This is one of a handful of new studies which provide a rigorous estimate of the impact of microfinance. Accepted applicants used credit to change the structures of their business investments, resulting in smaller, lower-cost, more profitable businesses. So while business investments did not actually increase, profitability did increase because the capital allowed businesses to be reorganized. This happened most often by shedding unproductive employees.
The results also highlight the importance of replicating tests and program evaluations across different settings. We are working towards that goal, and are currently implementing microfinance impact studies in Morocco, as well as continuing studies in the Philippines. See here for other studies on varying interest rates in Mexico, Peru and South Africa.
Microcredit, or the practice of providing very small loans to the poor, often with group liability, is an increasingly common tool intended to fight poverty and promote economic growth. But microlending has expanded and evolved into what might be called its “second generation,” often looking more like traditional retail or small business lending where for-profit lenders extend individual liability credit in increasingly urban and competitive settings. The motivation for the continued expansion of microcredit is the presumption that expanding credit access is an efficient way to fight poverty and promote growth. Yet, despite optimistic claims about the effects of microcredit on borrowers and their businesses, there is relatively little empirical evidence on its impact.
Context of the Evaluation:
First Macro Bank (FMB) is a for-profit lender that operates in the outskirts of Manila. A second generation lender, like many other Filipino microlenders, FMB offers small, short-term, uncollateralized credit with fixed repayment schedules to microentrepreneurs. Interest rates at this bank are high by developed country standards: several up-front fees combined with a monthly interest rate of 2.5 percent produce an effective annual interest rate greater than 60 percent.
The borrowers sampled in this study are representative of most mircrolending clients; they lack the credit history or collateral which are needed to borrow from formal financial institutions like commercial banks. Most clients are female (85 percent), and average household size (5.1 individuals), household income (nearly 25,000 Filipino pesos per month), and levels of educational attainment (44 percent finished high school and 45 percent had postsecondary or college education) were in line with averages for the area. The most common business owned by these clients is a sari-sari store, or small grocery/convenience store (49 percent own one). Other popular occupations among clients are in the service sector, such as hair dressing, barbering, tailoring, and tire repair.
Details of the Intervention:
J-PAL affiliates, with FMB, used credit-scoring software to identify marginally creditworthy applicants based on business capacity, personal financial resources, outside financial resources, personal and business stability, and demographic characteristics. Those with scores falling in the middle comprised the sample for this study, totaling 1,601 applicants, most of whom were first time borrowers. They were randomly placed in two groups: 1,272 accepted applicants served as the treatment and 329 rejected applicants served as the comparison. These rejected applicants could still pursue loans from other lenders, but it is unlikely they obtained one due to their marginal creditworthiness.
Approved applicants then received loans of about 5,000 to 25,000 pesos, a substantial amount relative to the borrowers’ incomes—for example, the median loan size (10,000 pesos, or USD $220) was 37 percent of the median borrower’s net monthly income. Loan maturity was 13 weeks, with weekly repayments, and with a monthly interest rate of 2.5 percent. Several upfront fees combine with the interest rate to produce an annual percentage rate of over 60 percent.
Data was collected on business condition, household resources, demographics, assets, household member occupation, consumption, well-being, and political and community participation one to two years after the application process was completed.
Results and Policy Lessons:
Impact on Borrowing: Being randomly assigned to receive a loan did increase overall borrowing: the probability of having a loan out in the month prior to the survey increased by 9.4 percentage points in the treatment group relative to comparison.
Impact on Business Outcomes: Accepted applicants used credit to shrink their businesses. Treated clients who owned businesses operated 0.1 fewer businesses and employed 0.27 fewer paid employees. One explanation could be that these smaller businesses cost less and are thus more profitable. Perhaps clients would more readily invest in and grow their businesses if loan proceeds are tied to detailed business planning or closer monitoring by the lender.
Impact on Risk Management: Evidence suggests that increased access to formal credit complements, rather than crowds-out local and family risk-sharing mechanisms. Treated clients substituted away from formal insurance into informal risk sharing mechanisms: there was a 7.9 percentage point reduction in holding various types of formal insurance, including life, home, fire, property, and car insurance, and treated clients reported increased access to informal sources of credit in an emergency, such as family and friends. In all, these results suggest that microcredit improves the ability of households to manage risk by giving them additional options: using credit instead of insurance or savings, and strengthening family and community risk-sharing.
See the full results in an executive summary here and the full paper here (PDFs).
Microcredit is the most visible innovation in anti-poverty policy in the last half-century, and in three decades it has grown dramatically. Now with more than 150 million borrowers, microcredit has undoubtedly been successful in bringing formal financial services to the poor. This practice has sparked a debate surrounding the question of “fair interest rates,” particularly given the extreme poverty of many microfinance clients. The arguments in defense of higher rates range from the belief that they are necessary in order to cover the high costs of lending, to access is more important than price and as more institutions enter the market, rates will drop. But these arguments remain untested, and the question of a “fair rate” remains unanswered. The debate has intensified as investors look to the potential profitability of microfinance. In 2007, Compartamos Banco, the largest microfinance institution in Latin America, held a successful IPO. While the bank’s leadership defended the decision as a way to raise capital and provide credit to even more clients and investors including non-profit Acción International reaped the benefits, critics accused the bank of profiting at the expense of the poor.
Context of the Evaluation:
In 1990, Compartamos Banco began offering credit to women in Southern Mexico in an effort to promote economic development through spurring the growth of micro-businesses. Today, the organization has branches in every state in the Mexican Republic, and has over a million borrowers. The bank requires all borrowers to have an existing business or plans to start one with the loan proceeds. There are many microfinance providers in Mexico, and Compartamos loans are neither the cheapest nor most expensive.
This study was undertaken in Compartamos branches throughout the country, representing a diverse population living in urban, periurban, and rural locations. The target population, comprised mostly of small-scale merchants who sell handicrafts or food products, also includes owners of more established businesses such as hair salons or restaurants, and people involved in agricultural activities.
Details of the Intervention:
Researchers sought to observe Compartamos borrowers’ reactions to varying interest rates, in order to determine the impact of loan cost on take-up and borrower behavior. The study focused on the bank’s most popular product, a group liability loan offered exclusively to woman called Crédito Mujer. In order to borrow, clients must be women, 18 years of age or older and either currently be engaged in an income generating activity or plan to start one once given the loan.
As part of the implementation of a new pricing model, Compartamos lowered the interest rates on the Crédito Mujer product for almost all clients. At treatment branches, they lowered the rates further. Under normal operations, each branch offers three rates – bronze, silver, or gold – which are assigned to borrowing groups based on the Compartamos pricing model. Compartamos lowered the interest rates offered at treatment branches so that borrowers at those branches received a flat monthly rate that was .5% less than the same borrowers would have received at comparison branches For example, a "bronze" borrowing group at a treatment branch received a rate that was .5% less than a "bronze" borrowing group at a comparison branch.
Results and Policy Lessons:
The results show that branches offering the lower interest rate scenario had more clients, more new clients and larger loan portfolios. The change in cost of borrowing, however, did not attract a different borrower profile. The new borrowers at treatment branches were not poorer or less educated than existing clients. The effect of lower interest rates on the financial sustainability of an MFI is also a crucial question. Attracting more clients may at first glance appear a wholly positive outcome, but its effect on profitability is not obvious. While adding several group members to an existing borrowing group increases income without increasing costs (because the same loan officer can service these loans in the same meeting), adding new groups may require hiring more personnel or even opening an expansion branch office. Still, though these new clients resulted in higher costs in some cases, the overall effect on net profits was positive.
These findings suggest that MFIs that choose to lower rates can both attract and retain more clients, who in turn borrow greater amounts. This has implications for MFIs that are looking to improve their outreach, and can result in more people gaining access to credit and making use of it. And, achieving these goals can also be profitable, in contrast to the arguments put forth by some defenders of high interest rates.
Few studies have rigorously quantified the impacts of microcredit loans or determined the sensitivity of borrowers to interest rate pricing. In cooperation with the Peruvian microfinance institution ARARIWA, IPA is investigating the impact of microloans on the whole as well as determining the demand curve for microcredit.
For the study, areas in Cuzco are divided into one of three groups: a control group with no access to credit during the 24 months of the study, a treatment group that will receive credit offers at a lower interest rate, and treatment group that will receive credit offers at a higher interest rate. Data is being collected to analyze the take-up of microcredit loans, changes in socioeconomic levels, and borrower sensitivity of interest rates.