Online Extra: Microlending: It's No Cure-all

An IPO from Banco Compartamos sparked an ideological debate over who best should do microlending. The real question: Does it work?

The initial public offering in April that earned $467 million for the owners of a Mexican lender to the poor, Banco Compartamos (BMOSF), provoked a passionate protest from nonprofit traditionalists around the world. Veteran development experts have argued for years that commercialized microlending inevitably means favoring investors ahead of vulnerable borrowers. "They're money lenders. They're not microcredit," says Muhammad Yunus, who won the Nobel Peace Prize in 2006 for his pioneering work in extending credit to the working poor in Bangladesh.

The debate over capitalism's incursion into microlending, while certain to continue, has the ring of an ideological squabble. Capitalism has proven irresistible as big lenders, investment bankers, venture capitalists, and pension funds grab for a piece of the action (BusinessWeek, 7/9/07) Meanwhile, a central assumption on which both the profit seekers and idealists agree—that tiny loans can lift up the poor—is far from an established fact.

"We're Devoid of Evidence"

There's been an overly enthusiastic rush to declare microlending a successful means to spur broad economic development, an optimism sharply boosted by Yunus' being awarded the Nobel prize last year. In fact, most scholarly and journalistic accounts have been anecdotal and far from conclusive. "We're strikingly devoid of evidence" that tiny amounts of credit lift up poor people as a group, says Dean Karlan, an economist at Yale, who has devoted his career to assessing microfinance.

Much is being made of recent efforts by Karlan and Dartmouth College economist Jonathan Zinman to gain insight into the effects of expanded access to credit. In a 2005 experiment in South Africa, the economists convinced a for-profit lender to the poor, Credit Indemnity & Financial Services, to randomly select 325 people in cities such as Cape Town who had been narrowly rejected for loans. They paid the usual annualized interest rate of around 200% over four months, and the economists tracked them for three years.

The result? The lender saw some profits, and borrowers had more food on the table, better job retention, more spending on transportation to get to work, and a boost in credit ratings.

Still, Karlan is quick to acknowledge the study's shortcomings. Cultures and economic structures vary, as do terms of credit and standards of disclosure. Would microlending by a nonprofit in Bolivia achieve the same results as consumer lending by a profit-seeking enterprise in Cape Town? That's unknown. What of smaller towns in South Africa itself? And what would be the longer-term, lasting effects?

A study published eight years ago by an Asian Development Bank economist, Brett Coleman, now at San Francisco State University, found no impact at all from small loans in 14 villages in Thailand. Of Karlan's own work in South Africa, he says: "It's just one study at one place at one particular point of time with one way of lending. You can't draw broad conclusions."

While economic theory suggests microlending has benefits, "rigorous evidence that shows it happening just doesn't exist," says Jonathan J. Morduch, an economist at New York University. "The evidence is pretty dicey."

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