Foreign Policy Blogs

The Poverty of Microfinance

In a recent piece which appeared on this website, fellow Southeast Asian blogger Rohan Poojara remarked on the potential which microloans could have on the economy of Indonesia, a country suffering from staggering levels of unemployment amongst its youth and which typically has difficulty in obtaining the necessary capital in order to build and expand small businesses. Indeed, there are plenty of positives associated with microfinance, despite the dark shadow lingering over the topic that has been accentuated over the last year. Microfinance promotes social mobility and gives the poorest of individuals a small opportunity to break out of the cycle of poverty. Additionally, the payback rate of the loans is remarkably high.

The primary reason for that, however, is because private lenders usually step in to prevent the borrower from defaulting with microfinance institutions directly. This is an underreported phenomenon but is the subject of a recent article on the microfinance climate in Cambodia by Simon Marks in the Asia Sentinel. According to Marks:

Private lenders often allow borrowers to pay back the formal lenders, who in return agree to provide their clients with more credit. A lack of available credit history has also produced cases where clients have taken loans from more than one microfinance institution at the same time.

It is hard to know if this scenario is representative of the broader microcredit sector. Only licensed microfinance institutions are obliged to report on loan defaults, while smaller, registered institutions do not.  According to figures from the Cambodia Microfinance Association, non-performing loans among licensed institutions were calculated to be just 0.99 percent in the first three months of the year.

Marks then details the consequences for individuals who are forced to take out additional loans from private lenders to repay the original microfinance loan:

The scenario being played out…in Trapaing Krasaing commune – a tight-knit community where strife in the quest to earn a living is shared – is at times dismal.  Both poverty and crippling debt levels loom over the heads of many here. By day, credit officers from some of Cambodia’s 27 licensed microfinance institutions travel round on motorbikes looking for new clients and collecting outstanding debts.

This leaves microfinance borrowers, already some of the poorest people in the world, in a debt trap that they will most likely never succeed in escaping. Moreover, a revealing article in the Harvard Business Review from 2007 asserted that “90 percent of microloans are used to finance current consumption rather than to fuel enterprise.” Apparently, many poor individuals perceive a quick influx of cash as a means to satisfy their hunger or quench their thirst for the week, rather than investing in a long-term solution. One cannot possibly blame people for this behavior – especially if one has never lived on two dollars per day and where the major question confronted is not “what will I eat today?” but, rather, “will I eat today?” The spike in suicides amongst borrowers is a testament to the perilous situation instigated by the debt trap. Furthermore, the successes which microloans are generally credited with are exceedingly small in nature and not meant to satisfy macro-economic objectives.  The type of large scale achievements by developing states such as Brazil or South Korea were accomplished by significant state spending on social projects and infrastructure, not a propagation of farmers or basket weavers turning handsome profits. At the risk of merely piling on top of a growing list of critics, I believe more scrutiny is needed for the microfinance sector before any declarations of success can be extrapolated from a few compelling stories.

 

Author

Tim LaRocco
Tim LaRocco

Tim LaRocco is an adjunct professor of political science at St. Joseph's College in New York. He was previously a Southeast Asia based journalist and his articles have appeared in a variety of political affairs publications. He is also the author of "Hegemony 101: Great Power Behavior in the Regional Domain" (Lambert, 2013). Tim splits his time between Long Island, New York and Phnom Penh, Cambodia. Twitter: @TheRealMrTim.

americasdiplomats_socialmediaasset