The Market as a Measure for Microfinance

> Posted by Elisabeth Rhyne

Many thanks to David Roodman for bringing people’s attention to an argument that I have been making for years: that measuring microfinance’s impact is far more complex than finding a one-to-one correspondence between a given loan and a client’s subsequent economic status.

I’d like to take the discussion a step further and consider why this message has been so hard to get across to donors and investors, researchers, and the general public. First, let’s look briefly at the main points.(If you disagree with any of them, I hope you’ll read the longer excerpt on David’s blog, or the chapter available here of The New World of Microenterprise Finance, on which it’s based.) Here they are:

• The causal links between receipt of financial services by individual borrowers and their subsequent economic growth are affected by many factors, finance being but one part of a complex process of decision making by enterprises and households. Clients use finance for a variety of purposes: protection against bad times, facilitation of efficient business operations (liquidity), and financing of investments. And they face a wide range of external forces, like competition, markets, health, weather, security, etc. The effect of finance is not likely to be as clear-cut as the effect of these other factors. Evaluations tend to strip out the richness of these dimensions.
• The service-client relationship is best measured by a market test of demand, or the willingness of clients to pay. If people pay full cost for a service on an ongoing basis, then evaluators can be sure that the service is valued at least as highly as its price.
• Microfinance has been all about building institutions, and more important, about building financial systems that serve low-income people. At the level of the institution, the strong test is commercial viability.
• These two market tests, which are interdependent, make finance programs “self-evaluating.” They provide information that is highly reliable (voting with feet rather than answering an interviewer’s question) and what’s more, cost nothing to collect.
• Financial services should be valued more for their general enabling effects across whole economic sectors as much as for the direct change induced by individual loans. This view argues that the far reaching and long lasting goal of microfinance is to build the capacity of the financial system to serve all people who need financial services.

Why do these arguments encounter so much resistance? I can think of several reasons:

• Short-term measures of economic impact are as seductive as short-term profits. Our society places supreme value on the sound bite and the short-term solution.
• As David pointed out, NGOs are under constant pressure to make that one-to-one heart-connection for their donors. “A $100 loan enabled Juanita to buy a potter’s wheel and so transform her life.” At ACCION, we have logged thousands of such microenterprise success stories. But just as often, the loan may tide Juanita over six weeks when she has no income, enable her child to stay in school when another relative working in the shop gets sick and she needs a pair of hands, or keep the house heated through the winter until business picks up. Complex stories are difficult to tell in donor brochures, and “institution-building” does not excite the emotions of most people.
• The argument that “the market is the measure” leads some people to conclude that microfinance practitioners are afraid of impact studies or don’t want to put in the hard work. While sophisticated, in-depth studies that account for the nuances outlined above can be valuable, they are far too costly for most MFIs, themselves, to conduct. On the other side of the coin, discounting the value of the demand test bespeaks a patronizing assumption that poor people using a responsibly-delivered product don’t know what’s best for themselves.
• There is concern that a market test implies a free-for-all in which clients return because they are in debt traps. Only a market that is operating responsibly can provide a true test of the value of microfinance. That is why a strong commitment to client service and client protection, ensuring that microfinance continues to produce value for clients, is crucial to the sustainability of the industry. That, in turn, is why we are strongly backing The Smart Campaign, a global, industry-wide effort to institutionalize client protection principles.

A sustainable microfinance industry that continues to attract and serve customers and demonstrate profitability and growth is passing the tests that matter most. Strong, widely diffused measures of client protection, combined with market discipline, will keep microfinance on a path of sustainable growth and so provide the justification that backs up these market tests.