In a blog post titled “The Rigidity of Microfinance,” Eva Pereira discusses how the structure of microfinance loans inherently stifle risk-taking among clients:
Compared to loans in developed countries, microloans have far shorter repayment cycles, oftentimes as short as a week. In Field’s 2009 study she analyzed the effects of allowing borrowers a two month grace period before repayments began. The study aimed to find out how borrowers would behave without the looming burden of an immediate debt repayment.
As it turns out, borrowers were more likely to start new businesses or invest in existing ones given the two month grace period. Exactly as they had suspected, with the immediate burden of liquidity gone, borrowers put their money into projects with higher profit expectations. While profits overall were substantially higher, the variability of outcomes increased. The high risk, high return bet did not pay off for all. Baseline default rates went from 3% to 11% after grace periods were introduced.
In an effort to stress the importance of having realistic expectations, Field drew comparisons to entrepreneurs in the first world, where as many as one in three startups fail. The rewards for success may have long term residual value for the proprietor and the community. Under the previous model of condensed repayment cycles, the loans had very little impact on the average incomes of the poor. The liquidity demands of the loans made it risky to invest in entrepreneurial ventures.
This is basically one of the core criticisms of microfinance. Continue reading