The Economics of Microfinance

Beatriz Armendáriz

Jonathan Morduch

second edition

The Economics

of Microfinance

The Economics of Microfi nance

The Economics of Microfi nance

Beatriz Armendáriz and Jonathan Morduch

The MIT Press

Cambridge, Massachusetts

London, England

Second Edition

© 2010 Massachusetts Institute of Technology

All rights reserved. No part of this book may be reproduced in any form by any electronic

or mechanical means (including photocopying, recording, or information storage and

retrieval) without permission in writing from the publisher.

For information about special quantity discounts, please email special_sales@mitpress.

mit.edu.

This book was set in Palatino by Toppan Best-set Premedia Limited.

Printed and bound in the United States of America.

Library of Congress Cataloging-in-Publication Data

Armendáriz, Beatriz.

The economics of microfi nance / Beatriz Armendáriz and Jonathan Morduch.—

2nd ed.

p. cm.

Includes bibliographical references and index.

ISBN 978-0-262-01410-6 (hardcover : alk. paper)—ISBN 978-0-262-51398-2 (pbk. : alk.

paper) 1. Microfi nance. I. Morduch, Jonathan. II. Title.

HG178.3.A76 2010

332—dc22

2009034760

10 9 8 7 6 5 4 3 2 1

A Georges-Antoine, Mikhaela y Eduardo. Con amor.

To Amy, Leon, Joseph, and Samuel

Contents

Preface to the Second Edition ix

Preface to the First Edition xiii

Acknowledgments xvii

1 Rethinking Banking 1

2 Why Intervene in Credit Markets? 29

3 Roots of Microfinance: ROSCAs and Credit Cooperatives 67

4 Group Lending 97

5 Beyond Group Lending 137

6 Savings and Insurance 169

7 Gender 211

8 Commercialization and Regulation 239

9 Measuring Impacts 267

10 Subsidy and Sustainability 317

11 Managing Microfinance 347

Notes 383

References 409

Abbreviations 439

Name Index 443

Subject Index 449

Preface to the Second Edition

When we started writing this book in 1998, the idea of microfi nance

was already gaining ground. But it did not fully burst onto the global

scene until around the time that the fi rst edition of The Economics of

Microfi nance was published in 2005. The year 2005 marked the United

Nations International Year of Microcredit, a worldwide celebration

that engaged banks, governments, philanthropists and the media. Kofi

Annan, then Secretary-General of the United Nations, lauded the social

promise of microfi nance as “an integral part of our collective effort

to meet the Millennium Development Goals” (United Nations 2003).

In November 2005, The Economist devoted a special supplement to

microfi nance with a decidedly commercial slant. Newspapers,

blogs, and television shows started to cover microfi nance with

greater frequency. The UN year was followed by the announcement

in Oslo that the 2006 Nobel Peace Prize would go to Muhammad

Yunus and Grameen Bank, the most visible microfi nance pioneers.

The Nobel Prize brought even more media attention, investment, and

research.

Microfi nance itself has also been transforming. When we started

writing the fi rst edition, the most comprehensive global count of micro￾fi nance customers totaled 13 million customers. By the time the fi rst

edition went to press, the count had reached 67 million. By the end of

2007, the number had swelled to 155 million, with $5.4 billion invested

in the sector in that year. By the time you read this, the number of

customers may well exceed 200 million. Many are women: the most

recent count shows that women made up 71 percent of the 155 million

customers at the end of 2007 (Daley-Harris 2009).

The expansion of scale and investment has brought new ideas and

new debates. Like the fi rst edition of this book, the second edition aims

to provide an honest reckoning rather than a pure celebration. Most in

the microfi nance sector have embraced the pursuit of profi t, but not

with identical degrees of ease and enthusiasm. If there is one unre￾solved tension that animates those who spend their days working on

microfi nance, it entails how to navigate the trade-offs between maxi￾mizing social impact and building strong, large fi nancial institutions.

It is a healthy tension, but an inescapable one.

New to this edition is a chapter on commercialization. We take up

tensions and debates directly, defi ne fi nancial terms, and give an

empirical assessment of the full fi nancial landscape so far.

The past six years have also seen an outpouring of work on savings

and insurance, much of it framed within the emerging academic fi eld

of behavioral economics. The fi rst edition strongly pointed in the direc￾tion in which the work proceeded, and we’re pleased to describe new

ideas and evidence. Chapter 6, on savings and insurance, is thus con￾siderably bulked up.

Chapter 9, on impact evaluations, has also grown. When we wrote

the chapter for the fi rst edition, we had to conclude that more evalua￾tions should be done—and we awaited them. As we go to press for the

second edition, we can happily report on a handful of excellent new

studies. Perhaps more important, we can report on a set of newly

refi ned evaluation tools based on randomized control trials. The new

results show mixed impacts of microfi nance. Microfi nance advocates

may be disappointed by the lack of stronger results so far, but the evi￾dence should be taken as a prompt to return to basic assumptions with

an eye toward improved solutions.

Apart from these large changes, we have taken the chance to update

data and describe new studies in nearly every chapter. Chapter 7 on

gender and microfi nance has been particularly revised, refl ecting the

importance of women among microfi nance customers—and as agents

of social change in their families and communities.

As with the fi rst edition, familiarity with economics will help,

and we use mathematical notation where it clarifies arguments, but

the main points can be understood without the math. We have

especially tried to make the book engaging for undergraduates and

graduate students in economics and public policy (and have fully

updated the exercises at the end of each chapter; as before some are

written for advanced economics students with a desire for analytical

challenge).

x Preface to the Second Edition

We were pleased to fi nd that microfi nance practitioners and policy￾makers found useful discussion in the fi rst edition. In response,

the second edition is even more focused on drawing analytical

lessons that extend outside the bounds of classrooms and seminar

rooms.

Beatriz Armendáriz

Jonathan Morduch

Preface to the Second Edition xi

Preface to the First Edition

Microfinance is one of those small ideas that turn out to have enormous

implications. When Muhammad Yunus, an economics professor at a

Bangladesh university, started making small loans to local villagers in

the 1970s, it was unclear where the idea would go. Around the world,

scores of state-run banks had already tried to provide loans to poor

households, and they left a legacy of inefficiency, corruption, and

millions of dollars of squandered subsidies. Economic theory also pro￾vided ample cautions against lending to low-income households that

lack collateral to secure their loans. But Yunus vowed to one day make

profits—and he argued that his poor clients would pay back the loans

reliably. Today, Muhammad Yunus is recognized as a visionary in a

movement that has spread globally, claiming over 65 million customers

at the end of 2002. They are served by microfinance institutions that

are providing small loans without collateral, collecting deposits, and,

increasingly, selling insurance, all to customers who had been written

off by commercial banks as being unprofitable. Advocates see the

changes as a revolution in thinking about poverty reduction and social

change, and not just a banking movement.

The movement has grown through cross-pollination. Muhammad

Yunus’s Grameen Bank has now been replicated on five continents.

Approaches started in Latin America have found their way to the

streets of El Paso and New York City; experiments in Bolivia have

given birth to institutions in Uganda and Azerbaijan; and policymakers

in the world’s two most populous countries, India and China, are now

developing their own homegrown microfinance versions. Recognizing

the energy and activity, the United Nations designated 2005 as the

International Year of Microcredit.

This book is about the ideas that have driven the movement. It is

also about lessons that the movement holds for economics and, more

specifically, for thinking about why poor people stay poor—questions

that, at some level, go back to Adam Smith’s inquiry into the wealth

and poverty of nations. Microfinance successes force economists to

rethink assumptions about how poor households save and build assets,

and how institutions can overcome market failures. In telling the story,

we draw on new developments in economic theories of contracts and

incentives, and we also point to unanswered questions and ways to

reframe old debates.

There is a great deal already written on microfinance, both by prac￾titioners and academic economists, but the two literatures have for the

most part grown up separately and arguments have seldom been put

into serious conversation with each other. Both literatures contain valu￾able insights, and both have their limits; one of our aims in this book

is to bridge conversations, to synthesize and juxtapose, and to identify

what we know and what we need to know. In this way, this book is

both retrospective and prospective.

Combining lessons from the classroom and the field is natural for

us. Armendáriz, apart from contributing to the theory of banking in

her academic role, founded the Grameen Trust Chiapas in Mexico in

1996, the first replication of the Grameen Bank in Mexico. While writing

this book, she devoted much time to the Chiapas project as it went

through major reorganizational changes. At the same time, Morduch

was carrying out research in Bangladesh, advising projects at Bank

Rakyat Indonesia, and analyzing financial data he had helped collect

in Chinese villages.

We have been thinking about this book since 1998, when Morduch

was visiting Princeton University and Armendáriz was visiting the

Massachusetts Institute of Technology. Our common concern at the

time was that our respective field experiences in Asia and Latin

America did not seem to accord well with the growing theoretical

literature, with its focus on group lending contracts to the exclusion of

most else. Broader ideas were needed to create workable microfinance

institutions in sparsely populated areas, in urban areas, and in the

Eastern European countries that were making the transition from

Communism to capitalism. Even in the densely populated rural and

semi-rural areas where microfinance had first taken root, we saw a

variety of mechanisms that were already at work and that economists

had so far ignored. This prompted us to undertake our first joint project,

“Microfinance Beyond Group Lending” (Armendáriz and Morduch

2000).

xiv Preface to the First Edition