Dhaka, Bangladesh
2019 Nobel prize impact on microfinance model

2019 Nobel prize impact on microfinance model

By Md Abdul Wasi

IN THE past two decades, novel work in the field of microfinance has received appreciation globally and led to a Nobel prize for Bangladesh. However, multiple studies have also discussed the insufficient evidence regarding the positive effects of microfinance and have concluded that its benefits have been overstated. Some of these prominent studies show the limited impact of microfinance using an experimental technique, which has earned the latest Nobel prize in 2019. Does this latest Nobel prize, therefore, further validate the recipients' criticism of the effects of microfinance at large? Microfinance has been regarded as an innovative financial instrument that is designed to help people with limited access to traditional financial products. For example, microfinance provides credit for borrowers with inadequate collateral and income, which conventional banking system would not service, otherwise. This can immediately improve the cash position (liquidity) of the unqualified borrowers and can achieve significant socio-economic development for them. However, over the years, researchers, such as Nobel laureate Abhijit Vinayak Banerjee and others have highlighted that microcredit does not effectively improve the financial position of the borrowers and have criticised the effectiveness of microfinance in reducing poverty. Various studies related to microfinance have used an experimental technique to assess the effectiveness of the microcredit programme. In particular, a sample of poor neighbourhoods is randomly selected where households (borrowers) are given a microcredit facility. At the same time, another sample of comparable neighbourhoods is also formed which is not provided with the microcredit facility. The experiment does a comparative assessment on the economic impact between these two sets of neighbourhoods after initiating this microcredit arrangement. The major findings broadly suggest that borrowers who were recipients of the microcredit facility showed negligible economic improvements compared with households which did not receive this lending support during the experiment period. This led to a general conclusion that the microfinance model can be unsuccessful in reducing poverty effectively and that its contribution may have been overstated. These results have been strongly supported by other studies as well that use alternative measures (equally robust) in assessing the effectiveness of the microfinance programme. Nonetheless, in recent times the same stream of studies has started to appreciate the core idea of microfinance with some modifications. For example, one of the recent working papers by Professor Abhijit Banerjee and others suggests that the microcredit model can enable people to avoid a poverty trap given that they are talented. Specifically, they highlight that if borrowers have an existing microcredit facility and have had previous entrepreneurial experience, the microcredit supply can help them grow their businesses further, as opposed to new borrowers. Furthermore, while most studies have empirically showed that the lending rates of the microcredit facility are considerably high, there is also evidence to show that the borrowers make sufficient financial returns (and obtain liquidity) to service their interest costs. It can also be argued that the high interest income for the microfinance providers can enable them to expand their range of borrowers and also establish a credit model which can self-sustain (in the event of donor agencies discontinuing their support based on the economic growth of the country). In addition, some studies have also showed that despite high levels of interest income, only a limited number of microfinance providers have been able to make economic profits (adjusted for macroeconomic factors). The main puzzle is, therefore, whether we can over-interpret the criticism of the microfinance model. The experimental methodology of related studies is unquestionably robust; however, it is hard to generalise their findings as they often investigate relatively short time periods (up to six years) after the microfinance programme is introduced. Well-known related academic studies often use couple of decades long time period to assess the long run and true economic impact of a macroeconomic policy or treatment (an example can be employing the microfinance model). In some cases, the short-run outcome of a financial variable can revert when a longer time period is considered in the analysis. Drawing conclusions in regard to the lack of effectiveness of the microfinance model based on a data period of a few years may, therefore, be too early. Moreover, these experimental setups often lack the assessment of broader economic and social welfare indicators which may have experienced a considerable change due to the microfinance model, as recent researches suggest estimating new measures of economic welfare in addition to the conventional economic growth given by the gross domestic product. For example, leisure, inequality, mortality and crime rate are some of the wider social welfare indicators which need to be examined. Among others, child marriage, child labour and women empowerment can also add significantly to the assessment of living standards within a neighbourhood (or a community) and help improve the strength of the related experimental results. Despite all the valid criticisms of the microfinance model, its significance in providing liquidity to the poor borrowers (especially to households with limited pledgeable collateral) in hard times is, therefore, powerful.

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