Performance Metrics
Microfinance

Microfinance 2.0: different methodology could reshape industry ... A recent paper published by EY advocates for taking a more scientific approach to evaluating the impacts of microfinance programs

Burgess COMMENTARY

Peter Burgess

Microfinance 2.0: different methodology could reshape industry A recent paper published by EY advocates for taking a more scientific approach to evaluating the impacts of microfinance programs

IMAGE Family using laptop ... Microfinance programs have the potential to be an effective driver for poverty reduction and women's empowerment. Photograph: © Scott Stulberg/Corbis

Microfinance needs to evolve. Once heralded as a panacea for poverty, microfinance has been shaken by a number of high-profile scandals, including corruption and the 2010 borrowers' debt crisis in Asia that tragically led to a number of suicides. In some cases people have started to question the very essence of microfinance. But is it time to call it a day on the $70bn plus industry or could we learn from past mistakes and create a more powerful, targeted microfinance model through trial and innovation?

The theory behind microfinance is that women suffer the highest financial exclusion but are sometimes better borrowers compared with their male counterparts. They are more likely to repay loans and, more importantly, to reinvest the proceeds in their family and their children's education. Microfinance products such as credit, saving, insurance and payment services specifically designed for low income clients can increase female borrowers' business opportunities, risk management ability and overall independence — enabling women to be a driver for social and economic growth, and in turn, overcome gender inequality.

There have been successes - microfinance as an industry now supports 200 million clients worldwide, of which over 135 million live on less than $1.25 a day. Small loans provided to the poorest, mainly female, borrowers have often been effective in promoting financial inclusion. But, if it is to survive, the industry needs to learn from its collective failures.

A paper, The Promise Of Microfinance And Women's Empowerment: What Does The Evidence Say?, by Harvard Business School's Dina Pomeranz, published by EY, as part of its longstanding engagement with microfinance and support for female entrepreneurs, advocates for taking a more scientific approach. It argues that, in the evaluation of microfinance's impact, we have to look beyond anecdotal evidence and conduct a rigorous measurement of the impacts of microcredit, microsavings and microinsurance. The results of such assessments should then be analysed from a more business-oriented perspective in order to translate them into concrete improvements. It concludes that microfinance can be an effective driver for poverty reduction and women's empowerment, only if the design and delivery of the products match the actual customer needs.

The paper found that an impact measurement methodology similar to the randomised evaluation methodology used in clinical drug trials could hold the key to improving how microfinance functions in practice. In a randomised control trial (RCT), a specific microfinance program is tested on a target group of people and its effects are compared against a control group with the same on-average conditions in terms of entrepreneurial ability, risk tolerance, motivation or wealth. Members of both the target and the control group are randomly selected.

The most recent RCTs have identified some specific changes or innovations that would have a significant impact. For example a delayed repayment schedule of microloans, a follow-up text message service to encourage deposits and varying the traditional peer group liability model have all been shown to substantially improve microfinance's effectiveness.

The microfinance industry is now beginning to use these insights to introduce more innovative solutions. Mobile banking solutions are already helping the industry to tackle common financial inclusion barriers, such as the cost of the services and overcoming geographic exclusion. And insights from applied behavioural economics, such as savings commitment devices, text message reminders and goal setting, are reshaping the design of microfinance products and, in turn, clients' incentives to save and invest in future growth.

In order to reshape the industry, practitioners and academics must join forces to overcome issues resulting in disillusion. Only then can we pave the way for Microfinance 2.0.

Zaina Ahmed-Karim is partner, financial services assurance, EY in the Netherlands.
Giacomo Folino is financial services advisory, EY in Italy.
Copy on this page is provided by EY, supporter of the finance hub.