The traditional microfinance model has had limited impact on the income and productivity of borrowers. More innovative and flexible lending models can boost entrepreneurship and welfare.

A growing body of research shows adapting and relaxing aspects of the traditional microfinance model improves the effectiveness of loans and increases positive effects on the lives of borrowers. Using community networks to identify productive borrowers and lending for activities beyond entrepreneurship, such as supporting migration during ‘lean seasons’, can lead to substantial welfare gains.

Microcredit is frequently touted as an effective policy tool to fight global poverty. In 2006, Muhammad Yunus and the Grameen Bank won the Nobel Peace Prize for pioneering microcredit, elevating its global profile. Over the past 15 years, the microfinance industry has been estimated at $60–100 billion with 200 million clients (World Bank, 2015). The industry has successfully targeted female clients and made credit available to them, while achieving overall repayment rates exceeding 90% (World Bank, 2017). Microfinance has been acknowledged globally as an effective approach for making credit accessible to the poor and unleashing their productive capacities.

However, multiple large-scale experimental evaluations have found no evidence that the classic microfinance product increases borrower income or production (Kaboski and Townsend, 2011; Banerjee et al., 2015). This is true for both joint and individual liability loans (Giné and Karlan, 2014; Attanasio et al., 2015). This brief presents results from new International Growth Centre (IGC) and non-IGC research on the traditional microfinance model and variations on this model – such as more flexible loans and lending for purposes beyond entrepreneurship – and discusses the impacts these models have on the lives of borrowers.

Key messages

  1. Traditional microfinance typically has small and uncertain effects on borrower welfare. 
    Recent literature shows the average effects of access to microcredit on welfare indicators are small and uncertain, with a moderate to high probability of zero impact.
  2. Flexibility can boost entrepreneurial activity but also increase risk‑taking and defaults.
    Research shows some simple changes to loan contract design could significantly
    enhance the effectiveness of microfinance. However, there is an important caveat of higher default rates being associated with more flexible contracts.
  3. Screening borrowers using local information can lead to better targeting and improved welfare. 
    The knowledge friends, family, colleagues, and local leaders have about one another can be highly predictive of clients’ marginal returns to capital and can be used for improving microcredit products.
  4. Broadening the use of microcredit beyond entrepreneurial activities could increase economic activity and borrower welfare.
    Microcredit has the potential to be used for a broader variety of purposes such
    as supporting borrowers to migrate, find jobs, or smooth consumption during difficult seasons. Recent studies show lending for such purposes could lead
    to increased household welfare.