Learning from failures in microfinance: what unsuccessful cases tell us about how group-based programs work

American Journal of Economics and Sociology, The,  Jan, 1999  by Michael J.V. Woolcock

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Money, says the proverb, makes money. When you have got a little, it is often easy to get more. The great difficulty is to get that little. - Adam Smith(1)

The success of microfinance programs as agents of poverty alleviation are well known to students of development.(2) Enthusiasts can point to repayment rates of over 95 percent, the high participation of women, associated improvements in the health and education of children, and the potential for programs to become financially sustainable in the long-term. In an era of domestic welfare reform and cutbacks to foreign aid budgets, microfinance programs continue to enjoy strong support across the political spectrum for their capacity to "help the poor help themselves" by "giving them a hand up, not a handout." As the recent Microcredit Summit in Washington clearly demonstrated, academics, politicians, activists, nongovernmental organizations (NGOs), and development agencies around the world now share not only a common concern about the importance of access to institutional credit in helping to overcome poverty, but a common vision for how best to deliver it to those four billion people currently overlooked by the formal banking sector (Sampson, 1989).

This concern, and the resolve to do something about it, is to be commended and encouraged. Roughly 80 percent of the world's population are without access to credit and savings facilities beyond that provided by family members, friends, or money lenders, while in developing countries this number rises to over 90 percent (Robinson, 1995). Informal arrangements, such as rotating credit associations and tontines, provide some measure of short-term assistance but do not sufficiently diversify risk and are inadequate for larger-scale projects, while long-term indebtedness to local moneylenders can entrench rather than relieve poverty. Commercial bankers, on the other hand, ignore the poor because of the high costs associated with lending small amounts to borrowers about whom little can be discerned in terms of their creditworthiness. Since the poor, by definition, lack material assets and a formal education, they have little to offer by way of security against any loans that might be extended to them. The very act of negotiating formal contracts, moreover, let alone filling out application forms and preparing a financial plan, is alien to them. These features contribute to a massive failure in financial markets for the poor in developing countries (Stiglitz, 1989; 1990).

For all the many positive developmental outcomes that doubtless can be attributed to participation in microfinance programs, there are nonetheless several methodological weaknesses in the literature documenting their impact and replication that should give pause to uncritical, wholesale endorsement. These weaknesses give rise to, among other things, the kinds of projections and expectations generated by the Microcredit Summit(3), while simultaneously distracting attention from the crucial issue of how the institutional and human resources are to be assembled to meet those projections and expectations.

Of the many methodological flaws in the microfinance literature, among the most serious is the systematic failure by enthusiasts and scholars alike to control for factors other than program participation itself that may be responsible for the observed outcomes (i.e., selection bias issues): how do we know these results wouldn't have occurred anyway? to what extent are outcomes attributable to noncredit and/or nonprogram variables? does it matter that villages and borrowers are nonrandomly selected? While it is highly unlikely that more sophisticated studies will show the actual impacts to be minimal - indeed, the work of Pitt and Khandker (1998) and McKernan (1996) suggest the impacts are positive and significant when attempts are made to correct for selection bias - precise answers to these questions are crucial for documenting the true impact of microfinance programs, and for policy analysts weighing the merits of alternative approaches to poverty alleviation.(4)

A second related methodological flaw - and the one this article seeks to address - stems from a systematic bias towards not only reporting favorable outcomes but selecting samples that are themselves overwhelmingly drawn from successful borrowers in large, mature programs. While freely acknowledging the enormous potential of microfinance to bring about positive changes in the welfare of the poor, this article examines specific cases of failed microfinance programs and failed loan portfolios, branches, or groups within otherwise successful programs. Such an approach not only allows us to gain a more complete and accurate insight into the range of performance outcomes associated with this approach to poverty alleviation, but also provides important insights into how (as opposed to why) the whole process actually works. Just as studying disease enables doctors to better understand the conditions nurturing health, so too does studying different sources of institutional failure enable us to get a better grasp of the various social processes at work in happier times. Given the importance of financial services to the poor, and the enormity of the challenge set by the Microcredit Summit, greater attention to the social mechanisms shaping institutional success and failure is needed to complement the more familiar issues of costs, subsidies, interest rates, lending policies, and training that have dominated discussions to this point.