TEXT OF COMMENTARY
Kai Ryssdal: Economic innovations don’t always come from Wall Street. One of the most significant — for developing countries, anyway — was perfected in Bangladesh and has since spread around the world: microfinance, where, say, a rural farmer in Bolivia or a craftsman in Indonesia can get a small loan to build a business.
The industry’s grown at an average of 25 to 30 percent over the past five years.
Commentator and economist Dean Karlan says microlending is a valuable tool… if you understand all its effects.
Dean Karlan: Practically everyone has heard an inspiring story about a poor woman who takes out a $50 loan. She starts a business and now earns a steady income, feeds her children and sends them to school. The idea of microfinance is powerful and the stories are certainly inspiring, but there are several unanswered questions and potential problems.
First, interest rates are on average around 30 to 40 percent per year — in some places as high as 100 percent — and most microfinance institutions require clients to already have businesses. In fact, most of these micro-businesses plateau in size fairly quickly. If the borrowers can generate the kind of return required to pay off their loans, why aren’t their businesses growing?
Also, in many markets, individuals are saying no to the loans being offered. Many continue to borrow from traditional moneylenders. What is it about the loan that makes them say no? Are the loan terms too expensive? Are they too inflexible?
It’s clear that loans are often used for household goods or to help pay for school fees or health emergencies. We should be happy that individuals borrow for these things, but wouldn’t it be better to help them save or get insurance for medical care? Figuring out how to do that could have huge benefits. Some of the most important work in microfinance today is not on loans, but rather on insurance and savings.
Why savings? The logic is simple: if someone borrows at 40 percent per year, every dollar less borrowed today could mean 40 cents more food on their table tomorrow.
So how do we improve savings? Here’s one way: just as we can have automatic deduction from a paycheck, how about automatic deduction when a farmer sells his harvest? Or offer people savings accounts which must be used for education or health expenses.
This is an exciting time for microfinance. There’s tremendous potential for creativity to make big impacts on poverty. The trick is to delineate between what sounds good and what really works.
Ryssdal: Dean Karlan is professor of economics at Yale University. He’s also the co-director of the Financial Access Initiative.
There’s a lot happening in the world. Through it all, Marketplace is here for you.
You rely on Marketplace to break down the world’s events and tell you how it affects you in a fact-based, approachable way. We rely on your financial support to keep making that possible.
Your donation today powers the independent journalism that you rely on. For just $5/month, you can help sustain Marketplace so we can keep reporting on the things that matter to you.