Study Contests Micro-Lenders’ Effectiveness

Micro-lending programs reach a “tiny” number of the low-income entrepreneurs they target and are burdened by operational inefficiencies, a three-year USC research project has found.

A report on the findings, titled “Microcredit Programs in the U.S.: The Challenges of Outreach and Sustainability,” will be presented at a public policy conference in Washington on Friday and published in this month’s issue of the Harvard Business Review.

Micro-lending programs have quadrupled in number over the last eight years and gained popularity among policymakers as community development tools. Programs lend between $500 and $25,000 to spur small-business development. They generally target low-income individuals with the notion that entrepreneurship is a path out of poverty.

The USC study stresses that some micro-credit programs are indeed effective, but it aims a harsh critique at them overall. Programs examined by researchers made an average of just 25 loans per year--implying that only 10,000 borrowers are served yearly nationwide--and most programs had difficulty finding credit-worthy applicants. Many borrowers were not living below the poverty line and so did not demonstrate the greatest need, the study found.

Furthermore, more than 30% of programs that were lending in 1996 had gone out of business two years later, and the “vast majority” were dependent on external subsidies. Recruiting by many programs was weak, they were slow to disburse funds, and criteria to determine credit-worthiness were too conventional, the study found.

“We need to be cautious about advocating more loan programs--something that the development community and policymakers have fallen in love with,” said Nitin Bhatt, executive director of USC’s Business Expansion Network and the study’s lead author. “The money is [already] there. We have to figure out why the money is not being used.”

Bhatt, public policy assistant professor Gary Painter and public policy associate professor Shui-Yan Tang examined 16 California micro-credit programs, interviewed 300 Los Angeles-area micro-entrepreneurs and reviewed national studies highlighting the industry’s successes.

The U.S. industry was modeled 15 years ago on the Grameen Bank of Bangladesh. That Third World program, along with Accion International in Latin America and BRI Unit Desas in Indonesia, has seen near-perfect repayment rates by poor residents, who are traditionally considered terrible credit risks.

But many early micro-credit programs here failed to take into account competitive pressures, higher costs, the need for business training and other complexities of the U.S. economy.

The study called for financial sponsors to support only those programs with track records. It urges micro-credit programs to offer technical assistance to borrowers and to consider alternative evidence of credit-worthiness such as landlord references and car payments. Programs also should adopt more stringent operational standards to become more self-sustaining, it said.

“Micro-credit still is a potent intervention for low-income communities . . . if the intervention is delivered in the proper fashion,” Bhatt said.

Responses to the study were mixed.

The industry clearly faces self-sufficiency issues, said Mark Pinsky, executive of the Philadelphia-based National Community Capital Assn. But he added that research by his organization, which represents 44 community development loan funds, has found that money is getting into the hands of the neediest people. Pinsky questioned whether California micro-lending organizations are representative of those of the nation as a whole.

The industry is already evolving to include technical assistance and financial literacy training for micro-entrepreneurs instead of focusing merely on lending, said Catherine Marshall, executive director of the Oakland-based California Assn. for Microenterprise Opportunity, which represents 125 organizations, about 30 of them with micro-loan funds.

“We certainly encourage micro-enterprise organizations to use micro-lending as a tool, but when you just look at micro-credit organizations themselves, and there’s no technical assistance involved, then usually you do have problems,” she said.

Added Roberto Barragan, acting executive director of the Valley Economic Development Center in Van Nuys, which operates five micro-loan funds: “I think there’s been a shakeout in the industry, and those micro-lenders that remain are working.”