I recently read Why Doesn’t Microfinance Work: The Destructive Rise of Local Neoliberalsim by Milford Bateman. First, I’d implore any individual who believes ‘new wave’ microfinance reduces poverty to read this book. Second, I was surprised to learn how many microloans are actually used to smooth over consumption spending (in the absence of income) and not for an ‘income-generating’ activity, as so many of use who make a loan through Kiva like to believe. Bates cites a September 2007 article published in the Harvard Business Review by Steve Beck & Tim Ogden, which reads as follows:

Many heads of microfinance programs now privately acknowledge what John Hatch, the founder of FINCA International (one of the largest microfinance institutions), has said publicly: 90% of microloans are used to finance current consumption rather than to fuel enterprise.

In response and adapting to client needs, microfinance instituions are now designing products that are increasingly flexible and provide their clients instant liquidity – through a ‘top-up’ feature –  to manage their consumption spending and protect against financial shocks. For instance, if a microfinance client has borrowed $100 and over the course of the loan term has repaid $50, but needs $50 for school fees or what not, they can ‘top-up’ their loan, drawing down the $50 already repaid and increasing their total loan balance back to $100.  This is a dramatically simple example and does not account for any transactional fees or the time value of the client’s money or any obligatory savings. So, while this is valuable in the sense that the microfinance client has liquidity to manage their consumption spending and protect against financial shock, it opens the door for ‘on demand’ access to credit.

In addition, the group liability model pioneered by Muhammad Yunus (which is baked into the design of many financial products around the world) is coming under serious scrutiny. While studies show that the shift away from the group liability to individual liability model does not negatively impact the repayment rate, it certainly is a paradigm shift in the borrowing psychology of an individual who is no longer accountable to a group of peers.

I view these two shifts in the landscape of microfinance as a slippery slope and tanamount to giving microfinance clients a modern day credit card. As microfinance institutions assume and expect that clients will be responsible with this cash injection, is it possible that these microfinance clients become addicted to this constant accessibility of credit and thus live a life in perpetual debt? This is not say there are some innovative attempts to boost the savings of microfinance clients, such as the products designed by SafeSave. However, I am not confident that commercialized microfinance instituions will design a savings component into their products – especially if it pays to keep clients in a revolving door of debt.

All this said, I couldn’t help but compre these two shifts in the microfinance landscape with the modern landscape of cash advance lenders in the USA (or at least in the 37 states that allow them). In the USA there is an incredible demand for quick and easy short-term financing to smooth over consumption (particularly those with irregular incomes). In November 2009, Frontline aired a program called, The Card Game. This program highlighted the demand of cash advance lenders by stating:

Across america, there are twice as many ’payday lender’ storefronts as there are Starbucks. They are not regulated by the federal governemnt, but they lend out over $40 billion a year.

Could this too become the landscape in developing countries saturated with highly competitive microfinance institutions seeking financial sustainability? With a large portion of  a microfinance institution’s revenue coming from the fees (and interest) of clients would constantly ‘top-up’?

I may be a bit negative in saying this, but no matter how transparent financial instituions become, or how financially literate people become, when offered ‘flexible-on-demand’ access to credit, 9/10 times people will always take a hit.