Seven randomized evaluations from around the world show that microcredit does not have a transformative impact on poverty, but it can give low-income households more freedom in optimizing the ways they make money, consume, and invest.
This page summarizes J-PAL's policy bulletin on the impact of microcredit, "Where Credit is Due."
From its beginnings as a lending experiment in Bangladeshi villages in the 1970s, microcredit—providing small loans to underserved entrepreneurs—expanded rapidly in the 1990s and 2000s, and now serves over 200 million clients worldwide. Traditionally, financial institutions excluded the poor, finding it too costly to make small loans to borrowers without credit histories or collateral. Yet through the expansion of group-liability lending, community-based banks, and new repayment models, microfinance institutions (MFIs) and banks have brought credit and other financial products to the poor on an unprecedented scale.
Throughout its history, microcredit has been both celebrated and vilified as a development tool. It was initially embraced by policymakers, donors, and funders as an important financial product to help small-scale entrepreneurs invest more in their businesses, increase profits, earn additional income, and potentially lift themselves out of poverty. Yet as microcredit gained widespread support, some questioned the validity of these claims. Early critics noted that reports of microcredit’s success were often based on anecdotes or simple before-and-after comparisons. Some suggested that expanding credit access could even be harmful. Business expansion is risky, and if entrepreneurs’ investments are not profitable, increased debt could potentially pull them deeper into a poverty trap.
Starting in the early 2000s, researchers began to conduct randomized evaluations to contribute rigorous evidence to this debate. Seven randomized evaluations have assessed some of the most pressing and important questions about microcredit:
- What is the impact of access to microcredit on financial behavior, business activity, and household welfare?
- Do borrowers’ investments translate into increased income?
- Does access to microcredit help empower women or increase household investments in education or health?
Demand for many of the microcredit products was modest.
In Ethiopia, India, Mexico, and Morocco, when MFIs offered loans to eligible borrowers, take-up ranged from 13 to 31 percent, which was much lower than partner MFIs originally forecasted.
Expanded credit access did lead some entrepreneurs to invest more in their businesses.
In Bosnia and Herzegovina and Mongolia, access to microcredit increased business ownership. All but one study showed some evidence of expanded business activity, but these investments rarely resulted in profit increases.
Microcredit access did not lead to substantial increases in income.
Despite some evidence of business expansion, none of the seven studies found a significant impact on average household income for borrowers.
Expanded access to credit did afford households more freedom in optimizing how they earned and spent money.
Six studies suggest that microcredit played an important role in increasing borrowers’ freedom of choice in the ways they made money, consumed, invested, and managed risk.
There is little evidence that microcredit access had substantial effects on women’s empowerment or investment in children’s schooling, but it did not have widespread harmful effects either.
Microcredit did not lead to increases in children’s schooling in the six studies in which it was measured, and only one of the four studies that measured women’s empowerment found a positive effect. Across all seven studies, researchers did not find that microcredit had widespread harmful effects, even with individual-liability lending or a high interest rate.
Microcredit access increased business ownership in two of the seven studies
If their main goal is poverty reduction, donors should facilitate, but not finance, standard microcredit lending.
While the seven studies summarized in this bulletin show that traditional microcredit can be a useful financial tool, there is little evidence to suggest that it leads to substantial improvements in income or social well-being. As the microcredit industry has grown and raised private capital, many international development donors have reduced or stopped subsidizing microcredit institutions. Given that microcredit has not led to transformative impacts on poverty, donors and private investors interested in increasing the social impact of credit could use philanthropic money to encourage the design, piloting, and testing of more flexible credit products (see third policy lesson). Donors and governments should also focus their efforts on creating supportive regulatory frameworks for financially viable and responsible product offerings for the under- and unbanked.
Microcredit may not be the best instrument to improve business profitability, but it can be an important tool for increasing people’s freedom of choice in deciding their occupations and managing their finances.
In Bosnia and Herzegovina, India, Mexico, Mongolia, and Morocco, access to a microloan enabled some entrepreneursto start, expand, or invest in new assets for their businesses. Yet those investments did not translate into significantly higher profits or income. These results do not imply that microcredit institutions and banks should stop offering credit, or that credit is not an important financial service for the poor; they instead suggest that conventional microcredit alone should be neither the primary nor only instrument used to promote entrepreneurship.
Rather than increasing profitability or household income, the seven studies suggest that microcredit may be most effective as a mechanism to improve people’s freedom of choice in how they earn and spend money. Financial freedom has many facets, including the ability for individuals to decide their occupation, make household spending decisions, finance larger purchases for their homes or businesses, refrain from selling off assets in times of crisis, and better manage risk. Across various contexts, microcredit has managed to expand financial freedom in all these ways. The lack of transformative impacts on poverty should not obscure these more modest, but potentially important effects. The rapid growth and unprecedented reach of the global microcredit industry points to the fact that low-income families around the world value credit as a tool that can help them better manage their complex financial lives.
Piloting and testing more innovative credit products may lead to greater impacts on poverty.
Despite their success in numbers, microcredit institutions could innovate more. Piloting lending models that more closely match the cash flow needs of borrowers may prove more transformative. Traditionally, microcredit has emphasized the importance of small loans, short repayment periods, and immediate and frequent repayment. These terms may limit the types of investments the loans can finance. Recent evidence shows that small tweaks to loan features can make a big difference (see Product Design on page 12 in the bulletin "Where Credit is Due"). In India, adjusting repayment schedules allowed poor businesswomen to start more businesses, invest more in them, earn more profit, and increase household income, though the product would not initially be commercially viable. And in Mali, rearranging microcredit cash flows to match agricultural seasons increased farmers’ investments in their land.
These results point to opportunities for more nuanced investment by providers and donors in piloting, testing, and scaling new credit models. As these new products may not be immediately commercially viable, the donor and nonprofit community could play an important role in supporting products that could improve the impact of credit on the lives of the poor. Finally, more evaluation is needed to better understand how credit products affect different types of borrowers to help inform consumer protection regulation and MFIs’ and banks’ targeting strategies.