Small loan science

IN 2006, the Nobel Peace Prize was awarded to the “banker to the poor.” Muhammad Yunus was recognized for his work in the field of microfinance, helping self-employed people who would not be approved for a regular bank loan gain access to funds in order to increase their business and improve their fortunes.

Yunus’ idea has grown and spread around the world. According to the 2011 annual report from the Microcredit Summit Campaign, microfinancing institutes had nearly 200 million clients by 2009, many of them from countries where as much as 80 percent of the population did not have a bank account.

Though there are several highly trumpeted success stories, determining the true impact of microfinancing is challenging. To assist in the process, the June 10 issue of the journal Science includes a microfinance model American economists say could be used to evaluate the impact of numerous small loans on the local economy, and which can be duplicated across study conditions and settings for more accurate comparisons.

Biggest lesson

“The biggest lesson we see here is one of process, and of shedding ourselves of preconceived notions on what credit is for,” said Yale economics professor and study coauthor Dean Karlan in a statement. He is the president and founder of the nonprofit organization Innovations for Poverty Action. His coauthor is Dartmouth College economics professor Jonathan Zinman, an IPA research affiliate. Their study is based on a survey of 1,601 “marginally creditworthy” microcredit applicants who went to the Philippines’ First Macro Bank (FMB) between February 2006 and November 2007. The loan amounts on the applications ranged from P5,000 to P25,000, with the FMB standard terms for first-time borrowers in effect.

Randomly selected through the use of credit scoring software they’d developed, Karlan and Zinman noted that the FMB applicants fell into one of two categories: those whose applications had a 60 percent chance of being approved for a loan and those who had an 85 percent chance of approval. The applicants’ credit information and history was entered into the credit scoring software, and after the loan applications had been verified, a fifth of the group did not receive loans.

To understand the impact of loan approval or loan rejection on the applicants, the researchers later surveyed the group to find out how the funding had been used, and whether these results support the use of microfinancing as a means to promote business growth and ease market failures, as well as improve the borrower’s general well-being.

Loan prospects

“Above all, our results highlight the importance of replicating tests of theirs across different settings,” Karlan and Zinman wrote in their study. “Our findings add to a very muddled picture on the impacts (or lack thereof) of microcredit.” For example, they noted, the survey results showed that the extra funds did not increase business size or lead to more employees hired, and having the loans significantly increased some borrowers’ stress levels. Having bank approval also increased the borrowers’ loan prospects in the community; there were reports that others were more likely to informally loan them money, and at larger amounts than before. Finally, the data indicated that the money allowed some people to freeing up household funds set aside for health insurance or similar expenses.

A perspective article in the same issue of Science said that the report from Karlan and Zinman indicates that microcredit loans may serve a slightly different purpose than expected. “The irregularity and insecurity of income is as challenging a problem for the poor has having low income,” wrote New York University economist Jonathan Morduch. “It is likely that helping poor families borrow and manage cash flow—reliably, flexibly and for a range of uses—will end up being the truly big idea behind microcredit.”

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