Whatever Happened to Microfinance? A Cautionary Tale

The success or failure of any development program depends on a thorough grasp of the context in which it is being implemented.


Microfinance, the provision of financial services to the poor, burst onto the world stage as a solution to underdevelopment in the 1970s. The basis of its popularity was the idea that once such services, especially credit, are made available to the poor, they will invest in small businesses that will lead them out of poverty.

Muhammad Yunus, whose Grameen Bank in Bangladesh started the movement in the mid-1970s, claimed that “credit is a human right.” And by the late 1990s microfinance had so much momentum that 3,000 people from more than 140 countries gathered at a Microcredit Summit in Washington, D.C., in 1997 to hear its praises sung by Queen Sofia of Spain, First Lady Hillary Clinton, Treasury Secretary Robert Rubin and the presidents of Peru and Uganda. In 2006, Yunus won the Nobel Peace Prize.

Yet after a decades-long run, the numbers tell the story of a fading fad. The 1997 summit had predicted 100 million borrowers by 2005 and continued growth, as the huge number of “unbanked” people began to avail themselves of microfinance services. As of 2019 there were 140 million borrowers worldwide (80 percent of them women), for a total gross loan portfolio of $124 billion. But measured against the reality that there are 1.7 billion people in the world who are “unbanked” (22 percent of the world population), the expected demand for microfinance services has simply not materialized. In fact, the rate of growth in new clients in the last decade has been going down.

Moreover, there is no evidence that access to financial services, especially microloans, has a significant effect on poverty, much less forms a sustainable basis for economic development, or that “financial inclusion” (the term used today to encompass microfinance services) is even a real need. Microfinance practitioners have largely ignored such findings, beginning with the conclusions of a 2009 randomized controlled trial in Hyderabad’s slums conducted by MIT’s Poverty Action Lab. Blinkered by their narrow focus on getting financial services to the poor, microfinance organizations, especially the nonprofits, see only the short-term effects: a roadside seller whose daily profit grows from $1.00 a day to $1.45, a woman who can now put a sheet of corrugated iron on her hut’s roof, etc. They blot out the all-important contexts in which their clients live—contexts that are layered with complexities that, especially in the poorest parts of the world, account for barriers that microloan programs can do little to surmount.

Yet a rigorous examination of the context for microfinance and the poor it seeks to reach is exactly what should have been done from the beginning. A review of just some of the contextual issues offers a cautionary tale of how important (and challenging) it is to understand them.

1. Position counts more than condition—the sociocultural context of poverty.

Most microloan recipients in the poorest countries are subsistence farmers or petty traders selling out of a small space on the ground or from a rickety table on a roadside or in the ubiquitous markets of sub-Saharan Africa, parts of South and Southeast Asia and some parts of Latin America. These largely informal sector “jobs” constitute the bulk of economic activity for most people in those countries. A woman selling spices by the 10-gram packet or razor blades by the unit sits in a row of others with similar goods. She takes a microloan of $20 and, in theory, buys more product, thus increasing her inventory and potentially raising her profit.

But studies by economic anthropologists, sociologists and field workers like myself (since the 1980s, I have evaluated scores of such programs) reveal that having more inventory in a low-margin economy actually increases risk by reducing the flexibility to shift to other products or other locations as demand changes. In the best-case scenario—let’s say that the spice seller has great natural selling skills—she does manage to raise her net income, say from $1.50 per day to $2.35. This is a meaningful increase for her, but it is not enough to move her out of poverty. Instead of being very poor, she is now merely poor; she can add a piece of corrugated roofing to her shack, but because of her lack of resilience her improved status may be temporary.

In short, her condition has changed in the short run, but her position in society has not; she is not on the ladder to economic growth. This important distinction between condition and position is largely ignored in the microfinance community. For, as we’re now relearning about “structural racism” in the United States, it is people’s position in society (determined by complex historical, sociocultural factors and, often, hidden arrangements in the political economy) that counts, not immediate or short-term changes in their “condition.”

It is a mistake to assume that before aid efforts came along, the poor had not already figured out how things work in their world and how to optimize that knowledge.

Such contextual complexities are specific to each country or region. They include but are not limited to: local and national history, custom, law, beliefs; the particulars of location, transportation and communications infrastructure; land tenure and labor arrangements; the differing economizing strategies of a variety of social units such as the household, clan or tribe; how political controls are exerted; the durability of social capital; ethnic, religious and class competition; the ways in which kinship bonds often underlie economic activities; and the possibility in many developing societies that the economic return of an activity (production, trading) is only one of many goals.

Not least among the contextual variables is the level of economic development, including the degree to which governance, legal and financial regimes and the rule of law are developed. If these institutions are “underdeveloped,” there is less stability, less equality of opportunity and more corruption, and people have less trust in government.

In short, in many of the developing country environments where microfinance has been applied, its potential as a poverty solution is severely diminished. Those who are supposed to benefit end up, at best, “all dressed up with no place to go.”

2. Human nature—money is fungible.

A founding assumption of microfinance was that loans would be invested in a business. In fact, much of microcredit instead goes to “consumption smoothing,” softening the peaks and valleys of the cash-flow graph so it looks more like a ripple than a roller coaster. Such smoothing makes it easier to get over a cash crunch or to enable the purchase of medicine or the financing of a wedding. While this is of value to a poor person, in business terms it does not generate the money to pay back the loan.

Yet many microfinance programs report repayment rates greater than 90 percent, something any big bank would die for. What we don’t see as clearly is whether such rates are sustainable; nor do we see the myriad ways borrowers use to repay (including borrowing from another microfinance program). Moreover, as loan size grows, it is more likely that payments will be delayed, or loans will not be repaid at all.

3. The poor of the developing world already have complex financial systems of their own.

Since the 1950s, when Sol Tax did fieldwork in the markets of northwestern Guatemala and coined the phrase “penny capitalism,” anthropologists and others have studied markets all over the world. They strongly suggest, first, that it is a mistake to assume that before aid efforts came along, the poor had not already figured out how things work in their world and how to optimize that knowledge.

In reality, poor people in agrarian and bazaar economies have long understood risk, resilience, credit, debt and savings—despite not being “financially literate” from our standpoint. Most important, in their terms, they may not want or need our interventions. The international development community that backs much of the financial inclusion agenda makes a simple zero-sum calculation: If you are not formally included, you are excluded. But the literature shows that a significant portion of the poor already are included in financial services that take many forms, albeit not formal modern ones.

Traditional societies have always had forms of savings—in land, livestock, jewelry, even cloth. And the poor in many societies have always had ways of acquiring lump sums of cash. Informally organized ROSCAS (rotating savings and credit associations)—called “susu” or “round robins” in parts of Africa, or “arisans” in Indonesia—are common throughout the world.

We are well advised to acknowledge a good dose of humility about how far, really, we have come, and how much, really, we know about poverty.

As for small business loans, trade credit (aka supplier credit) is also common. For example, say a trader buys samosas to sell along with her tea. She’ll get 30 samosas or so at a reduced per-item rate and not have to pay until later in the day when her tea business is over. But the most common source of business start-up capital is friends and family. In fact, most of the storied entrepreneurial successes in the United States (from Walt Disney to Subway and Amazon) began with loans from friends and family, not from banks.

To emphasize the point that “unbanked” people are not necessarily clamoring to be “banked,” there are cultures where wealth accumulation is not even a legitimate goal. In such cultures there are leveling mechanisms designed to prevent any one person or group from gaining wealth greater than the others in the society. While the potlatch of the Northwest Coast Native Americans (in which valuable goods are routinely destroyed) is long gone, similar mechanisms exist all over the developing world—such as a public feast or an expensive wedding, or the redistribution of grazing animals when a family comes into wealth.

All of this is not to say that poverty in the developing countries is a happy state, or that the poor have no desire to improve their lot—clearly they do. The point is that we outsiders need to be careful not to assume that our interventions are the right ones or the right starting point.

4. There is a difference between entrepreneurs growing the economy, and people generating income.

One of the pillars of microfinance was its assumption that the poor are entrepreneurial. With all our advantages in the advanced economies, it is obvious that only a small percentage of people are entrepreneurs. The rest of us are content to be employees or freelance gig workers. Similarly, the average petty trader or subsistence farmer selling products in a roadside market did not choose to be an entrepreneur, but rather to generate enough income to survive.

As for economic growth, a critical determinant of economic potential is the question of whether a small trader or farmer has the room to expand or grow even with an injection of credit. Almost by definition, the barriers to entry into the market are low for a petty trader or small farmer. Anyone can set up shop. Since the small trader is often part-time (e.g., fishermen’s wives or farm people in slack season), they move into the market and add another degree of saturation to an already crowded field, often made more crowded by the presence of microfinance. And since the opportunity costs and the barriers to entry are low, higher technical knowledge is generally lacking, profits (and risks) are low because transactions are small (sometimes at the level of selling sugar by the cube) and the duration of transactions is short.

In short, most of the characteristics of real enterprises and entrepreneurs are missing. In these bazaar types of economy (as opposed to the firm-based economies characteristic of the advanced industrial countries), goods flow, as anthropologist Clifford Geertz once put it, “in hundreds of little trickles, funneled through an enormous number of transactions,” and the trader “is perpetually looking for a chance to make a smaller or larger killing, not attempting to build up a stable clientele or a steadily growing business.”

First, Invest in Understanding

Since there has always been a social purpose to microfinance, its greatest fault is its almost willful ignorance of the social, cultural and economic complexities of the many systems in which its clients operate and live. Context is key, and if the contextual conditions are not conducive to a generally rising tide, then poverty remains and can even grow. Ironically, it is only now, after three-quarters of a century of post–World War II growth in the advanced economies, that we see how vulnerable most people in our own privileged world are to context. We are well advised to acknowledge a good dose of humility about how far, really, we have come, and how much, really, we know about poverty.

What Henry George said in 1879 in his famous book Progress and Poverty remains true today: “This association of poverty with progress is the great enigma of our times. It is the central fact from which spring industrial, social and political difficulties that perplex the world, and with which statesmanship and philanthropy and education grapple in vain. From it come the clouds that overhang the future of the most progressive and self-reliant nations. … All important as this question is, pressing itself from every quarter painfully upon attention, it has not yet received a solution which accounts for all the facts and points to any clear and simple remedy.”

In the enormously challenging project of poverty alleviation in the developing countries, therefore, the starting point must not be an urgent jump into action, but first an investment in understanding.

Thomas Dichter has worked in international development for 50 years in 60 developing countries. A Peace Corps volunteer in Morocco in the early 1960s and, much later, a Peace Corps country director in Yemen, he was vice president of TechnoServe, a program officer at the Aga Khan Foundation in Geneva, a researcher on development issues for the Hudson Institute and a consultant for many international agencies, including the United Nations Development Program, the International Fund for Agricultural Development, the World Bank and USAID, as well as the Austrian and Philippine governments. He is the author of Despite Good Intentions: Why Development Assistance to the Third World Has Failed (University of Massachusetts Press, 2003) and co-editor of What’s Wrong with Microfinance? (Practical Action Press, 2007). The views in this article are the author’s own and do not necessarily represent those of the U.S. government.