Landmark study on impact of micro credit

Despite mounting evidence on the positive impact of micro credit on low-income households, critics have expressed fear over excess borrowing. Responding to this criticism would require credible evidence on the impact of micro credit.

But such evidence has been difficult to obtain due to the self-selecting nature of micro finance clients and the selection of branch locations by micro finance institutions (MFIs): the profile and progress of a client taking a loan may be altogether different from a non-client. Thus, the difference in indicators between clients and non-clients may not give a proper sense of the net impact of micro finance. 

Against this background, Abhijit Banerjee, Esther Duflo, Rachel Glennerster, and Cynthia Kinnan (all from the Massachusetts Institute of Technology, USA) of Abdul Latif Jameel Poverty Action Lab, South Asia (J-PAL South Asia), managed by the Centre for Micro Finance, designed the first large-scale, randomised trial to address a key question: What happens when micro credit becomes available in a new market?

The trial was launched in 2005 by Spandana, one of India’s largest and fastest growing micro finance institutions, and the results are out.

Spandana identified 104 neighbourhoods in Hyderabad in which they saw potential for a branch and where there was a not very large migrant worker population. These 104 areas were paired off, with one of each pair assigned to the treatment group and the other to the control group, such that each area had an equal chance of being in the treatment or the control group.

In contrast to previous trials designed to gauge the impact of micro credit, Spandana’s trial was randomised such that those in the treatment group (clients) had no apparent reason to be different in terms of profile or trajectory from those in the control group (non-clients). 

Accordingly, differences between indicators for the two groups could be confidently attributed to the treatment, that is, the provision of micro credit. Spandana began operating branches in the 52 treatment areas between 2006 and 2007 and subsequently conducted a survey of each neighbourhood between August 2007 and April 2008.

The household survey exhibited a variety of uses for loans: 30% were used to start new businesses, 22% were intended to increase the asset base of existing businesses, 30% were taken to repay existing loans, 15% were employed to purchase durable goods for household use, and 15% were used to smooth household consumption.

Interestingly, the treatment areas saw 32% more new businesses being opened compared to their control partners, and new business owners in the treatment sectors enjoyed higher profits.

The trial also measured changing spending patterns with regard to durables, non-durables, and so-called ‘temptation goods’ (alcohol, tobacco, gambling, take-out food, etc).

Households that either owned a business or were likely to become entrepreneurs showed a significant increase in the purchase of durable goods, while those households with a low propensity for starting a business showed no increase in expenditure on durable goods.

Facing the large fixed cost inherent in starting a new business, likely entrepreneurs decreased spending on non-durables, while non-entrepreneurs exhibited a significant increase in spending on non-durable goods. 

Perhaps most interesting is the effect of MFI loans on ‘temptation goods’ expenditure: households unlikely to launch a new business showed an increase in ‘temptation goods’ spending in proportion to their increased expenditure on non-durable goods, while likely entrepreneurs reduced their ‘temptation goods’ expenditure by 17%. 

This pattern strengthens the notion of an MFI loan being a ‘disciplining device’, helping households reduce spending in areas that have proven difficult in the past.

While the results of the trial show no discernable effect on women’s empowerment, education, or health, it should be kept in mind that the data only provides short-term findings. Perhaps in the long run, when the investment impacts of MFI loans have resulted in higher spending for more households, advances in education, health, and female empowerment will emerge. 

While more research is required to understand the longer–term effects, the study does show clearly that micro credit allows households to borrow, invest, create and expand businesses to a degree that was previously impossible.

Read the full report on the randomised trial here.

Read a review of the report in The Economist.

Top