Making microfinance count

Having a bank account and credit card seem normal to many people, but for more than 2.5 billion people in the developing world, it is almost unimaginable. 

Excluded from the formal financial sector, they have no access to savings or current accounts, credit or other basic types of financial services.

Ending this exclusion has long been seen as a way of lifting the poorest people out of poverty. Microfinance took off around 30 years ago with the launch of Grameen Bank in Bangladesh, founded by the banker, economist and Nobel peace prize winner Muhammad Yunus, and was based originally on the idea of providing small loans to poor people to enable them to invest in their own livelihoods.

The concept of microfinance has gained widespread support among policymakers, and been lauded for its potential to transform lives and this is what the Sri Lankan Government is attempting to tap into when Prime Minister Ranil Wickremesinghe signed a new Microfinance Act into law this week. But microfinance has also come under closer scrutiny in recent years, with some questions raised about the effectiveness of microloans in particular as a way of combating poverty.

Another difference now compared with 10 years ago is a greater diversity of views of what microfinance should do. Many experts now think the assumption that poor people in developing countries want to invest their way out of poverty made a convenient business case for microfinance, but were misguided because it potentially exposed people to debt they couldn’t repay – and not everyone can be an entrepreneur. This can be seen in Sri Lanka as well, especially in pseudo- microfinance schemes such as Divi Neguma that absorbed huge amounts of public funds but did not result in substantial economic growth. 

These days, microfinance is increasingly diversifying into other instruments such as savings-based vehicles, which better suit the risk-averse. This signals a maturing of the industry, and a move towards a greater number of business models to create a “financial fabric” for developing countries, where there still isn’t much intertwining of financial products. But it also means that the players in this sector increasingly need to find their own place in a more diverse landscape. 

In other words, just offering small loans or savings accounts to whoever wants them isn’t enough: the financial service element needs to be bound up within a social program if it is to achieve lasting positive change. The charitable microfinance organisation Finca, for example, has provided microfinance in the form of “micro-energy” loans, where people in Uganda were able to buy solar-energy systems for their homes, which enabled children to study at night and also helped people to start new business lines, such as mobile-phone charging.

Embedding financial services into specific social benefits like this can deliver positive results faster and on a larger scale than isolated credit is likely to do. Microfinance on its own may not have any explicit social benefit at all: a loan can be just a loan, and nothing more. Bridging this gap is what will make microfinance really count.