An EBRD study is assessing the impact in Mongolia of microcredit lending techniques.
Dominated by vast steppes, the Gobi Desert and mountain ranges, Mongolia is the most sparsely populated country in the world with fewer than two inhabitants per square kilometre of the country’s arid landscape.
Building a suitable infrastructure and providing efficient services is not an easy task in such terrain. This is the reason why it can be difficult for Mongolians to access finance, especially for the poor living in remote areas. For commercial banks it is very costly to disburse, monitor and collect small loans. And it is these that are much needed in Mongolia where around a fifth of the population is estimated to live off less than US $1.25 a day.
The question remains of how best to lend to the poor in a sparsely settled country. A recently published EBRD study therefore looks at how microcredit can best support poor women in rural areas in Mongolia. Do individual loans provide borrowers with more flexibility and make it easier for them to set up their own small business? Or is group lending, where people decide collectively and can support and discipline each other the better option?
A comparison: individual loans and group lending
“Together with our partner, XacBank, we chose 40 remote Mongolian villages for our study and interviewed 1,148 women from the poorest parts of the population there. This was done at the very start of the field experiment so that we knew a lot about these people’s lives before we started our lending programme,” explains Ralph De Haas, Deputy Director at the EBRD Office of the Chief Economist’s (OCE) Research Pillar. While many men in these villages had access to finance, in particular in the form of herder loans, women were less included in the financial system.
“The goal was to determine how microcredit – either disbursed as individual or as group loans – affected their entrepreneurial activity and, ultimately, their economic well-being.” To measure these effects in a rigorous way, women were given access to individual loans in 15 villages and to group loans in an additional 15 locations. No loans were disbursed to them in 10 ‘control villages’. Crucially, the decision whether individual, group or no loans were introduced in a particular village was completely random. This ensured that at the beginning of the experiment these three types of villages and their inhabitants were on average very similar.
After one and a half years, all women were interviewed again to check how their situation had evolved – their income, consumption, savings, entrepreneurial activities, asset ownership and various other factors. “XacBank, disbursed loans between around US $250 and US $450, which were put to a variety of uses,” says De Haas. “One woman started to grow vegetables and opened a related shop, another one established a hairdressing business, many others bought yaks to produce milk or started to produce felt covers to better insulate gers.”
“Although the loans were intended to finance business creation, approximately half of all credit was actually used for household rather than business purposes,” De Haas adds. As a result, the probability of owning a VCR or a radio was significantly higher at the end of the study in both group and individual lending villages than in the control villages.
“This is in line with the results of several other field experiments on microcredit. Not everybody is an entrepreneur and many people use these loans simply to buy a large consumer good,” De Haas points out. “For such people, a trustworthy savings account may perhaps be a better financial instrument.”
Boosting entrepreneurial activity through group lending
The study also revealed some important differences depending on the type of loan that women received. “Our data suggest that group loans were more effective than individual loans when it comes to boosting entrepreneurial activity. This result was largely driven by less educated women who had a 29 per cent higher chance of operating a business compared with women in the control villages where no loans were disbursed,” De Haas explains.
But does this mean that those who received group loans are also economically better off? Did increased entrepreneurial activity also lead to improved household well-being? The study provides some evidence for this. By the end of the study, the women and their families had significantly increased their food consumption in group lending villages. On top of this, they ate healthier food, including fresh fruit and vegetables, which are relatively scarce in Mongolia. However, no such effects were found in the individual lending villages.
A reason for the different results with the two loan types could be that group pressure may prevent the borrowers from selecting overly risky investment projects and may ensure that a substantial part of the loan is invested in the first place. In addition, group lending was a new product in Mongolia and some women, especially the less educated, may not have felt comfortable with borrowing on their own. When given a chance to borrow together, they took the step to start an entrepreneurial activity.
“An operational lesson from this research project is that group and individual lending are complementary services for which demand may differ across borrower types. The move by microfinance institutions towards individual lending may therefore run the risk that certain borrowers may gradually lose access to finance,” De Haas explains.
How experimental research is shaping the debate on microfinance
The debate on microfinance and how it can affect entrepreneurial activity and poverty alleviation is in full swing. “The latest research findings suggest that there is little evidence that microcredit systematically helps people escape poverty,” De Haas adds. “However, small loans can help some people to set up enterprises, cope with unforeseen income shocks and buy large consumption goods. All these things improve people’s lives – although perhaps not to such an extent as was commonly believed until a couple of years ago.”
“Interestingly, recent research shows that micro-savings, rather than microcredit, may have as large or even larger impacts on entrepreneurship and consumption levels,” he says. Microcredits and micro-savings serve the same purpose in so far as they provide people with a lump sum that helps them invest into a business or buy a consumer good. The difference is that with credit one makes regular, small payments after the investment, while with savings one has to do so upfront – and the cost of credit is of course higher.
“Many people in developing countries find it difficult to save money and therefore like the idea of micro-savings,” De Haas says. “However, the problem is that microfinance institutions are typically not allowed to take deposits without a banking licence, although savings could provide them with extra funding. Many people would even be prepared to pay for such a service.”
OCE’s impact briefs
The findings of the microfinance study in Mongolia are summarised in a recently published EBRD Impact Brief , the first in a series of non-technical briefings on field experiments to be produced by OCE.
This will be followed by a second study on microfinance – this time on the impact of microcredit during the financial crisis in Bosnia & Herzegovina, which will be published during the summertime. This project was funded by the European Western Balkans Joint Fund (previously known as the Western Balkans Fund).
Together with the Legal Transition Team, OCE is also preparing a field study on the impact of judicial training in commercial law in Tajikistan. Finally, in cooperation with MIT’s Abdul Latif Jameel Poverty Action Lab, OCE is planning to conduct a study on restraints on female entrepreneurship in Morocco.
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