In 2006, a pioneer in the field of microloans was honored with a Nobel Peace Prize, and the concept has seemingly become even more popular since. It's easy to see why: the small, short-term loans are targeted toward small entrepreneurs in developing economies, and are intended to give them a chance to expand and update their local businesses. However, studies of the impact of microloans have painted a far more mixed picture, suggesting they might not provide the sort of boon to developing economies that their proponents promise. Now, a controlled study in the Philippines has found that, at least in that location, the microloans accomplish almost nothing they promise, although they do have some potentially positive effects.

The authors, who are based at Yale and MIT, worked with an existing outfit based in Manila called First Macro Bank. FMB provides three-month long microloans, although at a significant cost to the borrowers: once fees are included, the annualized interest rate is roughly 60 percent. Nevertheless, FMB is considered a reasonable example of a "second-generation" microloan bank, and it has received support from the US Agency for International Development.

Working with the bank, the researchers set up the financial equivalent of a double-blind trial. The company's risk evaluation software was set up to stratify potential borrowers into three categories: low risk, marginal, and high risk (rejected) candidates. The low-risk group got loans, but, for the marginal borrowers, the program was set up to randomly approve a subset, ensuring that there would be experimental and control populations of roughly equal risk. Bank employees had no idea that the selection process had an element of randomness, and in fact, accidentally made loans to five people the software rejected.

The loans went to over a thousand individuals and groups that were reasonably representative of the Manila population as a whole. Then the authors engaged in a little economic stimulation of their own, paying researchers at a local university to conduct follow-up surveys of the loan recipients starting 11 months after the loan. Given a 70 percent response rate, they ended up with information on over 1,100 borrowers.

The results did validate one premise of microloans: there appears to be a credit shortage in the Manila area, as the expanded loans run through FMB found takers. So the need for microloans appears to be real.

From there on out, however, hypothesis after hypothesis came up empty. Business growth didn't see any statistically significant boost following the loans. In fact, compared to the control group, those receiving loans ended up owning slightly fewer businesses, and had 31 percent fewer employees (these are small businesses, so 31 percent works out to be only 0.27 of an employee). The same sort of thing happened when loan recipients were surveyed about factors that reflect their subjective well being—those measures saw a small and statistically insignificant drop compared to the control group.

Many microloan organizations target female borrowers, in part because women have historically been excluded from full participation in the local business communities. In this survey, there were almost no differences in any measures between loans to men and women. The one significant difference is that males seem to have found the loan very stressful (the authors don't comment on whether this explained the drop in subjective well-being).

The few clear results they did find were rather peripheral to the whole premise of microloans. The authors conclude that the loans appeared to allow individuals to manage risk informally, as their recipients tended to have less formal life and health insurance. They do not seem to consider the prospect that the loan recipients had to cancel these services in order to pay off the loan, and had simply not re-established them afterwards. Savings, which might be the product of a successful business expansion, remained static.

The one thing the loans did seem to do is integrate their recipients further into their communities. Those who received the loans reported greater trust in their neighbors, and reported that they have better access to informal credit from friends and family afterwards.

The authors certainly don't argue that their study should be viewed as the last word on microloans. They consider the results of past studies to be "muddled" for various reasons, from national differences to the measures used to register their impact. What they do argue is that their method—random assignments of roughly equal borrowers, followed by a rigorous survey of outcomes—provide the best way to clear up the muddle.

Even with the muddle still around, however, they think that microloans are probably being oversold. "The theory and practice of microcredit remain far ahead of the evidentiary base needed to make good policy and to improve the delivery of financial intermediation," they conclude. With better studies in a variety of locations, however, they expect that situation will change.

Science, 2011. DOI: 10.1126/science.1200138 (About DOIs).

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