Anoothi, 3

rd
Year Eco. Hons
Spandana Case Study: An Analysis
This essay is based on the first randomized Impact evaluation of Microfinance.
Section 1 explains the methodology of the study, Section 2 presents the data
analysis and results, Section 3 presents the Caveats to be considered while
interpresting the results, Section 4 presents some conclusions derived from
the study and Section 5 talks about how some of the problems identified with
respect to MFIs can be addressed.

In a paper named Miracle of Microfinance: Evidence from a randomized evaluation, Abhijit Banerjee,
Esther Duo, Rachel Glennerster and Cynthia Kinnan analyze the first randomized evaluation of the
impact of introducing the standard microcredit group-based lending product in a new market. This study
also follows the households over the longest period of any evaluation (three to 3.5 years after the
introduction of the program in their areas) to trap impacts not only in the short run but also over the
medium run. The results of this study compel us to think about the functional difference that the
microfinance initiatives are making in the target community and whether its time to address this sphere
of developmental finance with less fancy and more caution.
SECTION 1: METHODOLOGY OF THE STUDY
CONSTRUCTION OF THE RCT
Baseline Survey
A baseline neighbourhood survey (2005) was conducted to assess baseline conditions such as household
composition, education, employment, asset ownership, expenditure, borrowing, saving, and any
businesses currently operated by the household or stopped within the last year. However, due to the
absence of census and the urgent need to collect information for stratification before Spandana began
operations, every nth house in the area was chosen such that there were 20 households per area,
instead of a random selection from a household list (total 120 areas). Since there was a lack of rigour in
this sampling, baseline sample was used only for stratication, descriptive analysis and for area-level
characteristics and dropped from subsequent analysis.
Sampling
Sixteen out of the 120 areas were dropped out of the study due to dominance of migrant-worker
households. The remaining 104 areas were grouped into pairs of similar neighbourhoods based on
average per capita consumption and per-household debt, and one of each pair was randomly assigned
to the treatment group for opening of an MFI branch by Spandana. Between 2006 and 2007 Spandana
began its operations in the treatment area.
Endline sample: A comprehensive census of each area in 2007 revealed low rates of MFI borrowing even
in treatment areas. The endline sample, thus, consisted of households whose characteristics suggested
high likelihood of having borrowed: households who had resided in the area for at least three years and
contained at least one woman aged 18 to 55. Spandana borrowers identied in the census were
oversampled, and the results presented below correct for this oversampling so that the results are
representative of the population as a whole. The overall sample size for the endline survey was 6,864
households.
End line Survey 1
Fifteen to 18 months after the introduction of micronance in each area, a comprehensive household
survey was conducted in an average of 65 households in each neighborhood, for a total of about 6,850
households. In the meantime, other MFIs had also started their operations in both treatment and
comparison households, but the probability of receiving an MFI loans was still 8.8 percentage points
higher in treatment areas than in comparison areas (27.1%borrowers in treated areas versus 18.3%
borrowers in comparison areas).
Endline Survey 2
Two years after this rst endline survey, we surveyed the same households once more. By that time,
both Spandana and other organizations had started lending in the treatment and control groups, so the
fraction of households borrowing from microcredit organizations was not signicantly dierent (38.5%)
in treatment and 33%in control). But households in treatment groups had larger loans and had been
borrowing for a longer time period. This second survey thus gives us an opportunity to examine some of
the longer-term impacts of microcredit access on households and businesses.
SECTION 2: RESULTS
To estimate the impact of micronance becoming available in an area on likely clients, there is a focus
on intent-to-treat (ITT) estimates
1
; that is, simple comparisons of averages in treatment and comparison
areas, averaged over borrowers and non-borrowers.
Interpreting the tables:
Each column of each table reports the results of a regression of the form
Y
ia
= + Treat
ia
+X
a
+
ia

where,
Y
ia
is an outcome for household i in area a,
Treat
ia
is an indicator for living in a treated area, and
is the intent-to-treat eect
X is a vector of control variables, calculated as area-level baseline values: area population, total
businesses, average per capita expenditure, fraction of household heads who are literate, and
fraction of all adults who are literate.

Standard errors are adjusted for clustering at the area level and are in parentheses.

1
An intention-to-treat (ITT) analysis of the results of an experiment is based on the initial treatment assignment
and not on the treatment eventually received. This helps avoid non-random attrition of participants from the study
and allows us to account for dropouts in the study.
All regressions are weighted to correct for oversampling of Spandana borrowers and for higher
probability of tracking them.
The tables present values for the Treated area
* is significant at the 10%level, ** at the 5% level,*** at the 1% level
The following text analyses the impact of microcredit on four crucial parameters: Business outcomes,
labour supply, consumption and social outcomes.
IMPACT OF MICROCREDIT ON NEW BUSINESSES AND BUSINESS OUTCOMES
Probability of target households to start a new business
TABLE 1: SELF EMPLOYMENT ACTIVITIES (DATA SET 1)
Has started a
business in the
last 12 months
New
businesses
Femalerun
new businesses
Has a self
Employment
Activity
Number of self
-employment
activities
Endline survey 1 0.009
(0.006)
0.015**
(0.007)
0.0143***
(0.00533)
0.009
(0.022)
0.021
(0.033)
Endline survey 2 0.000
(0.010)
0.00283
(0.0135)
0.0047
(0.00622)
0.023
(0.023)
0.045
(0.040)

Endline Survey 1 results:
In comparison areas, 4.7%of households opened at least one business in the year prior to the
survey, compared to 5.6%in treated areas leading to a difference of only 0.9%or 0.009 which is
not statistically significant (shown in first column).
More new businesses were created in treatment areas overall: 6.8 per 100 households, versus
5.3 per 100 households in control areas leading to a difference of 1.5%or 0.015. With the
calculated t-stat equal to 2.142, the difference is significant at the 5%level.
As Spandana lends only to women, the marginal businesses tend to be female-operated: when
we look at creation of businesses that are owned by women, we nd that almost all of the
dierential business creation in treatment areas is in female-operated businessesthere are
0.014 percentage points more female-owned businesses in treatment than in control areas, an
increase of 55%.
Nevertheless, overall treatment households are no more likely to have a business and they dont
have signicantly more businesses either. (last 2 columns)
Endline Survey 2 results:
There is no significant difference in business creation between the two groups: the point
estimate is virtually zero (the 90%condence interval ranges from 2pp fewer new businesses, to
2.5pp more)
For investment outcomes such as new business creation, business assets acquired in the
previous year the point estimate is very close to zero (however the standard errors are large).

Probability of investment in durables for a business
TABLE 2: SELF EMPLOYMENT ACTIVITIES (DATA SET 2)
Investment in last 12 months
Endline survey 1 391*
(213)
Endline survey 2 134
(207)

Endline Survey 1 results: Treatment households invest more in durables for their businesses. Since only
a third of households have a business, and most businesses use no assets whatsoever, the point
estimate is small in absolute value (Rs. 391 over the last year, or a bit less than a third of the increase in
average MFI borrowing in treatment households). The t-statistic is 1.835 and is hence statistically
signicant at the 10% level.
Endline Survey 2 results: By the second endline survey, there is a decrease in investment of durables in
the treatment group and the difference between control and treatment group is no longer significant
with a t-statistic of -0.65.
Impact on general business status (Assets, Revenue, Expenses and Profit)
TABLE 3: SELF EMPLOYMENT ACTIVITIES (DATA SET 3)
Assets
(stock)
Revenue Expenses Profit
Endline survey 1 598
(384)
927
(1183)
255
(1056)
354
(314)
Endline survey 2 1261**
(530)
266
(527)
530
(547)
542
(372)

Endline Survey 1 results:
Treatment households have more business assets (although the t-statistic on the asset stock is
only 1.56).
The treatment eects on revenues is positive but insignicant. The t-statistic on revenue is just
0.78 and is hence not statistically significant.
The treatment eects on expenses is positive but insignicant. The t-statistic on expenses is just
0.24 and is hence not statistically significant.
There is an insignicant increase in business prots. The point estimate, at Rs. 354 per month,
corresponds to a roughly 50% increase relative to the prots received by the average
comparison household. This is thus large in proportion to prots, but it represents only a very
small increase in disposable income for an average household. The average total consumption
of these households is about Rs. 7,000 per month and an increase of Rs. 354 per month in
business revenues is certainly not going to change the life of the average person who gets
access to microcredit.
Endline survey 2 results:
Businesses in treatment areas have signicantly larger asset stock, which reects the cumulative
eect of the past years during which they had a chance to borrow and expand.
Despite this, their prots are still not signicantly larger, though the point estimate is around
60%of the sample mean (with a t-statistic of around 1.5). The positive increase, nevertheless, is
once again concentrated in the top and bottom tails, although it starts being positive a little
earlier, at the 85th percentile.
Standardized index of business outcomes
TABLE 4: STANDARDIZED INDEX OF BUSINESS OUTCOMES
2

Index of business outcome
Endline survey 1 0.0365
(0.0188)
Endline survey 2 0.0151
(0.0186)

Endline Survey 1 results: Looking at all businesses outcomes taken together, we nd a 0.037 standard
deviation increase in the standardized index of business outcomes, which is signicant at 10% (t-
statistic is 1.94) with conventional standard errors but not once the multiple hypothesis testing across
dierent families of outcomes is taken into account (p-value of 0.17).
Endline Survey 2 results: By the time of the second endline survey, the increase in business outcome of
treatment group moderates and with a t-statistic of just 0.812, the difference between treatment and
control group is not significant.
Note: This is the ITT estimate, and part of the reason it is low is that few households took advantage of
microcredit in the treatment groups (and some did in the control as well). The marginal borrower in the
treatment group may also have fewer opportunities than someone who was interested enough to
borrow in the control group. This does not rule out that the businesses of some specic groups could
have beneted from the loan. To look at this in more detail, we focus on businesses that were already in
existence before microcredit started.
Impact on businesses that existed before microcredit started
TABLE 5: SELF EMPLOYMENT ACTIVITIES (HOUSEHOLDS WITH OLD BUSINESSES)
Assets
(stock)
Investment
in last 12
months
Revenue Expenses Profit Employees Index of
dependent
variables
Endline
survey 1
851
(1083)
1,129
(713)
5,417
(3763)
1,680
(3291)
2206**
(1112)
0.05
(0.0843)
0.0915**
(0.0412)
Endline
survey 2
1,715
(1752)
1,203
(739)
15
(1502)
-3589.2**
(1724)
950
(1160)
0.16
(0.120)
0.0162
(0.0297)




2
Presents the coefficient of a "treatment" dummy In a regression on treatment of an index of zscores of the
outcome variables for each round following Kling, Liebman and Katz (2007)
Endline Survey 1:
For businesses that existed before Spandana expanded, we nd an expansion in sales, inputs
and investment. The overall business index is signicant at 5%(t-statistic is 2.22) and positive.
This is so even after correcting for multiple inference (0.09 standard deviation, with a p value of
0.057 after the correction).
There is an average increase in prots of Rs. 2,206 in treatment areas, which is statistically
signicant at 5% (t-statistic is 1.98) and represents more than doubling, relative to the control
mean of Rs. 2,000. This increase is not due to a few outliers; however, it is worth nothing it is
concentrated in the upper tail (quantiles 95 and above). At every other quantile, there is very
little dierence between the prots of existing businesses in treatment and control areas. There
are 75 businesses above the 95th percentiles, so it is not a handful, but the 95th percentile of
monthly prot of existing businesses is Rs. 14,600 (or $1590 at PPP), which makes them quite
large and protable businesses in this setting. The vast majority of the small businesses make
very little prot to start with, and microcredit does nothing to help them. The nding that
microcredit is most eective in helping already-protable businesses is contrary both to much of
the rhetoric of microcredit and the view of microcredit skeptics.
Endline survey 2:
By the second endline survey, the difference in business outcome between the control and the
treatment group becomes insignificant.
IMPACT OF MICROCREDIT ON LABOUR SUPPLY
TABLE 6: HOURS WORKED OVER THE PAST 7 DAYS BY HOUSEHOLD HEAD AND SPOUSE
Total For self- employment For outside activities
Endline survey 1 3.176**
(1.421)
2.710*
(1.474)
0.466
(1.418)
Endline survey 2 0.991
(1.176)
1.703
(1.583)
0.712
(1.488)

TABLE 7: HOURS WORKED OVER THE PAST 7 DAYS BY TEENAGERS
All Girls Boys
Endline survey 1 1.629
(1.432)
2.076**
(1.046)
0.026
(2.065)
Endline survey 2 0.358
(1.226)
0.440
(0.948)
1.387
(1.521)

Endline Survey 1:
the household head and spouse in treatment households increase their overall labor supply by
an average of 3.18 hours (t-statistic 2.235 and significant at 5 level).
The increase occurs entirely in the households own businesses, and there is no increase in
number of hours worked for wages: those hours may be much less elastic, if the households do
not fully choose them.
Interestingly, we do not nd the increase in teenagers labor supply that is sometimes feared to
be a potential downside of micronance and that was found in the Bosnia study (as the
adolescents are drawn into the business by their parents).
Teenage girls work about two hours less per week in treatment than control areas, and this
dierence is signicant ( t-statistic is -1.98 and is hence significant at 5% level)
Given that there is an increase among adults and a decrease among teens, the overall index is,
not surprisingly, close to zero and insignicant.
Endline Survey 2:
By endline 2, as control households have started borrowing, the dierence between treatment
and control disappears.
IMPACT OF MICRO CREDIT ON CONSUMPTION
TABLE 8: CONSUMPTION (PER CAPITA PER MONTH)
Total Durables Non-
durables
Food Health Education Temptation
goods
Festivals Home durable
good index
EL1 10.24
(37.22)
17.08*
(9.90)
6.50
(31.81)
9.34
(10.18)
-2.86
(9.74)
0.78
(8.59)
-8.817*
(4.89)
11.76*
(6.80)
0.051
(0.057)
EL2 48.83
(51.53)
1.25
(8.579)
-45.45
(46.92)
11.20
(17.88)
21.01
(14.95)
10.40
(12.74)
10.07
(6.61)
5.62
(3.52)
0.013
(0.043)

Endline Survey 1
There is no signicant dierence in total household expenditureseither total or non-durable
per adult equivalent, between treatment and comparison households. The point estimate is
essentially zero in both cases and we can reject at the 5%level the null hypothesis that there
was a Rs. 85 per month increase in total consumption per adult equivalent and Rs. 56 in non-
durable consumption (about 6%of the average in control for consumption, and 4%for non-
durable consumption) increase. Hence, enhanced microcredit access does not appear to be
associated with any meaningful increase in consumption after 15 to 18 months. Of course, this
may partly be due to the fact that relatively few people borrow, and that some in the control
group borrow from another MFI.
There are shifts in the composition of expenditure: column 2 shows that households in
treatment areas spent a statistically signicant Rs. 17.08 more per capita per month, or Rs. 205
per capita over the last year, on durables than did households in comparison areas
3
.
While there was no detectable change in non-durable spending otherwise; the increase in
durable spending by treatment households was essentially oset by reduced spending on
temptation goods and festivals. Together, the average drop in consumption in temptation
goods and festivals is Rs. 21 per capita per month.


3
This is probably an underestimate of the total eect of loans on durable purchases, since this studys measure
would miss anyone who borrowed more than a year before the survey (the survey was 15 to 18 months after the
centers opened) and immediately bought a durable with the loan.
Endline Survey 2
At the time of the second endline, the eects on both total per capita spending and total per
capita non-durable spending are negative with t-statistics around 1.
Spending on temptation goods is still lower by about Rs.10 per month, similar to endline 1,
though the eect is now insignicant.
The eect on festivals is now positive but insignicant.
There is also no dierence on average in durable goods spending in endline 2.
Given that the main dierence between treatment and control households at endline 2 is that
treatment households have been borrowing for longer, this suggests that, in the second cycle,
households in the treatment seem to just repeat the rst cycle with another durable (of roughly
the same size), while households in the control group also acquire a durable.
IMPACT OF MICROCREDIT ON SOCIAL OUTCOMES LIKE CHILD LABOUR, EDUCATION AND WOMEN
EMPOWERMENT
A nding of many studies of household decision-making is that an increase in womens bargaining power
leads to an increase in investments in childrens human capital
4
.
TABLE 9: SOCIAL EFFECTS
Share of children
aged 515 in school
Hours worked per
child aged 515 over
the past 7 days
Share of teenagers
(aged 1620) in
school
Index of
womens
independence/
empowerment
Girls Boys Girls Boys Girls Boys
EL1 0.021
(0.027)
0.008
(0.021)
0.000
(0.003)
0.004
(0.003)
0.012
(0.010)
0.006
(0.012)
0.007
(0.023)
EL2 0.019
(0.025)
0.006
(0.021)
0.001
(0.002)
0.005
(0.003)
0.008
(0.011)
0.004
(0.012)
0.011
(0.021)

Endline Survey 1
Despite a reduction in teenage girls labour supply, the share of children (t-statistic is -0.78 for
girls, 0.38 for boys and hence insignificant) or teenagers (t-statistic is -1.2 for girls, 0.5 for boys
and hence insignificant ) who are enrolled in school remains unchanged.
There is no dierence in the number of hours worked by girls or boys aged 5 to 15.
Because there are many possible proxies for womens empowerment, and many social
outcomes we use the approach of Kling et al. (2007) to test the null hypothesis of no eect of
microcredit on social outcomes against the alternative that microcredit improves social
outcomes. We construct an equally weighted average of z-scores for the 16 social outcomes;
this method gives us maximal power to detect an eect on social outcomes, if such an eect is
present. There is no eect on the index of social outcomes (point estimate .007 standard
deviations). The t-statistic is 0.304 which is statistically insignificant.


4
Thomas, 1990 and Duo, 2003
Endline Survey 2
Nothing major changes by endline 2. The eect of micronance access on the index of women
empowerment is still very small (indeed, slightly negative) and insignicant, and anything but a
small eect can still be ruled out.
Recall that we are comparing households who, by EL2, are equally likely to borrow: the main
dierence by EL2 is that households in the treatment group have had greater access to
micronance for the rst 18 months; this may limit power to detect dierences in the social
outcomes at the community level.
This suggests that there is no prima facie evidence that microcredit leads to important changes in
household decision-making or in social outcomes.
SECTION 3: CAVEATS TO BE CONSIDERED WHILE INTERPRETING/GENERALIZING RESULTS
First, the dierence in micronance take-up between treatment and control areas is low, even
by the rst endline, which raises two issues: it lowers power and precision (though there are a
number of signicant eects), and it means that the impact of microcredit detected is driven by
the marginal borrowersthose who do not borrow when the cost of doing so is high (because
they have fewer MFIs to choose from or do not want to change neighborhoods), but do borrow
when that cost is lower.
Second, the evaluation was run in a context of very high economic growth, which could have
either decreased or increased the impact of micronance.
Third, this is the evaluation of a for-prot micronance model, and not-for-prot micronance
lenders may have larger positive eects if their interest rates are kept low.
Fourth, as Spandana does not provide any complementary services such as business training or
sensitivity education, the study is an assessment of the pure impact of providing loans to
women who may or may not use them for their own businesses (though Spandana does believe
that this is what the money will be used for eventually), and there is an expansion in women-
owned businesses.
Fifth, the study took place in marginal neighborhoodsthose Spandana was indierent about
working with at the outset and the impacts may have been dierent in the neighborhoods they
chose to exclude from the randomization
5
.
The results nevertheless are consistent with three studies that look at similar programs in dierent
contexts
6
.





5
Heckman, 1992
6
Crpon et al. (2013): Study of MFI Al Amanas impact in rural Morocco , Angelucci, Karlan and Zinman (2013) :
Study of MFI Compartamos impact in Mexico, Tarozzi et al. (2013) : study of microcredit impact in Ethiopia
SECTION 4: CONCLUSION
In this segment, I will draw conclusions based on the above analysis and try to back them by reasons.
The demand for microloans is not universal
With the constant emphasis on increasing accessibility and amount of micro loans, it appears that
demand for micro loans in the target community is significant and relatively inelastic. The results from
our study, on the other hand, present a different picture. At the end of three years only 38%of
households, with relatively high propensity to take up a loan, actually borrowed. This result is not
exclusive to the Spandana study. Similar results have been observed in the randomized evaluations in
Morocco
7
, Mexico
8
and a study in rural South India
9
. There is a fairly low take-up rate in all these
dierent contexts despite the incidence of high levels of informal borrowing and the purported benets
of microcredit over these alternative forms of borrowing. In all cases, except when the randomization
was among those who had already expressed explicit interest in microcredit, only a minority of likely
borrowers ended up borrowing.
Reasons:
For a borrower to take up a microcredit, his /her realized rate of return on investment needs to
be greater than the interest rate to service the loan. Thus, a possible reason for this could be
that even though microbusinesses have a high marginal rate of return, most households do not
have a project with the rate of return of atleast 24%, the APR (annual percentage rate) on a
Spandana loan, which in turn does not allow them to start a profitable venture using the micro
loans extended by the MFI.
Another reason why people might prefer to borrow from friends, relatives, or moneylenders
could be due to the greater exibility those sources provide, despite costs such as higher
interest (from moneylenders) or embarrassment (when borrowing from friends or relatives).
Microfinance has no discernible effect on women empowerment
Although microfinance has the ability to empower women, the connection is not straightforward or easy
to make. Just handing money to women and giving them access to financial assets and resources creates
a new set of challenges for women, who now face extra burden to run a business. Thus a possible
reason could be that the money goes directly to women who are often too over-burdened with
domestic and childcare duties to become successful small-time entrepreneurs.
Another argument is that focusing on womens empowerment leads to dilution of efficiency and
sustainability of MFIs, and this results in reluctance to focus on womens empowerment when designing
their systems and programmes.
The biggest cultural constraint on womens empowerment through microfinance programmes is the
culture of patriarchy pervasive throughout Asia. For a woman, it affects the bargaining power and the
ability to make decisions on economic issues within the household, ability to make decisions outside the

7
Crpon et al. (2013): Study of MFI Al Amanas impact in rural Morocco
8
Angelucci, Karlan and Zinman (2013) : Study of MFI Compartamos impact in Mexico
9
Banerjee et al. 2013
household, control over loans, building of social networks, responsibility for household chores, and
power over ones time and physical and emotional health and energy.
Microcredit does not help small businesses in scaling up (improving business outcomes and employment)
and their positive impact is concentrated in only the most profitable of the businesses
Stiglitz developed a model built on the observation that part of the household labour (women and
children) may be essentially non-traded. While there exists a labour market for male labour for women,
the outside labor market is largely missing in most of the developing countries, especially in the rural
areas. Even where the market for female labor exists, the selling price is, in general, much lower than
the buying price, due to the transaction costs that might reect social norms regarding womens
participation in the formal labor market (like Purdah) along with the usual search, information and
monitoring costs (Lopez, 1986, Sadoulet et. al., 1996). The existence of a transaction cost band implies
that many households fall within the band, and the female labor endowment becomes non-tradable for
such a household (i.e., household specic missing market for female labor). This implies that the shadow
wage rate for the non-traded part of the household labor is determined by the complementary
resources available to a household, like land. For a poor household with little land, the shadow wage, in
the absence of microcredit interventions, is very low, possibly close to zero. The availability of
microcredit enables this non-traded part of the labor to be productive.
However, as soon as the labour requirement rises above the labour availability in a household, a larger
loan (i.e. expansion of the business) is likely to change the household from a net supplier of labor to a
net demander of labor from the market. This means that the cost of labor increases discontinuously, as
the opportunity cost of labor is now the market wage rate (in case of a missing market which is
eectively innite, and for a labor market with transaction cost band, it is the buying price which is
much higher than the selling price). The household cannot service a high interest loan if it has to hire
labor from the market. Thus, a household might not nd it protable to expand its scale of activity
beyond a threshold.
Monthly consumption (indicator of overall welfare) did not increase for those who had early access to
microfinance neither in the short run nor in the long run.
This study took place in a dynamic urban environment, in a context of very high growth. Microcredit
seems to have played very little part in such a setting but may have had dierent impacts in other
settings
10
. Nevertheless, microcredit does aect the structure of household consumption. We see
households invest in home durable goods and restrict their consumption of temptation goods and
expenditures on festivals and parties. They continue to do so several years later, and this decrease is not
due to a few particularly virtuous households, but seems to be spread across the sample. Similar
declines in these types of expenses are also found in all the other studies.
Change in labour Supply choices and intertemporal substitution of income
Households that have access to loans seem to work harder on their own businesses while
reducing their labor input elsewhere. Thus, microcredit plays its role as a nancial product in an

10
The Impact of Microcredit Borrowing on Household Consumption in Bangladesh 2012 shows that an increase
in amount borrowed has a positive and significant impact on per capita household consumption
environment where access is limited, not only to credit but also to saving opportunities. It
expands households abilities to make dierent intertemporal choices, including business
investment.
SECTION 5: ADDRESSING PROBLEMS IN THE EXISTING MICROFINANCE MODEL
Addressing the problem of high interest rates
Some policy makers have suggested that interest rate ceilings to ensure access to affordable credit for
poor households. However, Charging prices high enough to cover costs is an essential practice for any
business enterprise that intends to continue its operations beyond the short-term and hence ceilings are
not the solution. Some possible measures to achieve the objective could be:
I. Promoting more competitive markets
Some countries in the region are already showing encouraging results from their efforts to
create a more competitive environment for the microfinance industry. Cambodia has allowed
national and international nongovernmental organizations (NGOs) to operate freely in the
market, helping them increase their outreach. A legal framework was created for licensing NGO
MFIs and helping them transform into regulated financial institutions to offer poor households a
wide range of services. Policy makers opted for a truth in lending law rather than impose an
interest rate ceiling. Together, these measures have resulted in a more competitive industry
that, in turn, has led to lower microcredit interest rates. Microcredit interest rates in the country
have declined from around 10%per month (on a reducing-balance basis) to 3-4%per month (on
the same basis) during the last 5 years.

II. Improving the Physical and Human Infrastructure
High operating costs is a root cause of the high interest rates on microcredit. Simple
infrastructure improvements-such as road links, bridges, and the reliable supply of electricity-
and better human infrastructure will have a positive impact on the operating costs of micro-
lenders. Such improvements also expand economic opportunities for poor households. Policy
makers also need to pay attention to improving infrastructure that specifically affects the use of
new information and communication technology by MFIs, given that such technology can have a
potentially significant positive impact on lenders' operating costs. Human infrastructure
improvements, particularly in primary and adult education and accounting and auditing will also
have a significant bearing on operating costs. For example, better-educated clients reduce costs
to the MFIs. Thus, policy makers need to help develop financial literacy among the poor and
low-income households.

III. Recognizing Innovation and Efficiency
It is essential for MFIs to undertake cost-reducing innovations that can then lead to lower
interest rates. One great example of this is the M-pesa project in South Africa which is
facilitating financial transactions via mobile telephones. In the most common application,
microfinance customers can pay loan installments via telephone by entering a code that
transfers funds from a personal account to the banks account. This significantly reduces
operation and monitoring costs. Similar technologies can be adopted by MFIs.
Tackling low flexibility problem of microloans
Microcredit institutions apply rigid and fixed repayment schedules when disbursing micro credit in order
to reduce transaction costs and to inculcate discipline for better repayment behavior. Microcredit
clients, however, do not typically have smooth income throughout the year. Thus this generates a cash
flow disconnect, and given the presumed liquidity constraints of the typical microcredit client, this is
resolved either through underinvestment, sale of productive assets, or failure to smooth consumption.
Introducing greater flexibility in terms of micro credit can encourage more borrowers to shift from
informal sources of borrowing to MFIs, inducing higher demand for micro-credit. An evidence of the
same was presented by Erica Field, an associate professor of Economics at Harvard University. Field
studied 169 groups of 845 female borrowers in Kolkata who were given loans between $100 and $250 at
an annual interest rate of 22%. What Field found was that women who were offered a 2 month grace
period in repayment had higher profits and more inventory. In other words, there was a clear business
expansion although grace periods brought up the default rate by 12%.
Enhancing the efficiency and sustainability of MFIs, while ensuring gender equality and empowerment
This can be done through:
Understanding and valuing womens activities, strategies, priorities and challenges
Making information available in language that is user- friendly to women
Including women in design plans through participatory research programmes
Integrating gender into core group mobilization for savings and credit
Giving women access to non-financial services, such as involving them in the application process
Recognizing womens talents and giving them loans in amounts that would help them expand a
business and increase its quality through the purchase of superior equipment and materials
Including women in value and supply chains so as to promote markets for services used by
women
Providing smaller loans with quick returns, targeted at productive activity, and making savings
and services available in locations that women frequently access

References:
Miracle of Microfinance: Evidence from a randomized evaluation (March, 2014)
Micronance and Missing Markets (2006)
Understanding and Dealing with High Interest Rates on Microcredit (2006), Asian Development
Bank
Womens empowerment and microfinance, An Asian perspective study (2011)
Does Flexibility in Microfinance Pay Off? Evidence from a Randomized Evaluation in Rural India
(2011)
From Microfinance to m-Finance (2007)