Micro-finance: the fuel or fall of entrepreneurship in emerging markets?

It’s no easy feat becoming an entrepreneur in emerging markets, especially since one’s entrepreneurial potential is so often stunted by the onerous bureaucratic processes involved in setting up a business and raising capital. For this reason, the advent of micro-finance has ignited hopes that micro-entrepreneurs would now have one less obstacle in their way.

But has micro-finance really lived up to these expectations?

A report compiled by the World Bank called Financing Businesses in Africa paints an interesting and unexpected story on the matter.

The most well-known type of microfinance is micro-lending (also known as micro-credit). This simple infographic I created explains the micro-lending process:

There is a clear rationale behind the emergence of several micro-lending firms around the developing world: the poor need access to funds, and they need it now. These are individuals who are unable to qualify for formal loans from top-tier banks. They also can’t depend on, or afford to wait for, the bureaucratic process of applying for government loans.

Private micro-lenders clearly fill a gaping need. And the hope has been that as a result, we would find more aspiring and struggling entrepreneurs realising their business potential. After all, one of the most cited reasons entrepreneurs in emerging markets give for struggling to launch their business is a lack of financing, not so?

The results surmised by the World Bank’s report, however, are counterintuitive.

While the introduction of micro-lending to emerging market communities accelerated business growth to some extent, the majority of credit was used by individuals on immediate consumption. No increase in budding entrepreneurial activity was detected. As the report aptly concludes: “providing access to credit to all will not make an entrepreneur out of everybody”.

So what does this mean? Are we to conclude that micro-lending is indeed living up to its bad name of creating over-indebtedness amongst an already poverty-stricken community? I don’t think it’s that simplistic, and there are two reasons for this: one technical and the other practical.

The technical issue comes down to the methodology of the research used by the studies conducted. The diversity of the borrowers included in these studies makes deriving a clean “average” outcome a slippery task. No doubt the introduction of micro-credit to a community has yielded stories of entrepreneurial success, but such gems are rendered dull in light of the myriad of other cases of entrepreneurial apathy.

The practical issue is that, considering the reality of impoverishment, perhaps borrowers were pressed to meet more urgent needs. Think about it. If you’re faced with the impending need to feed, educate and care for your family, wouldn’t you put that entrepreneurial dream on hold to make sure those needs were met first?

The World Bank also published a poll asking individual borrowers from developing economies what their main reasons for taking out a loan were. I have re-created the results here:

As you can see, “Emergency or Health” dominate the borrowers’ necessity for immediate funding, followed by education and housing needs. All these likely get in the way of justifying spending money on entrepreneurial aspirations.

Which brings us back to the point that micro-credit clearly serves an important purpose with regards to “consumption-smoothing and risk-coping” but not necessarily as a means of igniting and facilitating entrepreneurial endeavours. This conclusion, however, does not nullify the role (or potential thereof) of micro-finance as a whole in encouraging entrepreneurship.

Let’s talk about saving, rather than spending.

According to the World Bank, saving rates in poor communities are not only low due to limited disposable income, but also because saving facilities are largely unavailable to them. Here is a recreated World Bank chart comparing account penetration across the globe as of 2012:

Because poor communities are unable to access, or qualify for, formal bank-saving mechanisms, people are forced to “save in sub-optimal ways”.

The report cites a few “sub-par” examples. One popular way of saving is Rotating Savings and Credit Associations (ROSCAs) which involve a group of individuals contributing to a “pool” of funds on a regular basis and taking the kitty home on a rotating basis. Such arrangements don’t only deprive savers of accumulating interest, but also put their funds at risk of the ROSCA collapsing before it’s their turn to take home a lump sum.

As another example, a study conducted in Kenya showed that when 163 micro-entrepreneurs were offered savings accounts that provided zero interest and charged a withdrawal fee, 53% of them chose to use it, indicating that this sub-optimal way of saving was the best they had access to. Meanwhile, the choice to simply save cash at home comes with its own risks, of say robbery, or appropriation by friends and family.

But here’s the compelling part: the findings of a survey conducted by Gallup World Poll revealed that the second highest reason given for saving in sub-Saharan Africa was to start a business. So whereas credit appears to be used for immediate consumption/spending needs, it is in fact saving that is predominantly viewed as the means by which one may, someday, start a business.

So this is where micro-saving, as a sub-branch to micro-finance, may actually play the most important role in spurring entrepreneurship in developing countries. In order to achieve this, we need to put our time and energy into developing micro-saving solutions, and the necessary technologies to facilitate them.

Such mechanisms can emerge from government or policy-makers, (for example implementing regulations whereby top-tier banks are to provide minimum-fee paying accounts to entrepreneurs), or through the private sector, with platforms the likes of Mpesa.

Perhaps here also lies an opportunity for aspiring emerging market entrepreneurs themselves. How can we help the poor save more, save better, save securely – and make it a profitable business endeavour at the same time? That is the opportunity – and the challenge. Now let’s find some contenders.