In 2006, Bangladesh professor and banker Muhammad Yunus won a Nobel Prize for implementing an unusual practice in the world of finance: microcredit lending. Microcredit lending involves loaning small amounts of money at very low interest rates and without collateral to impoverished people with the goal of eradicating poverty. Some of the loans Yunus made went to entrepreneurs looking to start or expand businesses, like basket weaving, food preparation and auto repair.
Since then, microcredit lending has been touted as a huge success. Filmmakers and journalists have shown entire Third World villages transformed by microcredit from muddy wastelands to thriving centers of productivity. Sociologists especially praise microcredit for improving the lives of women, as access to credit has raised their social status and generated employment for them. Dozens of banks and non-profit institutions have joined the microcredit revolution in recent years, providing billions of dollars worth of small loans to those seeking to improve their economic situation.
However, a new study by economists at Yale University and Dartmouth College reveals that microcredit loans made to entrepreneurs may not be as beneficial as once thought. While microcredit lending was observed as providing some advantages for borrowers, they were not the advantages usually associated with microcredit lending. Researchers discovered that the loans did not lead to increased patronage at borrowers’ businesses, greater income, or an improved sense of well-being for borrowers as expected. In fact, borrowers experienced less business growth and a decreased sense of well-being.
The study, conducted in the Philippines, followed nearly 1,000 entrepreneurs and small business owners
who borrowed money to start or expand businesses. The research team, working with First Macro Bank, randomly approved loans for a group of applicants considered most likely to benefit from the loans: those labeled by the banking industry as “marginally creditworthy.” Applicants were pre-selected based on their credit scores. They received loans ranging from $100 to $500 at 2.5 percent interest. Within 22 months of granting the loans, researchers surveyed recipients to determine the outcome.
Researchers found that recipients, instead of increasing their business activities, actually reduced them. Borrowers also reported feeling slightly less secure and less satisfied, and more stressed and more pessimistic since obtaining the loans. However, researchers also uncovered a previously unknown benefit to microcredit lending: better risk management. Business owners who received the loans were able to protect their ventures from income fluctuations and unexpected expenses, sometimes eliminating the need for expensive insurance. The loans also increased borrowers’ access to other forms of credit, such as financial assistance from family and friends.
Through studies like these, researchers say they wish to provide insight into microcredit lending’s true function and benefit using clear economic data and analysis. Such insight is necessary for developing policies to govern microcredit lending so that it can continue functioning as a tool to eradicate poverty. Based on the results of this study, the researchers conclude that perhaps microcredit lending is best reserved for improving households instead of businesses.
The study, by authors Dean Karlan and Jonathan Zinman, can be found in the July 10 issue of the journal Science .
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