The Microfinance Trap?
Image Credit: Flickr / Christopher

The Microfinance Trap?

 
 

Much has been made in recent years of the potential of microloans and the positive impact they can have on the economies of Southeast Asia. For example, The Diplomat ran a story a few months back on Indonesia, a country suffering from staggering levels of unemployment among its young people, a group that often has difficulty in obtaining the necessary capital to build and expand small businesses.

Certainly, there are plenty of positives associated with microfinance, despite the growing shadow over the industry over the past year. Microfinance promotes social mobility and gives even the poorest of individuals a small chance to break out of the cycle of poverty. In addition, the payback rate of the loans is remarkably high.

Still, it would be naive to believe that the reason for the boom in the industry is based solely on altruistic objectives – lending institutions have cashed in on microloans. The primary reason for the high payback rates is because private lenders usually step in to prevent the borrower from defaulting with microfinance institutions directly. This is an under-reported phenomenon, but was the subject of an article on microfinance in Cambodia in the Asia Sentinel. The article noted:

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‘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.’

The article goes on to detail 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 said that ‘90 percent of microloans are used to finance current consumption rather than to fuel enterprise.’ This underscores the dire prospects of many poor individuals in the global south who perceive a quick influx of cash as a way of satisfying their hunger or quenching their thirst for the week, rather than investing in a long-term solution. In many remote regions of the developing world, the major question is not ‘what will I eat today?’ but, rather, ‘will I eat today?’

The spike in suicides amongst borrowers further underscores the perilous situation created by the debt trap. Moreover, the successes that 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 collection of farmers or basket weavers turning handsome profits. At the risk of merely piling on top of a growing list of critics, I’d still say more scrutiny is needed of the microfinance sector before any claims of success can be extrapolated from a few compelling stories.

At the very least, the microfinance sector could use some regulation. In order for poor borrowers to maximize the benefits that microloans can provide, it might be useful for an independent body or perhaps a non-governmental organization to provide supervision and guidance. Perhaps then, more tangible benefits can be realized from microlending.

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