Can Microfinance Work? How to Improve Its Ethical Balance and Effectiveness by Lesley Sherratt

Can Microfinance Work? How to Improve Its Ethical Balance and Effectiveness, Lesley Sherratt (New York: Oxford University Press, 2016), 256 pp., $39.95 cloth.
doi:10.1017/S0892679416000307

By 2009 the reckless greed of subprime mortgage lenders in the United States had become clear. Housing prices had collapsed by 30 percent or more, and families, unable to keep up with their ballooning mortgage payments, were being forced from their homes. True, borrowers were guilty of poor judgment, but the quest of lenders to make a quick buck was the major factor in creating an ethical and financial disaster. Still, no one was really surprised by their behavior. After all, pursuing profit is what financial firms do.

In contrast to the commercial lending model, one small corner of the financial market is assumed to work on vastly different ethical terms: microfinance. Muhammad Yunus, the Bangladeshi economist awarded the 2006 Nobel Peace Prize, is the most articulate advocate of this alternate financial terrain, promoting microfinance and other “social businesses” that declare allegiance to “double bottom lines,” one social and one financial. Microfinance institutions—the umbrella term for businesses and nonprofits that deliver financial services in underserved, low income areas—aim to earn a profit, but only as a means to serve the poor and reduce deprivation. Yunus’s Nobel Prize in 2006 capped three decades during which microfinance grew from small pilot projects in a handful of villages in the 1970s to the large global movement we see today. The latest surveys count over 200 million borrowers worldwide. The bank Yunus founded, Grameen Bank, alone serves over eight million in Bangladesh.

Microfinance, however, has had a terrible decade. First, the pursuit of profit led a few high-profile institutions to raise their interest rates so high that the distinction blurs between their version of microfinance and what others (including Yunus) dismiss as rapacious moneylending. Second, while the early pioneers sought to bring banking to the unbanked, too many borrowers are, as a result, now saddled with a problem at the other extreme: far too much debt. In markets as varied as Cambodia, Bosnia, Bolivia, and Bangladesh, debt crises have exposed lax lending criteria that have bolstered short-term profit for lenders at the expense of borrowers. Third, recent statistical evaluations have shown only modest average social and economic benefits for microfinance customers—certainly nothing like the rapid poverty reduction that Yunus once boasted. While no one equates microfinance with subprime mortgage lending, today it is harder to see them as worlds apart. The marriage of social and financial concerns is an uneasy one.

Lesley Sherratt, who has qualifications in both finance and ethics, provides a thoughtfully balanced report on the state of this marriage and whether it can be saved. Can Microfinance Work? grew out of Sherratt’s doctoral thesis on the ethics of microfinance, written in the philosophy department at King’s College London, but prior to that Sherratt was a fund manager overseeing global investments. On reading her book, my overwhelming reaction was a sense of regret that it had not been available twenty years ago, at a time when it might still have been possible to avert the crises that eventually befell microfinance. Nevertheless, it is not too late, and the need for “ethical balance” (the term Sherratt uses in the book’s subtitle) remains urgent.

Sherratt is a charitable critic and reformer, not a finger-wagger. She recognizes that microfinance institutions have indeed achieved some truly impressive things. They have set up shop in neighborhoods and villages that are often viewed as too risky or unprofitable by other large lending institutions and businesses. They have created networks of banks that intermediate funds across regions, bringing resources into low-income communities. These institutions have developed reliable protocols to hire and train staff. They provide secure banking services to millions upon millions of underserved people, while for the most part operating by clear rules, on time, and on the agreed upon terms. In short, they have solved the “last-mile problem” of service delivery, a problem that has tripped up many other well-intentioned interventions, not only in finance but also in health, energy, and education. There is plenty worth saving here.

Still, Sherratt describes microfinance as a “double-edged sword.” While social concerns suggest that lenders should charge the poor only a modest interest rate, financial concerns suggest that for institutions to become financially self-sufficient—and thus to grow more quickly and possibly serve more poor people—charging a relatively high interest rate may be required. While social concerns suggest that customers need consumer protections, financial concerns often privilege the quantity of loans over their quality. And while investors are required to fund these social enterprises, is it right for them to reap large financial returns when the institutions turn profits (especially when an institution was started with public funds)?

Sherratt argues that these questions lead to even deeper ones: Can microfinance institutions be trusted to police themselves? And are their interests truly aligned with those of their customers? The fact that these questions have been present from nearly the beginning of the microfinance moment suggests that such alignment cannot be assumed. Indeed, Sherratt takes a chapter to criticize Yunus’s signature contribution: group lending. This idea has been widely lauded as an empowering mechanism through which poor women join together into lending groups to support each other as borrowers and entrepreneurs. But even here reality has been more complicated, and studies show that group lending can sometimes devolve into the coercion of one member by others, with no protection (and sometimes with encouragement) from the microfinance lenders. (In 2002, Yunus in fact pushed Grameen Bank to drop group lending.)

So what to do? Sherratt’s ethical framework for microfinance has two prongs. The first concerns a “duty of care.” Sherratt argues that microfinance lenders have special obligations to protect their customers from harm, even if that harm is self inflicted by borrowers. The second is utilitarian, arguing that practices need to be put in place to ensure that the benefits of microfinance for some customers clearly outweigh the losses for others. We need to work harder to guarantee that there are many more winners than losers.

To go forward, Sherratt argues, lenders must assume a duty of care—and if it is not there naturally, it should be imposed by independent review boards or regulators. Only then might the number of winners be guaranteed to exceed that of the losers. Specifically, Sherratt argues that microfinance lenders should (1) eliminate exploitative interest rates, (2) drop group liability, (3) establish meaningful client protections, (4) make sure that loans are well used (and that they do not, for example, increase child labor), (5) coordinate to avoid oversaturating the economy with small loans, and (6) become far more transparent.

None of these arguments are particularly controversial, though there is plenty of room for debate. (Why drop group liability everywhere? When do interest rates become “exploitative”?) But step away from the specifics, and Sherratt’s overarching insight is that, more than anything else, microfinance advocates need to be far more humble. That holds for other social business as well, where the presumption is that social commitments can successfully tame financial imperatives. Microfinance has shown that it is insufficient to merely want to do good.

—JONATHAN MORDUCH
Jonathan Morduch is professor of public policy and economics at the Wagner Graduate School of Public Service at New York University and coauthor of Portfolios of the Poor: How the World’s Poor Live on $2 a Day (2009).