Responsible Finance Forum

Policy Bulletin: Where Credit Is Due

27 February 2015
Source:  Innovations for Poverty Action

Seven randomized evaluations from around the world show that microcredit does not have a transformative impact on poverty, but it can give low-income households more freedom in optimizing the ways they make money, consume, and invest.

From its beginnings as a lending experiment in Bangladeshi villages in the 1970s, microcredit—providing small loans to underserved entrepreneurs—expanded rapidly in the 1990s and 2000s, and now serves over 200 million clients worldwide. Traditionally, financial institutions excluded the poor, finding it too costly to make small loans to borrowers without credit histories or collateral. Yet through the expansion of group-liability lending, community-based banks, and new repayment models, microfinance institutions (MFIs) and banks have brought credit and other financial products to the poor on an unprecedented scale.

Throughout its history, microcredit has been both celebrated and vilified as a development tool. It was initially embraced by policy makers, donors, and funders as an important financial product to help small-scale entrepreneurs invest more in their businesses, increase profits, earn additional income, and potentially lift themselves out of poverty. Yet as microcredit gained widespread support, some questioned the validity of these claims. Early critics noted that reports of microcredit’s success were often based on anecdotes or simple before-and after comparisons. Some suggested that expanding credit access could even be harmful. Business expansion is risky,and if entrepreneurs’ investments are not profitable, increased debt could potentially pull them deeper into a poverty trap.

Starting in the early 2000s, researchers began to conduct randomized evaluations to contribute rigorous evidence to this debate. Seven randomized evaluations have assessed some of the most pressing and important questions about microcredit:

  • What is the impact of access to microcredit on financial behavior, business activity, and household welfare?
  • Do borrowers’ investments translate into increased income?
  • Does access to microcredit help empower women or increase household investments in education or health?