Is Micro-Finance as impactful as we think?

At Aegon Asset Management we are curious about the 'impact' of impact investment. We believe it is very difficult, if not impossible, to link the positive social or environmental impact of an activity directly to ‘our’ invested euro. But we also believe that certain activities do in fact have positive, measurable impact, and that therefore it makes sense for institutional investors to direct more invested capital to these activities to generate more of it, while meeting investment requirements of course. Based on anecdotal evidence, many people agree that microfinance is the prime example of a sector that yields impact. But is that really the case? For this chapter from our recently published 2017 Responsible Investment Report we pulled together academic research, notes from our conversation with an academic who is responsible for much of it, insights from the book Poor Economics, and - yes - also some more anecdotal evidence to try and answer this question. #microfinance, #SDG #responsibleinvestment, #sustainablefinance, #inclusivegrowth #sustainability #impactinvestment

Aegon Asset Management has been investing in micro-finance for a number of years. Despite being known as a prime example of impact investment, it is difficult to establish precisely which positive social outcomes micro-finance leads to. Micro-finance has given millions of people access to lending – an impressive “output”. But does that also lead to good ”outcomes” across the board?

For example, does it allow micro-finance clients to escape poverty or achieve a higher standard of living? Does it affect crime, health or education levels? These things are difficult to measure, and are barely documented. On the other hand, there is a lot of anecdotal evidence that micro-finance can have a significant positive impact on individuals’ lives. We are always looking to gain new insights into the impact of micro-finance and, in the course of 2017, we had opportunities to learn more. First, our colleague Anton Kramer, portfolio manager at TKP Investments, spoke with Niels Hermes, an economics professor at the University of Groningen, who has published numerous papers on micro-finance. (Niels is also featured in the interview on Long Term Investing on page 28 of our 2017 RI Report). Second, we continued to collect more ‘anecdata’ from real life case studies. Some of our findings are presented here.

Micro-finance not a silver bullet

In our conversation with Niels Hermes, he observes that originally, in the 1990s, many people saw micro-finance as a panacea, the way to alleviate poverty. “Many people thought of it as a silver bullet,” says Niels. The assumption was that providing very small loans to the poor would eventually allow them to generate stable incomes, manage their money, and in turn stimulate positive development at a macro level, like improving education and health. But, says Niels, “this was mostly based on anecdotal evidence and when people started digging into this, they realized it’s difficult to demonstrate the real impact”. Niels notes that while the number of micro-finance institutions has grown rapidly over the past several years, and a large number of poor people have been able to take out loans, researchers have struggled to capture whether micro-finance has truly had a positive overall impact on economic and social development.

“This was mostly based on anecdotal evidence and when people started digging into this, they realized it’s difficult to demonstrate the real impact”.

Niels refers to a 2014 study that looked at the impact of micro-finance and says that “on a country level, we do see that micro-finance can have a small positive impact on inequality. But it is very difficult to get data and measure exactly what the causality is.” Niels says that, in some instances micro-finance has also been shown to have a negative impact for example, by increasing income inequality (where women are exploited), over-indebtedness or reliance on child labor.

We also reviewed the book Poor Economics, whose authors delve in to the question, does micro-credit work? (“work” meaning, does it transform people’s lives?). They come to similar conclusions. “Unfortunately” they write, “until very recently, there was in fact very little evidence either way” and what was presented as evidence by supporters “turned out to be case studies, often produced by the MFIs (micro-finance institutions, the banks that provides loans) themselves”.

The authors also relate the story of a small scale evaluation program they were involved in, noting, “there was clear evidence that micro-finance was working. People in the neighborhoods served (by the micro-finance institutions that was being studied) were more likely to have started a business... and were actually consuming less, tightening their belts to make the most of the new opportunity. On the other hand there was no sign of a radical transformation”. They add there was no evidence that women felt more empowered, that there was more spending on education and health, or that more children were enrolled in private schools. They also note that, where an impact could be observed, the result was “not dramatic”.

Contrast this with the story of Roshaneh Zafar, who established the Kashf Foundation in Pakistan in 1996. Her goal was to give women in her country access to a better life. Kashf received financing from one of the projects supported by Aegon investments and since then has provided financial products and services to more than 1.7 million clients. Kashf was one of the first to open urban markets in Punjab and is the first and only organization to offer a female-centric health insurance product in Pakistan. “We provide financial products and services to low-income women, essentially those running home-based businesses” explains Roshaneh. “Most earn between USD 3 and USD 5 a day, and they don’t keep cash flow statements or balance sheets.

"Our success has been phenomenal, and there are so many client stories I can share. On the other hand, when I think about women in my country and read the local papers, we still have a long way to go."

Kashf’s approach is very much focused on creating solutions, which has given rise to working with schools. “When a woman earns more, she puts her children into private schools because the quality is perceived to be better than in public schools. So we developed a low-cost private school product. When we did our research, we discovered that finance was not the only need. The schools needed support with management training, bookkeeping, planning, rosters for attendance, and teacher training.” Kashf decided to collaborate with one of Pakistan’s largest private school networks, which designed a special train-the trainer program for teachers. 

“When I set up Kashf’s first strategic plan we expected to reach 1,000 women by 2003, but by 2003 we had actually reached 60,000 women. Our success has been phenomenal, and there are so many client stories I can share. On the other hand, when I think about women in my country and read the local papers, we still have a long way to go.”

So, based on anecdotal evidence, micro-finance appears to have true impact, though according to economists who have attempted to measure the impact, the result is “not dramatic”. Also, they note that if there is correlation it is not clear “which way the causality goes”. To supporters of micro-finance this may sound negative. Still, the Poor Economics authors note that “as economists, we were quite pleased with the results”, given that “the main objective of micro-finance seems to have been achieved – it was not miraculous but it was working”. Observing that more studies are needed they conclude by saying that “in our minds, micro-credit has earned its rightful place as one of the key instruments in the fight against poverty.”

"Micro-credit has earned its rightful place as one of the key instruments in the fight against poverty".

Niels agrees: “Based on current academic knowledge, micro-finance can make a positive contribution to improving the living conditions of the poor, but whether this contribution is positive and significant depends on the type of conditions as well as on the context. Investing in micro-finance is something institutional investors should continue to do. After all, micro-finance also offers diversification benefits, which has potential financial advantages. In addition, by investing in micro-finance you send a clear signal that you also care about social goals.”

"Micro-finance can make a positive contribution to improving the living conditions of the poor, but whether this contribution is positive and significant depends on the type of conditions as well as on the context."

Next steps in micro-finance

In terms of next steps in micro-finance research, Niels is studying how governance of micro-finance institutions affects outcomes. “It’s interesting,” he says, “western companies have improved their governance structures in response to corporate scandals and under pressure from financial markets and regulations. And recently, they have focused more on corporate social responsibility, and social issues. With micro-finance institutions it’s the opposite – they were already focusing on social issues but we need to now get them better organized from a governance perspective. This is where my two areas of interest come together.”

The Poor Economics authors point out that originally it was hoped micro-finance would be a stepping stone for larger businesses, but that - though micro-finance has its benefits - it does not appear to be a good instrument to fund larger firms. They say that “finding ways to finance medium-scale enterprises is the next big challenge for finance in developing countries”.

“A loan allows you to invest in a project, but many people don’t have a project or a small company. Then, savings are much more important."

Niels also believes that the design of micro-finance products could be improved to better cater to the needs of the poor. Until recently, micro-finance institutions mostly offered their clients loans, where – as we now know – it’s hard to demonstrate concrete social benefits. In contrast, there is evidence that access to savings accounts helps improve living standards more. Niels says: “A loan allows you to invest in a project, but many people don’t have a project or a small company. Then, savings are much more important. Starting to save is extremely difficult. Not because income is low but because income is unstable and uncertain. Also, people tend to procrastinate – they delay saving because there are other, more enjoyable, ways to spend your money. This is where product design comes in. Niels would like so-called “nudges” to be used more, referring to the concept popularized by the economist Richard Thaler, who recently won the Nobel Prize. Niels says: “Micro-finance institutions could use nudges to help people start to save. For example, a bank in the Philippines offers savings accounts. If a client wants to buy a motorcycle, she can open a savings account to save for this. When coming to the bank to open the account, she has to bring a picture of the motorcycle. The bank official will then make a jigsaw puzzle out of this picture. Then, each time the client comes to the bank to make a deposit, she gets a piece of the puzzle. The idea is that becoming a regular saver will bring the motor cycle within reach, which encourages the client to keep on saving. This has been shown to be effective in increasing savings among the poor."

More information on our Responsible Investment activities in our RI Report 2017.