How do charities help?

Microfinance organizations generally provide financial services - particularly loans, savings, and insurance - to people who are unable to obtain these services via traditional banking.

Microfinance is different from how it is usually presented. We feel that much discussion of microfinance - particularly microlending - is clouded by commonly held, appealing myths that have little or no basis in reality. Our 2009 blog post, 6 myths about microfinance charity that donors can do without, discusses and debunks myths including "microfinance has been shown to reduce poverty," "microfinance has been shown to work best when targeting women," and "microfinance donations get lent out again and again, and thus leveraged far more than other donations."

One point we feel most donors are particularly misled on is the question of how people use, and benefit from, micro-loans. Microlending is often presented as a way to help people escape poverty by giving them the capital to start or expand small businesses. However, the reality appears more complex: it appears that loans are often used for food, visits to the doctor, and other consumption. This isn't a bad thing - the poorest people in the world face considerable financial uncertainty, and loans may empower them to manage their own lives.1

What are the challenges of finding a great microfinance charity?

There does not appear to be strong direct evidence that microfinance improves clients' incomes (or other measurable aspects of well-being), and the highest-quality studies of microloans in particular do not appear to show strong effects. (See our discussion of these studies on our blog.)

Most microlending institutions do report data on their interest rates and repayment rates, and one take on microfinance is that when clients are taking out loans at relatively high interest rates and paying them back, this itself is evidence that the clients are being empowered (see our discussion with David Roodman of the Center for Global Development). However, in examining microlending organizations, we have generally seen high dropout rates (i.e., many clients seem to pay back their loans but drop out of the program), and have seen some reasons to be concerned that loans can do harm as well as good to the borrowers. (See our discussion on our blog.)

We have developed a set of critical questions both about microlending and microsavings, to get at the question of whether a microfinance charity is benefiting its clients. In searching for institutions with strong answers to these questions, we have found that:

• The large U.S. microfinance charities are rarely clear about what their value-added is.
• To the extent that we have been able to obtain and review their due diligence on partners (most of which is unfortunately confidential), it seems focused on financial performance, with much weaker examination of social impact-related questions. (See also our discussion of the NIgerian organization LAPO as a case study.)
• There is an argument for focusing on financial performance over social impact, in the hopes of creating self-sustaining microfinance institutions and reaching as many people as possible. However, we have concerns about mixing donations with for-profit enterprises, with the possible result that donations end up padding profits (concept; example). We have found that organizations hoping to use donations to start for-profit microfinance institutions are (perhaps for good reasons) rarely willing to share substantive information about their track record.

Another obstacle to finding great microfinance charities is the fact that telling oversimplified stories, and using oversimplified numbers, seems so widespread in the sector. See our posts on the potential difficulty of understanding a microfinance institution's true interest rates and repayment rates.

Recommended organizations

We identified microfinance organizations to contact, completed in-depth reviews of promising organizations, and identified the following recommended organizations:

• Small Enterprise Foundation (SEF), a microfinance institution operating primarily in the Limpopo province of South Africa. SEF shows a strong focus on collecting the information necessary to assess its social impact, including (a) data on how many clients are dropping out of the program (and why), and (b) data on whether SEF is succeeding in its attempt to target people with very low incomes. Nevertheless, we have concerns about SEF's social impact, particularly regarding its substantial dropout rates.
• Chamroeun, a microfinance institution in Cambodia. Chamroeun shows a strong focus on collecting the information necessary to assess its social impact, including (a) data on how many clients are dropping out of the program (and why), (b) data on client satisfaction with the program, and (c) data on whether Chamroeun is succeeding in its attempt to target people with very low incomes. Nevertheless, we have concerns about Chamroeun's social impact, particularly regarding its substantial dropout rates.
• Village Enterprise Fund (VEF), which aims to provide grants (as opposed to loans) directly to extremely poor individuals living in the developing world. It stands out for its clear targeting of extremely poor clients (and data collection to ensure that the targeting is working), addressing a key concern about cash grants. Nevertheless, we are concerned that some of VEF's funds may not reach the intended recipients.

• 1.
  • "Will the real microlending please stand up?" - a summary of this idea, 2 years old (more evidence has become available since)
  • Post on evidence of impact for microfinance - most encouraging effects came from programs not focused on business investment.
  • Conversation with David Roodman about microfinance.
  • More information on how loans are used.
  • Collins, Daryl, et al. 2009. Portfolios of the poor: How the world's poor live on $2 a day. Princeton: Princeton University Press.