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Microcredit may have opposite results than perceived

June 11, 2011 - Washington

Micro-credit, which involves giving small loans to very small businesses in an effort to promote entrepreneurship and reduce poverty, might not be an efficient tool in promoting business growth or improving the lives of its beneficiaries, a new research has found.

Instead, it might have just the opposite effect.

A study of microloans conducted by economists Dean Karlan of Yale University and Jonathan Zinman of Dartmouth College conducted among nearly 1,000 small business owners and entrepreneurs in the Philippines, has found contrary results.

They found that the loans did not generate bigger businesses, higher income, or greater subjective well-being for the recipients, but instead, the loans led to fewer businesses and a lesser sense of well-being. However, the practice did result in stronger risk management.

"This study suggests that microcredit works through complex mechanisms that are not entirely understood, and it's clear that we can't set policies and make decisions based on our intuition about what microcredit accomplishes. We need a better understanding of how this strategy works, based on sound data and analysis," Karlan said.

Karlan and Zinman developed a new method for evaluating the impact of microcredit lending, working in partnership with First Macro Bank, which made loans to 921 men and women in the Manila area. The team randomly approved loans for a subset of applicants who had been pre-selected based on their credit scores and who were considered "marginally creditworthy," and found that women among them were most likely to benefit from microcredit lending.

The team gave loans ranging from about 100 to 500 dollars, with an average monthly interest rate of 2.5 percent.

However, their surveys showed that the entrepreneurs who received loans actually shrank, rather than grew, their number of business activities, and that their self-reported sense of well-being (including life satisfaction, self-esteem, optimism and stress levels) did not improve, but in fact got slightly worse.owever, they also discovered that the loans did provide a buffer against income fluctuations and unexpected expenses, allowing the recipients to manage risk without relying on formal insurance.Rethinking microcredit as a tool for the household, rather than merely as a tool for enterprise growth, is clearly the first step in the right direction to understanding the impacts of microcredit. We hope our methodology can provide a model for others to conduct similar research in other settings and help provide a clearer picture of whether and how microcredit works," Karan added.


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