The microfinance debate: Pertinent issues

Once again, the microfinance debate is on and it comes at a time when the government is stepping up efforts to see Micro Finance Institutions (MFIs) back in business after a serious downturn in the industry since 2006.


Huge sums of money geared to building capacity in the sector have been earmarked but this money comes along with serious warnings against its abuse. All this revival effort is hinged on the widespread belief that MFIs, if properly managed can help eradicate poverty.

I am no pessimist when it comes to the benefits of microfinance. My concern, however, is in how the whole concept is understood, and utilized.

Going back in history, the usual model [and I believe exemplary pioneer] was Bangladesh’s Grameen Bank, which made small loans accessible to enterprising poor villagers and relied on peer pressure and strict-credit discipline to ensure repayment.

Grameen Bank was established in 1976 by Dr. Muhammad Yunus, an Economics professor, as an action research programme to deliver bank credit to poverty-stricken villagers in rural Bangladesh. It was later converted into an independent bank by government ordinance.

As income-generating facilities dedicated to serving the poor, MFIs reject conventional notions of creditworthiness which make commercial banks unsuited for channelling credit and other services to the poor, who by definition possess no collateral. Inspired by the notion that very poor people possess sufficient initiative and energy to put together small projects that could increase their income, numerous Grameen-like institutions in form of savings and loan cooperatives have sprouted.

Although concerted efforts are geared into regulating this sector, its real capacity to eradicate poverty still risks being elusive if certain issues are entirely ignored.

For one, MFIs have tended to disappoint by failing to pass the sustainability test. This has left the cycle of poverty among billions of poor people intact all over the world and a lasting solution still eludes governments, multi-nationals, the public and private sectors. The big question in this regard is: What or how much has been achieved by Microfinance in Rwanda, other than the demystification of the age old image of the poor as non-credit worthy?

Please let me assure you, once again, that I remain a compulsive optimist despite all the bad signs. I am certainly a friend of the idea that microfinance is a promising industry that supersedes many other poverty eradication interventions if properly harnessed.

It is important to raise public awareness about microfinance and promote innovative partnerships among governments, donors and international organisations, the private sector, academia and beneficiaries as well. However, it is even more important for all of us to ask where and how things are going wrong.

Conceptual clarity

Many understand that microfinance or micro credit is geared towards meeting the needs of the poor (especially the very poor), but what about the need and importance of naming and framing this poverty?

Before we can formulate effective policies and programmes to eradicate or alleviate poverty, we need some specific knowledge of who these poverty groups are and what their economic characteristics are. Indeed, conceptual vagueness has contributed to the failure of poverty alleviation-focused programmes.

To help the poor, one should know who and where they are or one risks slipping past them, sometimes without even realizing it. It has been pointed out that there are frequent encounters in literature where rural and poor are often used interchangeably, which is not only wrong but misleading.

Looking at the exemplary Grameen Bank experience in rural Bangladesh, Yunus revealed that equally misleading is the common practice of talking about small or marginal farmers with the firm belief that small and marginal farmer is a synonym for the poor.

The argument is that depending on the economic make-up of a country, ‘poor’ may or may not include a small or marginal farmer. Also regretful is the way rural credit schemes tend to go astray. ‘Rural’ has been taken in many instances to be synonymous with agricultural and therefore by definition excluded all those engaged in a multitude of other subsistence activities. The landless and women in such cases constitute the group most removed from the possibility of credit.

Accordingly, our MFI sector stands to succeed if we avoid identifying our target groups with respect to any particular occupation such as farming, and simply call them ‘poor people’ or by any other suitable name.

There are two reasons for that. First, the landless and near landless people in most poor economies are basically non-farmers. They supply most of the total labour required in the agricultural sector, but out of the total usable time available to them they may be using hardly one fifth of it in agricultural activities. Eighty per cent of their available labour time is used in non-farming activities plus idleness.

And indeed, if we refer to the landless and near landless people as farmers we will be committing the gross mistake of categorizing them by a minor characteristic.

The second objection is based on the universally accepted male image of the farmer. As soon as we identify a section of the people as farmers, our thinking process gets drawn into exclusively male issues and one blissfully forgets about the women. If they are remembered at all, it is always done in their capacities as minor helpers of the all-important male members of the household.

Nowadays, more heads of households are women [and children, especially in post-conflict economies like Rwanda] among the poor than among the non-poor. It is thus very important to properly target the most needy in our society if micro-credit initiatives are to bear any fruit.

That can only be achieved if the real poor are clearly and most effectively identified. Just like a doctor can only prescribe the right medication after proper diagnosis, success in microfinance will come if the really poor people are identified and reached. In Rwanda’s case these could be Umutindi nyakujya and Umutindi.

Aspects of outreach and sustainability

The performance of Rwanda’s microfinance sector should also be judged basing on the concepts of outreach and sustainability. Are players in the sector making any effort to extend services beyond the usual limits? Are they permanent, or do they have the ability to repeat their performance through time?

What the reader should note, however, is that permanence does not mean constancy; the managers of these organisations should adapt and adjust to keep performance healthy in an ever shifting environment.

A sustainable MFI should meet its goals now without harming its ability to meet its goals later.

Outreach is the social value of the output of a microfinance organisation in terms of aspects such as depth, breadth, length, and scope. Strong emphasis on these aspects is vital for improving the welfare of Rwanda’s very poor.

Depth of outreach is the value that society attaches to the net gain from the use of micro credit by a given borrower. Just as it is emphasized with respect to conceptual clarity, poverty is a good proxy for depth and hence more weight should be placed on the poor than on the rich.

Efforts should be made to reach out to the bottom poor if the Rwandan poverty profile is to be improved.

Breadth of outreach is the number of poor people that an MFI serves and this matters very much because the poor, and indeed the very poor are very many yet the available micro-loans are few.

The length of outreach is the time frame in which MFIs produce loans. Length matters because society cares about the welfare of the poor both now and in the future. Without length of outreach, MFIs will improve social welfare in the short term but wreck their ability to do so in the long term.

Longer outreach through sustainability strengthens the structures of incentives that serve to maximize expected social value minus social cost discounted through time. No one should doubt that without length borrowers have very few selfish reasons to repay because the lender cannot promise to lend again in the future.

Scope of outreach on the other hand is the number of types of financial (and non-financial) contracts offered by MFIs. Microfinance organisations with the best outreach produce both small loans and small deposits.

Deposits matter for two reasons: first, all poor people are deposit worthy and save to smooth consumption, to finance investment and to buffer risk. Secondly, deposits strengthen the incentives for sustainability and length of outreach. Depositors will shun microfinance organisations if they do not expect them to live to return their deposits.