Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
3/10/2011
Chapter 2. How the Other Half Finances
It is not sufficient to stimulate the poor to industry, unless they can be persuaded to adopt habits of frugality. This is evinced amongst many different kinds of artizans and labourers, who earn large wages, but do
not in general possess any better resources in the day of calamity than those who do not gain above half as
much money. The season of plenty should then provide for the season of want; and the gains of summer
be laid by for the rigours of winter. But it must be obvious, how difficult it is, for even the sober labourer
to save up his money, when it is at hand to supply the wants that occur in his family;—for those of intemperate habits, ready money is a very strong temptation to the indulgence of those pernicious propensities.
—Priscilla Wakefield, 18051
If I had my way I would write the word “Insure” over the door of every cottage, and upon the blottingbook of every public man, because I am convinced that by sacrifices which are inconceivably small,
which are all within the power of the very poorest man in regular work, families can be secured against
catastrophes which otherwise would smash them up for ever. —Winston Churchill, 19092
Perhaps you remember when you first heard about microcredit. Did it surprise you that you could help
the poor by putting them in debt? The root of that surprise is that the microfinance movement replaced
of the old story of lending to the poor—usury and the debt trap—with a new one. After all, it seems, the
poor are not so locked in by the lack of money that credit will only stave off hunger for a few weeks,
then leave a residue of hopeless debt. Instead, the poor are masters of their fates, incipient entrepreneurs
who only lack credit to bloom.
There is an irony in this modern myth-making. The microfinance movement has rightly been animated by a belief that the poor are no less creative or ambitious for being poor. But to live up to that
spirit of respect, we ought to minimize our preconceptions about how they use financial services and
how they ought to. Let us define the global rich as the billion or so people who live in relative material
comfort and security. If you belong to this group, you can see that it is diverse. Rich people use financial
services such as savings and loans in diverse ways and experiencing diverse outcomes. The poor are at
least as diverse in these respects. Indeed, some do get trapped in debt. And others, whom we call microentrepreneurs, do borrow money to buy goats or stock their corner stores. But the poor use financial ser-
1
2
Wakefield (1805), 208
Churchill (2007 [1909]), 146–47.
1
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
3/10/2011
vices in other ways. A family might save to prepare for a wedding, buy insurance to dampen the feared
shock of a father’s death, or borrow for antibiotics for an ill son.
It turns out that the poor people in general want financial services for many purposes in addition
to starting a business. If anything, because they live close to the jagged financial edge, the poor need financial services more than the rich. Unfortunately, and inevitably, while the better-off can usually find
services tailored to specific needs, from mortgages to life insurance to retirement accounts, the less fortunate must choose from fewer options, which are often not well matched to the needs at hand. As the
authors of the seminal Portfolios of the Poor have shown, the poor must patch together low-quality services—loans from friends, store credit, neighborhood savings clubs, burial insurance societies—to manage their finances as best they can.3
So let us start our investigation of microfinance from the clients’ points of view. The advantage
of working this way is that it avoids the trap of focusing on just one service, and credit, and just one use,
microenterprise. Instead of asking whether the popular microcredit-microenterprise-escape-from-poverty
story really stacks up, we can look more broadly at the financial problems poor people are trying to
solve, and what services help them most. In this perspective, credit comes out looking both more and
less valuable. On the one hand, it can be used for many things besides enterprise. On the other, alternative financial services can too, and sometimes do so better than pure credit. The richer understanding we
achieve this way is essential the book’s thesis that the goal of microfinance should be provision of useful
financial services to millions of people in businesslike ways.
3
Collins et al. (2009).
2
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
3/10/2011
Summary

The poor use financial services such as credit, savings, insurance, and money transfer to solve
broadly the same problems as the “rich” (including middle-class people rich by global standards).

These include transacting, investing, building assets, and sustaining consumption of necessities.

To these ends, financial services help people accumulate small sums in large ones.

They do this in part by helping people muster self-control.

Poor people need financial services more than reach people. Their incomes are more volatile and
unpredictable, as are their spending needs, mainly for lack of health insurance. Poor people need
ways to set aside money on good days, and in good seasons, and draw it down in bad.

The emphasis on microcredit for microenterprise has some basis in fact: lacking jobs, the poor
more often work for themselves.

But microenterprise is just one use for credit and other financial services, and it is best thought of
as subsistence, not a ladder out of poverty.

Financial services are remarkably interchangeable. A family can use savings, credit, or insurance
to pay a clinic bill.

But they are not perfect substitutes. Sometimes a family takes a loan because it lacks good ways to
save or insure.

Accepting that financial services for the poor will never be as good as those for the rich, the practical question is how to improve those for the poor to help them meet their financial challenges.
How the rich use financial services
The global rich, which probably includes you, can access a spectacular variety of financial services:
checking and savings accounts, home mortgages, car loans, credit cards, mutual funds, insurance for life,
3
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
3/10/2011
car, health, and home. Just as it is hard for a New Yorker who samples a new restaurant each week to
ken the life of the Guatemalan highlander who subsists on tortillas and beans, so is it hard for those who
enjoy a wealth of financial services to empathize with a woman for whom saving means hiding money
from her husband in the folds of her sari.
Despite the gulf in experience, a rich person can gain insight into the poor’s use of financial services by contemplating her own. Try this exercise. List all the financial services you have used. For
each, determine what it helps you do. Transact? Invest? Build a business? Spend money you have not
earned yet? Then confront this question: if you had to give up all these services but one, which would
you keep? Here is my list, which is fairly representative for middle-class American families:
Table 1. My financial services
Service
Purpose
Savings account
Prepare for emergencies such as job loss
Checking account
Transact safely over long distances or in large amounts
Wire transfer
Send and receive money internationally (rare)
PayPal account
Send money to friends; buy things online
Credit cards
Transact without cash; buy things I want before I have the money
Home mortgage
Live in a home I own before I can pay for it
Home equity line of credit Ditto; and cheap credit to improve house
Car loan
Get a car before I can pay for it
Student loan
Invest in my own skills, for higher pay after graduation
Retirement savings
Prepare to support myself when I no longer work
College savings
Prepare to invest in children’s education
Health insurance
Protect family against financial catastrophe in event of serious health
problems; assure access to care
Homeowner’s insurance
Protect family against financial catastrophe in event of serious harm to
home
Automobile insurance
Protect family against financial catastrophe in event of serious harm to
car, or liability for accident
Umbrella liability insurance Protect family from liability suits in general
Life insurance
Protect family against financial catastrophe if I die
Disability insurance
Protect family against financial catastrophe if I am unable to work
If you show your list to a microfinance client (assuming it resembles mine), the luxury will become apparent in the variety and low cost of the services, the college education foreseen, and the home
4
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
3/10/2011
valued in six figures. But if you articulate the needs that underlie your use of these services, you two
might understand each other well. In scanning the list, I discern four major reasons I use financial services. All are universal:
1. To transact. The credit cards and checking account helps me move sums too large to be safe
in my wallet. They also help me remit amounts large and small over long distances. And they
make it remarkably easy: My paycheck goes into the checking account automatically; the
mortgage payment comes out just as smoothly. A swipe of a card at the pump pays for gas.
2. To invest. I borrowed to help pay my college tuition, and I save into a fund to do the same for
my sons. Notably, like most people in rich countries, I have not used financial services to invest in my own business, for I have none. I prefer the stability of the job I am fortunate to
hold.
3. To build assets. Some people ascribe an investment purpose to the home mortgage. But I
bought my house for other reasons. In fact, on general principles, a mortgage-financed home
is a terrible investment. It puts a lot of financial eggs in one basket, violating the principle of
diversification. Using credit to buy the home—investing with leverage—multiplies the risk
because a lot of the eggs are the bank’s and the homeowner is supposed to replace them if
they are crushed. And homes can be illiquid, meaning hard to sell. Why then make such a terrible investment decision? With ownership comes security. Someone who holds title to her
home need not worry about being forced out by a landlord who does view the building as an
investment. Home ownership also strengthens communities by increasing the interdependence: what one neighbor does to her property affects the values of others’. A more collective
view encourages people to work together on local institutions such as schools. And secure
people think longer-term: a farmer is more apt to take care of land he owns than land he leas-
5
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
3/10/2011
es. Finally, as Peruvian economist Hernando de Soto has famously argued, title to a major asset can also serve as collateral for credit.4 I once borrowed against my house to fix the roof,
and could borrow again to help put my sons through college.
4. To sustain consumption. I was struck to discover that most of the services on my list serve to
secure my family’s ability to obtain necessities such as food and clothing through thick and
thin. The savings account is a safety net if I lose my job. Retirement savings should let me
buy what I need after I stop working. Credit cards and the home loans let me make big purchases without starving. The insurance policies take the financial bite out of life’s traumas.5
Economists call this function consumption smoothing. And to respond the challenge I posed
earlier, if I was told I had to live with just one financial service, I would beg for two, and
choose two that smooth consumption: life and health insurance. They protect my family from
bankruptcy in the face of life’s greatest tragedies.
We can learn a few more lessons from this exercise. First, risk is intimately intertwined with
money. Insurance policies embrace risk head-on. But they are not unique in involving it, for whenever
one party to an agreement to provide financial services commits to delivering money under certain circumstances at some future date, there is risk. Perhaps a borrower will not repay, or a bank holding deposits will go under. Second, and related to this, many financial services bind even as they serve. The
mortgage and other loans force me to set aside enough money each month to make the payments rather
than spending it all on more frivolous things. The retirement accounts add inertia to my financial regime
since my employer automatically makes the contributions out of my paychecks. In appropriate doses,
this discipline is healthy; we all need help resisting the temptation to spend now.
4
de Soto (2000).
Perhaps I should also have listed the government insurance programs my employer pays into on my behalf, to aid me when
I retire, or before then if I lose my job.
5
6
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
3/10/2011
Third, what financial services you can use depends on who you are. If I were a poor American,
my financial service inventory would look different. I might not have the steady job that would make me
an attractive risk for lenders. My compensation might not include a retirement plan. I might have trouble
maintaining a minimum balance in a checking or savings account. To borrow a term from the Commission on Thrift, a coalition of U.S. non-profits, the “concierge services” of government-subsidized retirement and college savings accounts would probably disappear from my list of financial services.6 So
might most of the insurance and the checking account. In their place would appear check cashers and
payday lenders extending credit at 400 percent per annum. Just as there are more drugs for male impotence than for malaria, the financial services available to the rich outshine those for the poor—in quality,
diversity, and cost.
This too is worth noting: my wife’s inventory is identical to mine. But in many countries, law
and custom come between women and formal finance.
Perhaps the most important lesson from this exercise is about how financial services, like roads
and piped water, undergird the comfortable life. Imagine living without financial services: no bank accounts, no bank loans, no credit cards, no insurance, not even payday loans…just cash. The importance
of financial services is belied by their intangibility. Their paramount benefit is the last one on my list,
namely, helping people manage and maintain consumption, especially during catastrophes. In the vocabulary of Amartya Sen, financial services give people more agency, more control over their lives.
However, as Sen emphasizes, freedom begets freedom: those who already have more agency, thanks to
being rich or male, say, are able to afford and free to buy more and better services.7 Those who come to
the financial service marketplace with fewer advantages leave with fewer.
6
7
Commission on Thrift (2008).
Sen (1999).
7
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
3/10/2011
The poor navigate rough seas
“The rich are different from us,” F. Scott Fitzgerald once observed. “Yes,” retorted Ernest Hemingway,
“they have more money.”
Actually, that exchange never happened. The story is a bit of Hemingway fiction, a put-down of
his literary rival’s fascination with the lives of the rich.8 But it does capture a real question for us: is
there much difference between being rich and being poor? Do the global rich and the global poor use
financial services in essentially the same ways? I suppose the answer is yes in theory and no in practice.
Broadly, rich and poor are no different: all need to transact, invest, build assets, and sustain consumption. But the financial circumstances of the poor are qualitatively, not just quantitatively, distinct. Poor
households are not just micro-rich ones; and microentrepreneurs are not simply micro-versions of the
iconic entrepreneurs who perpetually roil the capitalist economy. Understanding the distinct financial
challenges of the poor is essential to understanding how microfinance institutions can contribute to economic development.
Here’s one difference: Poor families are more apt to dispatch a member to the big city or to another country for work. That generates a need to transfer money over great distances. Living in 1995–96
in a village in southern Bangladesh served by the Grameen Bank, graduate student Sanae Ito discovered
that the surest way for residents to get out of poverty was to get out of the village. A family would save
up or borrow to send a daughter or son or husband to the capital, Dhaka, to work as a day laborer, and
send money back to the family.9 In Kenya, the wildly popular mobile phone–based money transfer service, M-PESA, got its start with the slogan “Send Money Home.” The target client (and there are millions of them) lived in Nairobi and needed safe ways to remit funds to his parents, wife, and children in
the countryside.10 Villages in many developing countries export workers even farther afield. Mexicans
8
Berg (1978), 304–05.
Ito (1999).
10
Mas and Radcliffe (2010), 9.
9
8
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
3/10/2011
working construction and factory jobs in the United States are sending macroeconomically significant
sums homeward. In Bangladesh, BRAC Bank, a spin-off of the giant non-profit BRAC, has teamed up
with Western Union to turn its branches into money transfer points. Meanwhile, Safaricom, the phone
company that created M-PESA, is working to bypass Western Union by extending its network internationally. (See Figure 1.) Worldwide in 2010, $325 billion was remitted to developing countries. For 21
receiving countries, the flow exceeded 10 percent of domestic economic output, which is a sign how of
economically important the foreign earnings are for many poor families.11
Figure 1. Posters for international write transfer services, Bangladesh and Kenya
(Photos by author)
11
Mohapatra, Ratha, and Silwal (2010).
9
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
3/10/2011
But the rich-poor differences do not end there. Even before migration became the major economic option that it is today, poor households felt fundamentally different financial needs. For the poor are
short of money, yes, but also of control over their financial circumstances. Their incomes and spending
needs are more variable and unpredictable, their lives more dangerous. Perhaps the most important financial distinction between poor and rich—leaving aside the superrich—is that by and large the rich
have salaries. My steady paycheck rivals all my insurance policies in bestowing financial security. It allows me to think long-term, helping me invest in my children; and it makes me more creditworthy, helping me borrow to build up assets. Surveying findings from household surveys done in 13 developing
countries, MIT economists Abhijit Banerjee and Esther Duflo found that what most distinguished people
living on more than $2 a day from those living on less was not education or health, or even wealth, but
holding a steady job.12 To put that another way, as I wrote in chapter 1, most people who live on $2 a
day don’t live on $2 a day: they make $4 one day, $1 cents the next, $3 the day after that, and so on. Or
perhaps their big earnings come once a season, at harvest time.
No work has made this reality clearer to the world’s salaried minority than Portfolios of the
Poor, the 2009 book by Daryl Collins, Jonathan Morduch, Stuart Rutherford, and Orlanda Ruthven. Following a suggestion some ten years ago by the University of Manchester’s David Hulme, detailed financial transaction logs called financial diaries were assembled for a few hundred families in Bangladesh,
India, and South Africa. Typically, a researcher visited a household every two weeks over the course of
the year to update the logs, noting down every income and outflow, every instance of borrowing or saving. Among the stories revealed in the diaries, and in the book, is that of Pumza, who cooks and sells
sheep intestines out of a stall in a Cape Town slum. After netting out her spending on firewood and raw
intestines, Pumza makes $95 a month on average; adding a $25 child support grant brings the monthly
income to $120, which for Pumza and her four children works out to $0.80 per person per day. Hidden
12
Banerjee and Duflo (2008). The authors use purchasing power parities to convert to U.S. dollars.
10
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
3/10/2011
within that average, however, is a great deal of unpredictability and volatility, day to day and month to
month. (See Figure 2.) The human body, however, does not do so well on a diet that alternates between
feast and famine: the children should eat every day. The collision between volatile income and constant
needs creates an intense demand for financial services, ways to set aside money on good days, or good
seasons, and pull it out on bad. At least once when income fell below expenses, for example, Pumza
went to the moneylender for a short-term loan at interest of 30 percent per month. Another time, she
used a payout from a savings club she belonged too (see discussion of ROSCAs at the beginning of
chapter 3). Interestingly, Pumza is also a provider of financial services, if an informal and hesitant one.
To people she knows, she sometimes she sells her wares on credit.13
13
Collins et al. (2009), 40–42.
11
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
3/10/2011
Figure 2. Revenues and expenses of Pumza, South Africa [redo after obtaining data; maybe show
net income]
As if this income volatility wasn’t hard enough, the spending needs of the poor also tend to be
more unpredictable than those of the rich, above all because of health problems. Not only do most poor
people lack health insurance, but disability and death visit their doorsteps more frequently.14 Together,
the cost of pills and doctors and the loss of income when a breadwinner takes sick can undo years of
saving and asset-building, plunging a family into destitution. One day in 1989, recounts Portfolios of the
Poor, a Bangladeshi rickshaw driver named Salil came home to his wife, complaining of a sore throat.
He consulted a series of doctors. To pay them, he sold off his three rickshaws, the capital of his livelihood, one by one. The doctors did not help. Salil ended up in the hospital, was diagnosed with throat
14
On income volatility, see Morduch (1995).
12
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
3/10/2011
cancer, and died within days. Through the period his wife, bereft of income, borrowed to support the
couple and their three small children. His widow and children became the poorest Bangladeshi household in the financial diaries studies.15 Salil’s story may be unusual only in degree. Fifty percent of the
Bangladeshi households experienced illness during the yearlong periods of financial diary collection, as
did 42% of Indian ones. Fully 81% of the households in South Africa, where AIDS is common, were
affected by funerals.16 Again summarizing household surveys, Banerjee and Duflo found that, depending on the country, 11–46 percent of households living on less than a dollar a day had someone who had
been bedridden or had needed a doctor within the last month.17 An ambitious World Bank project to collect and analyze thousands of life stories in 15 developing countries found the second-most-cited cause
of falling into poverty as “health/death shocks and natural disasters,” at 19.4 percent of the time.18
One way families manage risk on the income side of the ledger is diversification. A survey of 27
villages in West Bengal, India, found that households typically had three workers who among them
practiced seven occupations.19 Banerjee and Duflo found that a fifth of urban households in Peru living
on less than $2 a day per person earn from more than one source, as do a quarter in Mexico, a third in
Pakistan, and half in Côte d’Ivoire.20 In the countryside, it is common for people to both work their own
land and work for others. In the extremely poor Udaipur district in the Indian state of Rajasthan, almost
everyone owns and farms some land, but 74 percent of those below a dollar a day earn most of that dollar in day labor.21 Self-employment is common too, found among a quarter percent of similarly poor and
15
Collins et al. (2009), 86–87.
Ibid., 68.
17
Banerjee and Duflo (2007), 149. The poverty line is $1 of household spending per member per day, converted to local currency using purchasing power parities.
18
Narayan, Pritchett, and Kapoor (2009), 21.
19
Banerjee and Duflo (2007), 152. “Typical” figures are medians.
20
Ibid., 152.
21
Ibid., 151.
16
13
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
3/10/2011
rural households in Guatemala and a third in Indonesia and Pakistan.22 Banerjee and Duflo explain the
attraction of working for oneself:
If you have few skills and little capital, and especially if you are a woman, being an entrepreneur is often
easier than finding an employer with a job to offer. You buy some fruits and vegetables or some plastic
toys at the wholesalers and start selling them on the street; you make some extra dosa [rice and bean pancake] mix and sell the dosas in front of your house; you collect cow dung and dry it to sell it as a fuel;
you attend to one cow and collect the milk. These types of activities are exactly those in which the poor
are involved.23
The subtle truth about microenterprise
Self-employment, then, is one natural response to being poor in a poor country. But thanks to the promotion of microcredit, microenterprise became something more in the public imagination: not just one reason the poor want financial services but the reason; not just a way to earn but a way out of poverty. In
fact, the poor do fend for themselves economically more than the rich. But partly because there is such a
strong structural desire within the microfinance world to view the poor as microentrepreneurs, it is hard
to get accurate data on the extent and strength of microenterprise. The process in which a rich investor
finances microcredit for a poor borrower can be seen as a chain with a reality at one end an image at the
other. The investor, say, a user of Kiva, the on-line peer-to-peer microcredit site, might lend money to
one of the “entrepreneurs” listed on the site. The funds would go to Kiva, then to a local microcreditor,
then to a borrower rather like the one pictured on the site.24 That borrower might use the credit for microenterprise…or might not. Somewhere along the chain, the simple image and the rich reality must
come into tension. The more a fundraiser like Kiva promotes the image in order to raise funds, such as
by calling all clients “entrepreneurs,” the more that point of collision is pushed toward the client. Microfinance institutions raising money through Kiva, for example, will understand that they should emphasize entrepreneurship in their own rhetoric. When collecting stories from clients, they will cue their cli22
Ibid., 152.
Ibid., 162.
24
Information about borrowers are posted on Kiva after they get their loans, so the Kiva user’s money goes to someone else.
See blog post, “Kiva Is Not Quite What It Seems,” j.mp/1yAS6n.
23
14
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
3/10/2011
ents in the same way. What clients really do with the credit, which is elusive under the best of circumstances, falls further below the radar of the investor and the intermediaries.
When asked how they use a service, microfinance clients often give the answer they believe is
wanted. They respond this way out of ordinary self-interest; to ignore self-interest is a luxury most poor
people cannot afford. In Bangladesh, a borrower’s husband told anthropologist Lamia Karim with a
smile that “We took a cow loan. Fifty percent will be spent to pay off old debts, and another fifty percent
will be invested in moneylending. If the manager comes to see our cow, we can easily borrow one from
the neighbors.”25 But the fabrication is not always from whole cloth; rather, the fungibility of money
makes it easy for appearance and reality to diverge. What a person appears to use a loan or savings
withdrawal for—appears, perhaps, even to herself—and what it enables her to do can be two different
things. Beatrice, the female half of an entrepreneurial couple in Zambia’s Copperbelt, explained to British researcher James Copestake that, in his words, “the main difference the loans had made over the last
year was in freeing their own capital for construction of their house.” Formally, microcredit went into
the business, but its main effect was to bump the couple’s own capital into additional personal uses.26
The Malaysian writer Helen Todd succeeded better than most in piercing this fog, giving us a rare statistical view of what of microcredit allowed poor people to do. Throughout 1992, she and her husband David Gibbons, who was also studying microfinance, lived amid two villages in the Tangail district of Bangladesh, one of the first regions in which the Grameen credit program operated on a large
scale. With a research team that included Bangladeshis, they tracked the financial and personal lives of
62 women, 40 of whom borrowed from Grameen. The researchers record every loan payment, every sale
of rice paddy, every lease of land. Todd and her team complemented their quantitative data with “qualitative” evidence—hundreds of conversations and observations over the course of a year. Table 2 shows
25
26
Karim (2008), 16.
Copestake (2002), 746.
15
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
3/10/2011
their tabulation of how the 40 borrowers said they would use the credit, in order to obtain loan approval,
and how they actually used it. All the stated purposes were investments. “According to the [Grameen]
Bank records,” Todd writes,
35 of our 40 member sample took loans in 1991/92 for either “[rice] paddy husking” alone or “paddy
husking/cow fattening.” As far as we could tell, only four women did any paddy husking for sale during
the year and that only for limited periods. Two young women who lived in the same bari [homestead lot]
had taken their last few loans for “cow fattening.” Although I was in and out of their bari for seven
months of the year, I never saw hide nor hair of any cows.27
Important, Todd’s data in Table 2 show that there is something to the image of poor women as
microentrepreneurs, even if less than sometimes thought. In Todd’s assessment, four women took loans
for cows, and another two invested in equipment or stock for back-breaking work of grinding the oil out
of mustard seeds. Three more bought rickshaws, presumably for their husbands to use as a source of income. But clearly more was going on. Some women used the loans to pay dowry, breaking a vow they
took as Grameen members.28 Others bought rice. Some improved the roof or walls of their small homes.
In fact a majority did use the credit for what could be called business activities, though not ones usually
thought of as microenterprise: moneylending and the leasing or buying of rice land. Bank policy proscribed land leasing in particular, viewing the rents as usury extracted by landlords, a perspective which
reflects the long and bitter history in South Asia of moneylending and land monopoly intertwining. But
for many families, leasing land was a step up in security and freedom: instead of working someone
else’s land for a daily wage set by someone else, the husband could plant and manage the family’s
“own” field. Once during the research project, Grameen Bank founder Muhammad Yunus visited Todd
and Gibbons, who briefed him on their findings. They urged him to allow land leasing:
Dr Yunus listened but did not commit himself.
“Let’s go to the village,” he said.
…
Professor Yunus questioned Kia [a borrower] about [a new] loan. “Do you want one?”
“Yes, sir!”
27
28
Todd (1996), 25.
The custom dowry makes girls economically burdensome and boys lucrative, reinforcing discrimination against girls.
16
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
3/10/2011
“What will you use it for?”
I saw Kia hesitate for a moment. Then she looked the Managing Director in the eye.
“I won’t lie to you,” she said. “I am going to lease in some land.”29
Table 2. Approved and actual use of Grameen Bank loans to 40 women, 1992
Number of loans
Approved
Rice paddy husking
Amount of loans (taka)
Actual
Approved
Actual
20
73,500
Rice husking/cow
8
46,000
Cow
7
4
42,500
19,300
Mustard oil grinding
4
2
23,000
5,760
Grocery trade
1
5,000
Mustard oil/sweets
1
5,500
Land transactions
20
70,320
Loan repayment
16
24,720
Stocking rice
12
27,134
Lending
7
6,849
Rickshaw
3
6,137
Dowry/wedding
2
5,075
Housing materials
1
4,680
Other/unknown
25,025
Notes: Loans put to more than one use listed more than once. $1 = 40 taka.
Source: Todd (1996), 24.
We see here some basic differences and similarities between rich and poor in how they manage
money. As for the differences, the poor more than the rich pursue strategies that incrementally diversify
and improve their control over their sources of income, which often does include what is called microenterprise. Thus they are indeed more apt to want capital for small, productive investments. Microcredit
can give them capital they would otherwise lack, or substitute for more expensive sources. For example,
the stoolmaker whose plight changed Muhammad Yunus’s life subsisted in virtual bondage to the person
who supplied her with bamboo on credit. (See chapter 4.) Yunus sprung her from that trap by breaking
the supplier’s credit monopoly. As for the similarities, the poor, like the rich, juggle several fairly uni-
29
Ibid., 16–17.
17
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
3/10/2011
versal priorities such as consumption smoothing and investment. And they do so with resourcefulness
and variety that sometimes elude even the managers of microfinance organizations.
It is worth reflecting on how we label people who work for themselves as a matter of survival. In
the 18th and 19th centuries in the British Isles, such people were “industrious tradesmen.”30 Some on the
Continent some saw them through the lens of the labor-capital divide—as workers who could become
small capitalists.31 Today, rickshaws drivers and mustard grinders are often said to be running “microbusinesses.” They are “microentrepreneurs.” This fusion of a silicon-era prefix with a capitalist projection appear to have originated with a volunteer for Acción International named Bruce Tippett in 1974,
not long after “microprocessor” entered currency.32 “Microentrepreneur” is apt in important respects, for
the people so labeled risk their tiny bits of capital, work for themselves, and reap the profits and loss of
their operations. This is the image favored and advanced by Muhammad Yunus:
I believe that all human beings are potential entrepreneurs. Some of us get the opportunity to express this
talent, but many of us never get the chance because we were made to imagine that an entrepreneur is
someone enormously gifted and different from ourselves.33
But “microentrepreneurs” differ from the prototypical rich-world entrepreneur in important
ways. Few of them tap capital markets, innovate, expand, or create jobs. They do not abandon steady
employment in order to launch themselves into bold ventures. Rather, they are quite conservative in investing in themselves. Evidently, living on the edge curtails one’s appetite for risk. An experiment in Sri
Lanka showed that injecting modest additional capital into microenterprises let the owners earn average
returns of an astounding 5 percent per month.34 The same experiment in Mexico generated returns exceeding 20–33 percent per month.35 Why poor people leave these potential winnings on the table by un-
30
E.g., Piesse (1841), 9.
E.g., Wolff (1996), 2, 10, 16, 19.
32
Jeffrey Ashe, Director of Community Finance, Oxfam America, Boston, MA, interview with author, November 26, 2008.
33
Yunus (2004), 207.
34
de Mel, McKenzie, and Woodruff (2008a).
35
McKenzie and Woodruff (2008). Other studies have found similar conservatism among poor farmers in deciding, for example, whether to apply commercial fertilizer. See Morduch (1995), 105.
31
18
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
3/10/2011
derinvesting in their own businesses is not fully clear. They may not recognize the opportunities to sew
more saris or better stock their shelves. They may struggle to pull together the lump sums need to invest.
Or perhaps microbusinesses are like tech stocks: high return on average but also high risk. To reduce
risk, diversify across several businesses (as we saw), not investing too much in any one. Whatever the
reasons, poor entrepreneurs are apparently less venturesome than they could be. All in all, they are not
the agents of creative destruction whom economist Joseph Schumpeter saw as the heroes of economic
development. They undertake—to revert to the root meaning of “entrepreneur”—in order to survive.36
To this extent, labeling them “microentrepreneurs” romanticizes their plight and implies too much hope
for their escape.
A somewhat older and now less fashionable view of poor entrepreneurs, historically associated
with the International Labor Organization, is as victims of economic systems that fail to employ them.
To put this more constructively, since the Industrial Revolution, explosive job creation has powered all
national economic successes. Comprehensive economic development is hard to imagine without increases in jobs. In this view, the people of whom we speak have not benefited from such development.
They are “people without jobs” or “self-employed” or “own-account workers” who heroically, but tenuously, survive their circumstances.37
We do not need to choose between seeing the poor as victims or masters of their own fates.
Those are images, stories. What matters is how poor people put financial tools to work, and how better
tools can improve their lives. If you’ve ever tried to hammer a nail with a wrench, you know that the
right tool makes all the difference.
36
37
de Mel, McKenzie, and Woodruff (2008b).
ILO (1993), §§7, 10.3.
19
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
3/10/2011
How the poor use financial services
Having dethroned one common view of how poor people use financial services—microcredit for poverty-escaping microenterprise—it remains for us to assemble a more realistic view. Once we understand
how poor people go about solving financial problems we can think more clearly about how microfinance
can give them better tools. Perhaps no one is a better interpreter of how poor people manage money than
Stuart Rutherford. A trim man with thin-rimmed glasses and a dusting of white hair, Rutherford loves
nothing more than interviewing people about how they handle their finances. After training as an architect, he became interested in our subject while investigating the effects of the earthquake in Managua
just before Christmas 1972. As in Haiti in 2010, many slum dwellers lost their homes. Yet somehow
they summoned the resources to rebuild rapidly, confounding many foreign aid officials. In his book,
The Poor and Their Money, Rutherford focuses less than I have on the purposes for which the poor use
financial services, and more on the transactions involved. At base, he argues, poor people need financial
services in order to turn small, regular savings into “usefully large sums” that can go toward most of the
purposes I discovered in my inventory: investment, gaining ownership of assets, and managing consumption.38 The last, as we have seen, is essential. As one Bangladeshi told Rutherford, “I don’t really
like having to deal with other people over money, but if you’re poor, there’s no alternative. We have to
do it to survive.”39
Rutherford emphasizes how credit, savings, and insurance all help people summon the discipline
to build usefully large sums. Providers of any of these services can take small, regular payments from
the client—loan payments, savings deposits, insurance premiums—and occasionally make large payouts. As a matter of money flow, the services differ only in when the large sums are paid out. In particular, borrowing and saving are not as opposite as they appear. Rutherford illustrates the kinship with two
38
39
Rutherford (2009a).
Collins et al. (2009), 13.
20
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
3/10/2011
examples he and his research partner Sukhwinder Singh Arora found in the slums of Vijayawada, in
southeastern India. The first example is of savings:
Jyothi is a middle-aged part-educated woman who makes her living as a peripatetic (mobile) deposit collector. Her clients are slum dwellers, mostly women. Jyothi has, over the years, built a good reputation as
a safe pair of hands that can be trusted to take care of the savings of her clients.
This is how she works. She gives each of her clients a simple card, divided into 220 cells….Her
clients commit themselves to saving a certain amount of money, regularly, over time. For example, a client may agree to save five rupees (Rs 5) [about 10¢] a day for 200 days, completing one cell each
day….Having made this agreement it is Jyothi’s duty to visit her client each day to collect the five rupees…
When the contract is fulfilled—that is when the client has handed Rs5 to Jyothi 220 times…the
client takes her savings back. However, she does not get back the full amount, since Jyothi needs to be
paid for the service she provides. These fees vary…but in Jyothi’s case it is 20 out of the 220 cells—or Rs
100 out of the Rs 1,100 saved up by the client in our example.40
Notice that Jyothi does not pay interest on deposits as conventional banks generally do; she charges—at
a rate that works out to 30 percent a year.41 Rutherford asked Jyothi’s clients why they pay so much to
save when stashing cash in a box is free:
The first client I talked to…knew she had to have about Rs 800 in early July, or she would miss out on
getting her children into school. Her husband, a day labourer, could not be relied on to come up with so
much money at one time, and in any case he felt that looking after the children’s education was her duty,
not his. She knew she would not be able to save so large an amount at home—with so many more immediate demands on the scarce cash she wouldn’t be able to maintain the discipline. I asked her if she understood that she was paying 30 per cent a year….She said she knew she was paying a lot, but still thought it
a bargain….[D]wellers in a neighbouring slum, where there is no Jyothi at work, envied Jyothi’s clients.42
Bankers would call Jyothi’s service a “commitment savings account.” By removing a bit of
money from the house each today, Jyothi protects her clients from themselves—from temptation to
spend everything on the needs of the moment—and from children, husbands, and parents pressing for
cash. Jyothi facilitates thrift. Paradoxically, commitment savings ties the client’s hands in a way that
strengthens her control over money and her power in the family. Poor people do have other ways to
save, such as in jewelry and livestock. But thieves can take rings and pigs can die. And such assets are
40
Rutherford (2009a), 16–17.
As discussed below, steady repayments over the loan period make the average balance half the starting balance and approximately double the effective interest rate.
42
Rutherford (2009a), 18.
41
21
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
3/10/2011
inconvenient: as one Indonesian pointed out, “when you have to pay the school fees, you cannot sell the
cow’s leg.”43
In India, Rutherford also talked to clients of a moneylender, whose
…working method is simple. He gives loans to poor people without any security (or “collateral”), and
then takes back his money in regular instalments over the next few weeks or months. He charges for the
service by deducting a percentage (in his case 15 per cent) of the value of the loan at the time of disbursal.
One of his clients reported the deal to me as follows.
“I run a very small shop” (it’s a small timber box on stilts on the sidewalk inside which he squats
and sells a few basic household goods) “and I need his service to help me maintain my stock of goods. I
borrow Rs 1,000 from him, but he immediately deducts Rs 150, so I get Rs 850 in my hand. He then visits
me weekly and I repay the Rs 1,000 for ten weeks. As soon as I have finished he normally lets me repeat.”
This client, Ramalu, showed me the scruffy bit of card that the moneylender had given him and
one which his weekly repayments are recorded. It was quite like the cards Jyothi hands out.44
The similarities with Jyothi’s commitment savings service are striking. The moneylender too uses grids
printed on cards to track payments. Both the savings and credit services operate cyclically, producing
the same predictable rhythm of frequent, small pay-ins and infrequent, large pay-outs.
Perhaps most importantly, both provide discipline. They help people set aside money each day or
week and resist what must be strong temptations to spend or hand over it all. A study in Hyderabad, India, found that offering microcredit reduced household spending on “temptation goods” such as tea and
cigarettes, and increased spending on durable goods such as sewing machines.45 Financial services discipline by both reminding and binding. This distinction might seem odd. Is not discipline synonymous
with compulsion? Not quite. In an experiment run in Bolivia, Peru, and the Philippines, people with voluntary savings accounts saved 6 percent more on average if they received regular text message reminders.46 Evidently, the reminders helped them summon self-discipline. And evidently, part of the value of a
loan repayment schedule, binding as it is, lies simply in regularly drawing clients’ attention to the priority of setting money aside.
43
Robinson (2002), 264.
Rutherford (2009a), 21.
45
Banerjee et al. (2009).
46
Karlan et al. (2010), 39.
44
22
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
3/10/2011
Here we see financial services meeting a need that the rich also experience, but less intensely.
Self-control is harder to summon when money is tighter and life is less predictable. In Nairobi, researchers Siwan Anderson and Jean-Marie Baland found that 84 percent of participants in local savings clubs
known as ROSCAs were women.47 And among women, the ones most likely to join were neither those
earning all the household’s income nor none of it, but those in between. Roughly speaking, sole breadwinners did not need the leverage (with respect to husbands) of a commitment savings arrangement;
non-breadwinners had no income to leverage. And evidently, women needed the leverage with respect to
their spouses more than men. In their paper, “Tying Odysseus to the Mast,” economists Nava Ashraf,
Dean Karlan, and Wesley Yin discovered the same need in the southern Philippine island of Mindanao.
Working through a rural bank, they offered a new commitment savings account to randomly picked customers. Interestingly, even though the commitment account locked up clients’ money, it compensate for
this seeming inconvenience by paying higher interest rate than the bank’s ordinary savings account did.
Yet 28 percent of customers who got the offer took it. After one year, those offered had saved 81 percent
more than those not. Among all the study subjects, the most likely to join were those who a) were female and b) felt a strong tension between how they manage money in the moment and how they wish
they could over the long term (as revealed by psychological tests).48 Evidently they recognized their
need for external discipline.
To the extent that financial services resemble one another—in turning small, frequent pay-ins into large, occasional payouts—they can substitute for one another. One woman might save to buffer her
family against the possibility of a husband taking sick. Another might avail herself of rudimentary health
47
Anderson and Baland (2002). The rotating savings and credit association (ROSCA) is the most prevalent form of informal
group financial service. See chapter 3.
48
The average effect reported here is for those receiving the offer, not those taking it. The group receiving the offer is randomly defined, and is the basis for meaningful comparisons. People in the subgroup taking the offer are self-selected and
might have saved more anyway. “Tension” refers to the time consistency, or hyperbolic discounting, the researchers found.
Asked to choose between hypothetically receiving 200 pesos today or 300 a month later, and then between 200 in 6 months
or 300 seven months from now, those women offering conflicting answers—200 when the choice was today, 300 when it was
deferred—were more likely to join than other women, and than men generally.
23
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
3/10/2011
insurance such as that sold by the microfinance group SHARE Microfin in India.49 Another might borrow to pay clinic fees when needed. Of course, few poor people are in a position to choose from all these
options. A survey in the Indian state of Karnataka found that 67 percent of households with someone
who had suffered an expensive health problem in the last year tapped savings to help pay the bills and
44 percent borrowed.
But financial services are neither perfect substitutes for each other nor freely substitutable. In
Karnataka, only 0.3 percent of the households with health troubles drew on insurance, which is not surprising since almost none could buy any. Few could swap in this superior service to replace savings or
credit. And credit and savings are opposite in some ways. For one, credit can cost more than savings.
The core reason is that financial service providers are easier to hold to account than their clients, some
of whom can disappear overnight. That means that a client must pay more to compensate creditors for
trusting her (in lending to her) than she must pay if she is to trust them (in saving with them). In Vijayawada, for instance, Ramalu’s moneylender charges far more than Jyothi the savings-taker, rupee for rupee. After subtracting the Rs 150 fee, Ramalu’s initial balance is Rs 850. He starts repaying immediately
so that his average balance over the 10 weeks is half the Rs 850, or Rs 425, of which the Rs 150 is 35
percent. A rate of 35 percent for 10 weeks compounds to a stunning 382 percent on an annual basis,
more than ten times Jyothi’s rate.
Another difference is in the risks imposed on clients. With savings (and insurance) the client runs
the risk that the financial institution will collapse or steal her funds. Hyperinflation can effectively do
the same thing. With credit, the danger is that bad luck or bad judgment will lead the borrower into repayment difficulties. Whatever mechanisms the lender uses to enforce collection—public shaming, peer
pressure, the proverbial damage to kneecaps—will then come to bear.
49
sharemicrofin.com/services.html, viewed October 20, 2010. The insurance is underwritten by the U.S. group MicroEnsure.
24
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
3/10/2011
Thus, various financial services can substitute for one another, but imperfectly. That means that
poor people often use the services in ways that are not ideal. That a loan is often taken in practice, for
instance, does not mean that a loan is as often best in principle.
Conclusion
If you are not a poor person in a poor country, and want to understand how people who are poor in poor
countries manage money you need to absorb four points:

Broadly, their financial goals are the same as yours. They want to transact, invest, build assets, and
sustain consumption of necessities. To achieve such purposes, they need ways to accumulate regular
small sums in large ones. Looking deeper, to do this they need help with self-control.

Their financial challenges differ from yours qualitatively as well as quantitatively. Their incomes are
volatile and predictable; likewise their spending requirements. If anything, they need financial services more than you. Self-control is harder when needs are so pressing.

Those who need financial services most have them least. The barriers between poor people and good
financial services are several: discrimination on the basis of class, race, and gender; lack of formal
collateral; and the high relative cost for financial institutions of administering small transactions.

Poor people are at least as intelligent and resourceful as you would be in patching together the financial tools at hand to solve the problems at hand.
These points put the popular storyline of microcredit and microenterprise in a proper and rich
perspective. The storyline is not just a myth: almost by definition, poor people in poor countries lack
steady jobs, so they fall back on their own resources, farming, processing crops, trading, sewing, and
engaging in a hundred other independent economic activities. But the storyline is not the whole story.
Microenterprise is more about surviving poverty than escaping it. The poor need financial services for
25
Roodman microfinance book. Chapter 2. DRAFT. Not for citation.
3/10/2011
many things in addition to enterprise. Credit can serve many needs, but savings and insurance serve
some of those purposes more effectively when available.
All this suggests that next to the extraordinary poverty-reducing power of industrialization, microfinance is a palliative. Does that mean its value is exaggerated? Probably. Does that make it wasted
charity? Not necessarily. For people navigating the unpredictable and unforgiving terrain of poverty,
additional room for maneuver, additional control, can be extremely valuable. As Jonathan Morduch, a
New York University economist and thoughtful observer of microfinance, told a writer for the New
Yorker, the charge that microfinance is merely a palliative “is a valid critique, to a point. But get real.
How long are you willing to wait for the revolution? I can’t see any moral foundation for not trying to
address the current deprivations of the world’s poorest billions. If microfinance can help provide options
in cost-effective ways, we should celebrate it.”50
It is worth investigating whether the microfinance movement lives up to the myth it created;
chapters 6 and 7 of this book do too. But the more practical question is how outsiders, under the umbrella of “microfinance,” can best help the poor solve their financial problems. It is a tough question. While
it is easy to argue that the poor ought to have access to, say, health insurance, it is much harder to do
make it happen. Financial services for the poor will always be inferior to those of the rich. To gain insight into what can realistically be hoped for, we will next take a tour of the history of financial services
for the masses. The history is surprisingly long and rich.
50
Bruck (2006).
26