Microcredit loans do help, but not in the way we thoughtS

Microcredit institutes like Kiva claim to help small business in the developing world by offering small loans to people who aren't able to get them through the normal channels. Their claim is that these tiny loans help the people who are the most impoverished grow their businesses, and substantially improve their lot. Microfinance expert Dean Karlan has just published a study of the effects of microcredit, and while there are some advantages, they're definitely not what we originally thought.

Microloans have been a contentious issue for quite some time — a status exacerbated by the recent surge in interest thanks to online donations. Criticisms have been leveled at microcredit institutes for problems like high interest rates (getting up to 60% per year) and causing the borrowers to become dependent on repeat loans — which sound remarkably similar to the complaints against payday loans.

Dean Karlan and his colleague Jonathan Zinman undertook a large study of 1600 individuals in the Philippines, randomly giving half of them small loans and tracking the progress of all of them over the next 11-22 months. Rather than seeing the businesses grow, most of them stayed the same size or even shrunk. The microloans didn't generate higher income, and the recipients wound up feeling less confident.

The benefit the researchers did find was that the people they funded had stronger risk management, and their families were better able to weather fluctuations in personal finance and unexpected expenses. They were then able to better rely on informal lending from other sources, and the ties between the individuals and their communities were strengthened.

While this is only one study in one country, it does paint a picture remarkably different from the one that the creators of these programs want us to see, where microfinance leads to small businesses growing stronger and more wealthy. Instead we see businesses stay the same size or even shrink, but cement their places in the community.