Microfinance Around the World: The Promise and the Evidence

How small loans to poor entrepreneurs became a global movement, and what careful studies later found about their real effects.

Microfinance means providing financial services, such as small loans, savings accounts and insurance, to people too poor to be served by ordinary banks. Its best-known form is microcredit: loans that may be worth only a few dozen or a few hundred dollars, often given to women running tiny businesses. For a time, microcredit was celebrated as perhaps the most powerful tool against global poverty. The story of how that belief was tested is one of the most instructive in development economics.

A movement is born

In the 1970s, economist Muhammad Yunus began lending small sums to poor villagers in Bangladesh, eventually founding the Grameen Bank. Its loans were typically given to small groups of women who met regularly and whose members were responsible for supporting each other’s repayment. Repayment rates were reported to be very high, which seemed to show that the poor were creditworthy after all. Yunus and Grameen shared the Nobel Peace Prize in 2006.

By then, microfinance had spread across Asia, Latin America and Africa, reaching well over one hundred million borrowers. Some lenders remained nonprofit, while others became profit-seeking companies, a few of which went on to list their shares on stock markets.

Putting the promise to the test

Early success stories were often based on comparing borrowers with non-borrowers. But people who choose to borrow may already be more energetic or entrepreneurial, so such comparisons can exaggerate the benefits. To solve this, researchers ran randomized studies in which microcredit was introduced in some randomly selected neighborhoods and not others. In 2015 a leading economics journal published six such studies from Bosnia and Herzegovina, Ethiopia, India, Mexico, Morocco and Mongolia.

Their findings were strikingly consistent. Access to microcredit did help some people start or expand businesses and gave households more flexibility in managing their money. But on average, it did not produce the large increases in income, consumption, schooling or women’s empowerment that advocates had promised. The researchers described the effects as modestly positive but not transformative.

How a small loan is actually used

Consider a vegetable seller who borrows 200 dollars to buy stock in bulk at a lower price. If her profit rises by 10 dollars a week, the loan helps, even after interest. But her neighbor borrows the same 200 dollars and uses it to pay a hospital bill after a sudden illness. That loan does not grow a business at all, yet it may still be valuable, because it keeps the family from selling its goat or pulling a child out of school. Studies found that many microloans are used in both ways, which helps explain why average business effects were smaller than hoped.

Risks and the shift to broader inclusion

Microfinance also carries risks. Interest rates are often high, partly because lending tiny amounts is expensive to administer. When many lenders compete in the same area, borrowers can take loans from several at once, leading to over-indebtedness. A crisis in the Indian state of Andhra Pradesh in 2010, amid reports of aggressive collection practices, showed how quickly things can go wrong.

Today the field talks less about microcredit alone and more about financial inclusion: safe places to save, affordable insurance, and digital payments through mobile phones. Evidence suggests that simple, secure savings tools can be especially valuable for poor households, whose incomes are often irregular.

Swinging from hype to dismissal

After the randomized studies, some commentators declared that microfinance does not work at all. That overcorrects. The evidence shows it is not a cure for poverty, but it can still be a useful financial service that gives households more choices. The honest lesson is to match expectations to evidence, not to replace one slogan with another.

Key takeaways

Microfinance offers small loans, savings and insurance to people excluded from ordinary banking.
Muhammad Yunus and the Grameen Bank popularized group lending to poor women.
Six randomized studies published in 2015 found modest, not transformative, average effects.
High interest rates and multiple borrowing can lead to over-indebtedness.
The field has broadened toward financial inclusion, including savings and mobile money.