
The field of microfinance, which has benefitted more than 500 million people, has gained considerable popularity since Muhammad Yunus won the Nobel Peace Prize in 2006 for creating Grameen Bank, Forbes reported. Organizations such as Kiva, Accion and Grameen Bank have allowed people to take out small loans to support their businesses, even in areas where financial services are difficult to obtain.
The impact has been staggering. Grameen Bank alone is reported to have served seven million of the world’s poorest families, according to the Grameen Foundation website.
“Many see microcredit as much more than a financial instrument: it has been suggested that it has the potential to be entirely transformative,” Kristof wrote.
Yet, it wasn’t long until the backlash against microfinance began. Many questioned the use of the microfunds by lenders in rural areas. “Nine out of 10 microfinance loans are for consumption rather than to start or grow an enterprise,” said Hugh Sinclair, author of Confessions of a Microfinance Heretic: How Microlending Lost Its Way and Betrayed the Poor.
Although the statistic is shocking, the idea that families in poverty are likely to spend financial loans on basic survival resources instead of on burgeoning business is understandable. Nonetheless, the spending of microfinance funding on consumption goods rather than on businesses is contradictory to the message of the industry.
“There is a lot of misinformation and misunderstanding about what really is going on in microfinance,” Sinclair notes. “On the one hand, we hear of rumors of exploitation of the poor. On the other hand, good, well-meaning Americans and Europeans are donating and investing their money in this sector without really knowing what’s happening.”
In fact, reports of people in poverty caught in a circle of serious debt, as well as of people unable to repay debts with high interest rates, has drawn attention to the limitations of microfinance in a for-profit industry. While proponents of microfinance continued to defend the field, the criticism has become more and more severe. “On current evidence, the best estimate of the average impact of microcredit on the poverty of clients is zero,” said David Roodman, a fellow at the Center for Global Development.
Though it might be disheartening to hear, microfinance is most likely not the silver bullet to ending poverty. The underlying causes behind poverty are complex and based on a number of factors, not just financial stability or access to capital.
The potential of microfinance to make a difference can be severely inhibited by problems of organizational corruption, unsustainable accumulation of debt, high interest rates and other issues. Though microfinance might be a step in the right direction because it empowers people to start businesses, a multi-disciplinary approach to poverty reduction is a much better course of action.
Despite all these factors, the future of microfinance is bright. “World leaders should come together again to provide the powerful and visionary leadership to help steer microcredit back on course,” said Yunus, arguably the world’s leader in microfinance.
With the right insight and protection of microfinance institutions, such progress might be possible. They might not be the answer for impoverished nations, but socially responsible microfinance organizations like Kiva clearly have the potential to make a positive impact.
Payal Mukerji is a junior majoring in business administration. Her column “Risky Business” runs Tuesdays.