By Logan Shewmaker
Many businesses start on loans. Traditionally, the loan process works by allowing a business owner or individual to approach a bank, receive the money upfront, and then pay back the amount loaned out over a period of time. Bank loans range anywhere from a few hundred dollars to millions. Eligibility criteria usually include a favorable credit score or some form of collateral asset to ensure the lender will be paid back. But what if you have no credit or collateral? What about the impoverished people around the world that have the drive to start a business but are starting from zero?
In recent decades, the rise of microfinancing in developing areas has offered an alternative to traditional lending practices for the extremely poor. Microfinancing is exactly what it sounds like: providing very small loans of no more than a few hundred dollars to people with very limited means. By fostering local business growth through small-scale loans, microfinance appears to offer a highly efficient way to break the cycle of poverty. However, research has shown mixed results when testing the effectiveness of this method to promote economic and social progress.
Enterprising Solutions Global Consulting released a report in 2003 on the United Nations Capital Development Fund (UNCDF). Using impact assessment surveys, the researchers tested whether microlending provides “poor clients with capital for investments, extra liquidity to allow them to take advantage of economic opportunities as they arise, and the opportunity to accumulate assets and gain access to savings to help protect against shocks in times of need.” The researchers assessed UNCDF microlending in several Least Developed Countries (LDC), including Nigeria, Malawi, and Haiti. The study found positive associations between participation in MFIs (Micro Finance Institutions) and investment in land as a household asset, secondary education, and risk protection for financial emergencies (medical expenses, natural disasters, etc.) when comparing treatment and control groups.
Other studies have yielded less promising results. Researchers at the UK Department for International Development reviewed dozens of studies on MFIs from several databases and determined that many of the reviewed cases were at a high risk of various selection, reporting, and attrition biases. Many studies did not test the validity of the instruments used or were not deemed rigorous enough. The researchers synthesized data from the studies to determine the impacts of MFIs on economic and social well-being. Most of these data were statistically insignificant. Overall, the researchers found the data to be inconclusive.
Impact assessment may be particularly difficult for MFIs because much of the quantitative data is subject to the potential bias of self-reporting. While many micro financing firms point to positive correlations between MFI participation and social progress, further research by independent agencies is needed to back this claim.
