Measuring the Impact of Microcredit and Interest Rate Sensitivity in the PhilippinesPDF version
Microcredit, or the practice of providing very small loans to the poor, often with group liability, is an increasingly common tool intended to fight poverty and promote economic growth. But microlending has expanded and evolved into what might be called its “second generation,” often looking more like traditional retail or small business lending where for-profit lenders extend individual liability credit in increasingly urban and competitive settings. The motivation for the continued expansion of microcredit is the presumption that expanding credit access is an efficient way to fight poverty and promote growth. Yet, despite optimistic claims about the effects of microcredit on borrowers and their businesses, there is relatively little empirical evidence on its impact.
First Macro Bank (FMB) is a for-profit lender that operates in the outskirts of Manila. A second generation lender, like many other Filipino microlenders, FMB is a for-profit bank offering small, short-term, uncollateralized credit with fixed repayment schedules to microentrepreneurs. Interest rates at this bank are high by developed country standards, at 63 percent APR on its standard loan for first-time borrowers.
The borrowers sampled in this study are representative of most microlending clients; they lack the credit history or collateral which are needed to borrow from formal financial institutions like commercial banks. Most clients are female (85 percent), nearly all are well educated, having finished high school (93 percent), and are wealthy compared to local and national averages (average household income of US$770 per month). The most common occupations among clients are in the service sector, such as hair dressing, barbering, tailoring and tire repair. They also include small grocery stores and food vending, which serve as important commercial and social venues in their communities.
Researchers, with FMB, used credit-scoring software to identify marginally creditworthy applicants, placing roughly equal emphasis on business capacity, personal financial resources, outside financial resources, personal and business stability. Those with scores falling in the middle comprised the sample for this study, totaling 1,601 applicants, most of whom were first time borrowers. They were randomly placed in two groups: 1,272 accepted applicants served as the treatment and 329 rejected applicants served as the comparison. These rejected applicants could still pursue loans from other lenders, but it is unlikely they obtained one due to their marginal creditworthiness.
Approved applicants then received loans of about 5,000 to 25,000 pesos (US$200 to US$1,000), a substantial amount relative to the borrowers’ incomes. Loan maturity was 13 weeks, with weekly repayments, and the costs of monitoring and administering the loans were small relative to the amounts being lent. Several upfront fees combine with the interest rate to produce an annual percentage rate of around 60 percent.
Data was collected on business condition, household resources, demographics, assets, household member occupation, consumption, well-being, and political and community participation approximately one year after the application process was completed.
Impact on Borrowing: Being randomly assigned to receive a loan did affect overall borrowing: the probability of having a loan out in the month prior to the survey increased by 9.6 percentage points in the treatment group relative to comparison.
Impact on Business Outcomes: Accepted applicants used credit to change the structures of their business investments, resulting in smaller, lower-cost, more profitable businesses. So while business investments did not actually increase, profitability did increase because the capital allowed businesses to be reorganized. This happened most often by shedding unproductive employees. One explanation is that increased access to credit reduced the need for favor-trading within the community, and clients no longer felt the need to employ friends and relatives.
Additionally, borrowing households substituted away from labor for their businesses and into education for their children, choosing to invest in their family’s human capital, rather than in capital specific to their businesses. They also substituted away from formal insurance into informal risk sharing mechanisms, suggesting that increased access to formal credit complements, rather than crowds-out local and family risk-sharing mechanisms. Because microentrepreneurs with access to credit have more places to turn for formal and informal credit, they may rely less on formal sector insurance.
Treatment effects were stronger for groups that are not typically targeted by microcredit initiatives; male, and relatively high-income, borrowers saw the most benefit. This suggests that the groups typically targeted for poverty alleviation by microcredit programs- lower income women, may not be benefiting as much as was previously thought.
