On microloans & credit cards

Patriotic plastic chair (“Let’s Reconstruct the Congo!”)

Ah, I have so much to write about after 2.5 months with FINCA in the DRC, and so little free time in which to do it!  But one comment that I’ve been turning over in my mind for some time now is something my father said to me when I was explaining the concept of group microlending to him.  I pointed out that most clients don’t borrow for discrete events, like buying a car or paying for college, but rather take out multiple sequential small loans to finance everything from business activities to children’s educations.  (Granted, many microfinance clients aren’t supposed to be using loans for consumption purposes, but even the social pressure of group lending can’t always prevent this.) My father’s response was that this type of lending sounded much more analogous to owning a credit card than taking out a “traditional” Western loan.  And I’ve been increasingly fascinated with this idea as its implications have sunk in.

Consider the long-dominant narrative of microloans as a pathway out of poverty, now coming up against a more nuanced narrative of microloans as consumption smoothing tools whose efficacy in moving borrowers out of poverty is also dependent on the individual borrower.  (See the end of this post for more on individual variation.)   I don’t actually find these positions contradictory, just varying in their levels of nuance, but for those who do find them mutually exclusive, I think the credit-card-vs.-traditional-loan idea may resolve many of the apparent contradictions here.  “Traditional” loans are usually aimed at smoothing consumption around the type of significant investments that provide positive, and lasting, long-term shocks to income levels.   Borrowing to finance a university education is a good example of this.  Credit card companies, on the other hand, make few claims about their beneficial effects on one’s long-term financial health – and are better served overall when a portion of their customers spend themselves into debt and pay hefty fees for the privilege.   The whole point is to smooth consumption of inexpensive-to-midrange products & services, and few people consider them a substitute for a larger “traditional” loan unless they’ve no other choice.  (Have you discussed putting a $180,000 undergraduate education on a credit card with your friendly local admissions officer? [Hello, Dartmouth, you expensive old dear.] I didn’t think so.)

In short, the “pathway out of poverty” narrative expects microloans to function similarly to “traditional” Western loans, and play a significant investment and capacity-building function on a personal level.  The consumption smoothing narrative, on the other hand, is redefining microloans as something closer to cash-only versions of credit cards.  (Without so many options for punitive fees for defaulters, and with a greater risk of an angry group of Congolese women coming to your house at 6 am to repossess all your plastic chairs as punishment for a missed payment.)  There are a thousand interesting directions one could go with this thought, but what I think it mostly points to is the fact that the formal economic structures of microfinance are still going through a dramatic period of evolution.  There aren’t many Western banks that wake up wondering if their primary product is a mortgage loan or perhaps really a credit card, after all.  And that leads into implications for product design, and the unbanked’s perceptions of and interactions with formal banking institutions, and on and on into what I’m sure will be many future blog posts.

5 thoughts on “On microloans & credit cards

  1. Hey Rach!

    Thanks for the post, very thought provoking!

    I look at consumption smoothing and investment as separate entirely. Investing is obviously straight forward, loans for education or a business, the criteria being that it provides a return. Defining consumption smoothing is perhaps less obvious. Ask yourself this: am I taking out a loan to buy something with money I’ll make in the future (not money from what I put the loan to)? Buying a car is an example where you do this with a traditional loan. Your car is only going to lose value, there’s no return on the investment, but since you know you have future income to pay for it, you buy it now. Credit cards are the same thing, us for smaller purchases and at higher interest rates. So the distinction is less credit cards vs. micro loans (bc a credit card is just a tiny loan) but loans for consumption vs. investment (which is I think what you’re getting at when you ask if a microloan is the same as a credit card).

    And then I think that pathway out of poverty – which I assume means ‘does this alleviate poverty?’ is a separate question. Or it should be, and people aren’t making it one. Why? Because when we talk about poverty all too often we focus on income growth and not the well being implications that it’s only a proxy for.

    What I’m getting at is this: too often the debate focuses on whether the loans are used for consumption vs. investment. Consumption is bad, investment is good, because investment leads in income growth, “the path out of poverty,” But I would argue that if a microfinance loan is used for consumption smoothing, this still has an important impact on well being that improves the lives of the poor. If I can take out a microfinance loan to smooth consumption because of an income shock which enables me to not take my kid out of school, or send my sick sister to the doctor, or not go hungry — my future income may remain unchanged but I’m able to borrow against it to get through tough times. If my consumption shifts due to microfinance (which is what the most recent random eval studies showed) away from alcohol and tobacco and more towards things that matter for well being, then people are better off, even if long run income levels are unchanged.

    Underlying all of this is a reminder to focus on not the income growth itself, but what it is you’re trying to proxy by measuring it. Credit for both consumption smoothing and investment improve the lives of the poor, if you ask me.

    Like

  2. Hey Rach!

    Thought provoking as always. In fact I think my next blog posting is about to pour out :). I think I would state this one a bit differently: “Traditional” loans are usually aimed at smoothing consumption around the type of significant investments that provide positive, and lasting, long-term shocks to income levels.”

    I look at consumption smoothing and investment as separate entirely. Investing is obviously straight forward, loans for education or a business, the criteria being that it provides a return. Defining consumption smoothing is perhaps less obvious. Ask yourself this: am I taking out a loan to buy something with money I’ll make in the future (not money from what I put the loan to)? Buying a car is an example where you do this with a traditional loan. Your car is only going to lose value, there’s no return on the investment, but since you know you have future income to pay for it, you buy it now. Credit cards are the same thing, us for smaller purchases and at higher interest rates. So the distinction is less credit cards vs. micro loans (bc a credit card is just a tiny loan) but loans for consumption vs. investment (which is I think what you’re getting at when you ask if a microloan is the same as a credit card).

    And then I think that pathway out of poverty – which I assume means ‘does this alleviate poverty?’ is a separate question. Or it should be, and people aren’t making it one. Why? Because when we talk about poverty all too often we focus on income growth and not the well being implications that it’s only a proxy for.

    What I’m getting at is this: too often the debate focuses on whether the loans are used for consumption vs. investment. Consumption is bad, investment is good, because investment leads in income growth, “the path out of poverty,” But I would argue that if a microfinance loan is used for consumption smoothing, this still has an important impact on well being that improves the lives of the poor. If I can take out a microfinance loan to smooth consumption because of an income shock which enables me to not take my kid out of school, or send my sick sister to the doctor, or not go hungry — my future income may remain unchanged but I’m able to borrow against it to get through tough times. If my consumption shifts due to microfinance (which is what the most recent random eval studies showed) away from alcohol and tobacco and more towards things that matter for well being, then people are better off, even if long run income levels are unchanged.

    Underlying all of this is a reminder to focus on not the income growth itself, but what it is you’re trying to proxy by measuring it. Credit for both consumption smoothing and investment improve the lives of the poor, if you ask me.

    Like

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