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What's the Impact of Loan Size in Microfinance?

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(Plus afterthoughts on mission drift and the quality of Bangladeshi microcredit products.)

I recommend reading David Roodman’s blog from last Wednesday about framing a “bottom line” verdict on microcredit. I was particularly interested in his concluding observations:

…[W]hile high-quality impact studies are valuable, they can never give us the whole story, for each is a static snapshot. (Often, it should be said, of impacts at low doses, because randomized trials are often performed as MFIs roll out services to new customers, which in microcredit means making those small first loans.) Much of the story of the impact of credit lies in the dynamics of the market, how it evolves over time, as we have just seen here in the United States. You don’t understand those through traditional impact studies.

It also means, by the way, that impact studies ought to report doses and impacts with equal prominence.

Some would argue that USAID’s AIMS impact studies did not successfully screen out selection bias. But my recollection is that the impact that they found (whether truly caused by the microcredit or not) tended to be associated with a series of loans, not just one, let alone the initial MFI loan that is often far below what the client wants and can handle. That doesn’t mean that we should ignore the results of randomized trials that cover 15 or 18 months of entering clients’ experience. But it does suggest that longer-term results, if obtainable, should be a lot more significant.

While we’re on the subject of small initial loans… People tend to see loan size as a rough proxy of client poverty, which appears to be more or less true as long as you say the word “rough” very emphatically. But the first few loans that an MFI makes to a client typically reflect, not the client’s ability to use and repay the amount, but rather the MFI’s risk management policy (i.e. we’ll give the client more serious money only after she’s established a good track record in repaying little—i.e. low risk—loans.) This is one

of several reasons why it is a serious mistake to view increase of average loan size as ipso facto evidence of mission drift in an MFI.

When Compartamos started out, no client could get an initial loan bigger than $50. After some years of great loan collection performance, management decided that they could loosen the reins a bit, and give clients the choice of a range of initial loan sizes, from $50 up to several hundred. Once the new policy was implemented, almost no one chose a $50 loan, and most new clients took the maximum loan size. This produced a big increase in average loan size, which had nothing to do with the poverty level of the incoming clients.

Microloans per 1000 households (or per 1000 poor households) are a lot higher in Bangladesh than anywhere else. Why is the country such an outlier, with some other countries appearing to approach market saturation at much lower levels? And why haven’t we seen more signs of price competition and pressure on profit levels in Bangladesh, given that large percentages of potential clients have access to multiple providers. My speculation is that both of these things may reflect MFI loan size policies that are not well matched with client needs and repayment capacity. Anecdotally, one hears that there are very high levels of multiple indebtedness in Bangladesh. But I’ve seen a couple of studies reporting that in Bangladesh, unlike most other countries, multiple indebtedness has not been strongly correlated with repayment problems. Maybe the MFIs are handing out loans that are too small, forcing clients into the hassle of going to multiple MFIs to borrow an amount that fits their needs and repayment capacities. If I want loans from all three MFIs in town, the fact that one of them charges a little more interest than the others is unlikely to deter me. In an environment like that, one wouldn’t expect to see much price competition.

If any readers have any data bearing on this speculation, I’d be very interested to hear about it.

Category: Payday loans

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