> Posted by Alex Counts

During my final years as President of Grameen Foundation and Co-Chair of the Microfinance CEO Working Group (MCWG), I advocated that two papers be written that I had neither the time nor the expertise to do justice to myself.

The first paper was a distillation of lessons for practice from recent studies on the impact of microcredit and microfinance. Many papers that set out to determine whether microfinance worked stumbled on important insights about how it could work better. Unfortunately, those discoveries were buried in papers that people barely read beyond summaries and extracts. A paper that presented these “lessons for practice” in a form that was accessible to busy practitioners could make a big impact, by removing friction from the maddeningly difficult process of using research to positively influence policy and practice.

The second paper I advocated for was one that made the case for how philanthropy and social/impact investing, and more broadly, subsidy, could play a positive role in the microfinance industry today. Such a paper would need to start with making the case that such social investments had any role to play, as the conventional wisdom was settling on the idea that it did not have any.

When Tim Ogden joined a MCWG meeting about four years ago, I was surprised when he responded positively to my plea for some researcher to agree to write the paper on lessons for practice. He later agreed to write it and I helped connect him with a source of funding, the Linked Foundation, an impressively flexible philanthropy based in Santa Barbara. I wrote a blog post about how his openness to ideas from others and to this idea in particular was refreshing. In one of the amusing ironies of my relationship with him, Ogden ended up not writing a paper about “lessons for practice,” but instead the second one I was calling for on the role of philanthropy and impact investing in microfinance (though this paper does touch on the former topic). Fortunately, he has done an excellent job with the paper he ended up writing.

I will start with three quibbles. In an otherwise clear-eyed and accessible analysis of the research literature to date (including both RCTs and other methodologies), he fails to acknowledge the central weakness of the often-made argument that studies have proven that microfinance in general has modest (if any) positive impact on poverty. While the clients of the microfinance institutions being studied are randomized, the choices of the MFIs themselves have been anything but random. In fact, those choices were highly opportunistic and as a result, not especially representative of MFIs in general. The tendency to generalize these findings is actually on quite shaky ground. (For a more complete treatment of the research literature, see this Grameen Foundation report by Professor Kathleen Odell, and for more on my critique on how current research has been characterized, see this post on the Center for Financial Inclusion blog.)

Secondly, when he writes about smart subsidy, Ogden leaves off investments in industry infrastructure such as the Microcredit Summit Campaign, the MIX, the Social Performance Task Force, the Smart Campaign, and Cerise, even though he notes their importance earlier in the paper. (So this may simply be an oversight on his part as he rushed to finish it.)

Lastly, his idea of microfinance failing the “eyeball test” (in terms of villages where microfinance was widely available having significantly improved over a reasonable period of time) suggests that he did not walk around rural Bangladesh in the early 1990s then repeat the exercise twenty years later.

Here are eight of the unique strengths of this paper:

  1. He helpfully puts microfinance in a larger context by acknowledging the fact that it developed a uniquely powerful and global platform for social change. He notes that microcredit is the only social innovation to: (1) reach global scale, (2) build a complete industry infrastructure, (3) tap into commercial capital on multiple continents, and (4) “produce enough profit to generate actual controversy over the returns to social investments.” I have been making similar points myself, so it is good to have Ogden affirming them in his own way.
  1. The paper includes an excellent and accessible analysis of the research literature and also the current role and extent of subsidy in microfinance. He notes that subsidies remain widespread but generally small. He describes the counter-intuitive (and frankly ironic) reality where “for-profit [microfinance] institutions rely more heavily on subsidy than non-profit ones” – the apparent result of recent funding priorities and fads. He cites new research showing the total average subsidy as $26 per borrower, and acknowledges that even this modest figure is inflated due to “the very high subsidies at some commercial institutions.”
  1. He points out that focusing almost entirely on the “average impact” on clients in research studies, which many industry players have done, distorts the findings and their meaning. In his words, “…concluding that microcredit ‘doesn’t work’ because the average impact is modest is wrong.” His point is that simple averages mask important distinctions within a distribution that can make the difference between something that shows great promise and something that does not. He makes the important related point that studying what is going right with the 10 percent of microcredit clients who are already benefitting significantly from current products – the ones on the extreme positive end of the benefit/harm distribution curve – can help us better target existing products and to develop better ones for everyone else. Furthermore, he notes that recent studies are attempting to measure the impact of increased access to microcredit, not the impact “when it is (or was) first introduced.”
  1. He persuasively makes the case that the current business models of microfinance – with their low subsidy and low profitability in many of the largest and most competitive markets – almost ensure that investment in innovation will be minimal. In other words, testing new approaches that build on important research findings will be limited without external support. Ironically, the flight of philanthropy and (to a lesser degree) social investment from microfinance – caused in part by the widespread misinterpretation of recent research – would help ensure that research findings that could lead to improved practice and impact are not acted upon.
  1. He argues that social investment and philanthropy will be critical to spurring innovations in leveraging the global microfinance platform for greater sustained impact. Ogden writes, “Increasing the impact of microcredit will require new products, new operational procedures and perhaps even new business models. Testing these … will almost inevitably lead to higher default rates, higher operating costs and lower sustainability ratios in the short term. Social investors will need to adapt their mindset to drive innovation in microcredit.”
  1. He states what should be obvious to any observer of the industry but is rarely acknowledged: “Raising interest rates enough to generate surplus needed for risk-taking innovation is simply not in the cards for most microfinance institutions.”
  1. The paper argues that the significant opportunity is to leverage findings showing that targeting loans to those “most likely to achieve high returns” and to particular industries holds great promise, but is unlikely to be acted upon given the funding priorities of most donors and social investors.
  1. Another area ripe for social investment is product design. He notes that researchers found that building in grace periods for loan repayment increased positive impact but led to somewhat lower repayment rates, and as a result were cancelled by MFIs as their “social” investors were uncomfortable with the uptick in default rates (even though the product was still profitable). Truly patient capital can make it easier for MFIs and other lenders to absorb short-term losses that come from potentially high-impact experiments like this one.

Before this review grows longer than the paper itself, let me conclude with a simple observation. The conventional wisdom about two related subjects – the meaning and implications of microfinance research and the optimal role of subsidy – has been deeply flawed for a long time. Tim Ogden has brought some fresh thinking in an accessible format to these issues, and I applaud him for this contribution.

To read Tim Ogden’s paper, “The Case for Social Investment in Microcredit”, click here.

Counts is the President of American India Foundation, the founder of Grameen Foundation, and a founding member of the Center for Financial Inclusion’s Advisory Council.

Image credit: Accion

Have you read?

Considerations for the Pursuit of Financial Inclusion – Beyond Account Access

Part of a Toolbox: Angus Deaton Urges Reconsideration of the Role of RCTs

What Impact Investors Could Learn from Microfinance