Microfinance and entrepreneurship: An introduction

Introduction

Despite considerable growth in microfinance services worldwide over the last three decades, the impact of such services on entrepreneurship is not yet well understood. Indeed, the size of the microfinance industry – in terms of small, unsecured microcredit loans provided to poor households and individuals – is estimated at more than US$ 80 billion in outstanding loans to more than 90 million clients (Roodman, 2013). Additionally, the definition of microfinance has expanded to include a broad range of products encompassing insurance, savings, funds transfers, mortgages, and retirement plans for people underserved by traditional banks, primarily in emerging economies (Khavul, 2010). Yet, it remains unclear whether this level of investment is achieving its primary goal of enabling the poor, many of whom live on less than US$2 per day (Cruz et al., 2015), to start or expand their businesses (Phan, 2009).

This Special Issue of International Small Business Journal aims to enhance the understanding of how microfinance fosters entrepreneurial activity in emerging economies, as a mechanism for economic growth and poverty reduction (Ahlstrom and Ding, 2014; McCloskey, 2016). Although the management literature on microfinance and entrepreneurship is growing (Bruton et al., 2011), and a small number of studies have begun to examine whether and how microfinance contributes to the creation and development of new ventures (Banerjee et al., 2015; Newman et al., 2014; Shahriar et al., 2016), knowledge in this area is still limited. Extant research, primarily in economics, has typically focused on how microfinance lending influences broad development outcomes such as poverty alleviation, rather than looking at its effects on key entrepreneurial outcomes such as new venture creation and growth, performance, and survival (Chliova et al., 2015). This Special Issue represents a first step to address this key issue, with the goal of seeding future research in this important domain.

Microfinance, poverty, and entrepreneurship

Microfinance has been widely hailed as the solution to abject poverty since its modern development in Bangladesh in the 1970s (Yunus, 1999). In providing access to finance for the so-called unbankables, microfinance aims to bring credit, savings, and other financial services within the reach of those too poor to be served by regular banks, often because they are unable to offer sufficient collateral or simply do not have easy access to banks. In this way, microfinance can provide minimal capital for the start-up and expansion of small enterprises, mainly to low-income individuals and households in the emerging world.

In 1970s rural Bangladesh, economist Muhammad Yunus, became disillusioned with the responses to regular famines in Bangladesh. He began visiting local villages, where he found a group of 42 women who made bamboo stools. Because they lacked funds to purchase raw materials, they were tied into a cycle of debt with local traders, who lent money for materials on the agreement that they would sell the stools at a price barely higher than the cost of the raw materials. Yunus was shocked to find that the borrowing needs of the 42 women amounted to the equivalent of US$27; by lending them money from his own pocket at no interest, the women sold their products at a higher price and so, broke out of the cycle of debt. The solution seemed obvious - capital was the main problem. That is, give the poor access to capital in the form of small loans that can be used to grow small businesses which, in turn, allows them to raise living standards.

Based on this idea, in 1983, Yunus created Grameen Bank (derived from the Bengali word gram, which means rural or village) to specialize in microcredit. As the scope and success of Grameen grew, the number of microfinance institutions (MFIs) expanded globally (Bruton et al., 2011). Microfinance pioneers and leaders were recognized with awards, including the 2006 Nobel Prize to Grameen Bank and Muhammad Yunus. In these early days, microfinance was seen as a key weapon that could be utilized to assist millions to address poverty and aid economic development.

Over the subsequent three decades, the total number of microfinance loans provided has come to total well above 100 million. Yet the question remains: have these loans actually reduced the poverty level of the borrowers? To date, research by economists has not found consistent benefits from microcredit loans in terms of venture outcomes (Armendáriz and Morduch, 2010; Karlan and Valdivia, 2011).

There have been few published studies that evaluate the impact of microfinance on entrepreneurship and poverty using a randomized, comparative methodology (Roodman, 2012). Extant studies have not been able to demonstrate a decrease in poverty for those receiving the microloans, compared to a matched set of borrowers that did not take such loans. One major study (Banerjee et al., 2015) showed that business investment and profits of pre-existing ventures did increase in the presence of microloans, but the entrepreneur’s consumption did not significantly increase. This study also found that no significant improvements occurred in health, education, or women’s empowerment outcomes. Meanwhile, other studies have shown that access to microfinance increases the savings rate of the poor enhancing living standards but not entrepreneurial activity (Dupas and Robinson, 2013; Karlan and Ratan, 2014). The evidence suggests that despite billions lent by MFIs across the globe, its effects on borrowers and entrepreneurial activity may not always be positive (Bruton et al., 2015; Khavul, 2010).

The focus on microfinance and entrepreneurship is timely and interesting for several reasons. First, microfinance has gained increased attention from researchers and the general public alike, particularly as economic growth and development have shifted toward emerging economies where microfinance is particularly important (Lewin et al., 2016). Second, it is well understood that innovation and entrepreneurship are important to economic growth and development (Ahlstrom, 2010; Link and Siegel, 2011; Siegel, 2016). Yet, MFIs tend not to fund what might be thought of as truly entrepreneurial or innovative activities. Indeed, most loans issued by the Grameen Bank tend to fund small retail operations or farming. Such firms rarely generate enough revenue and profit to raise their owners beyond subsistence levels or generate growth in a regional economy.

Limited research at both the level of the entrepreneur and that of the MFI has identified the factors that enhance venture outcomes among microfinance borrowers. This is an important issue given that MFIs are not funding entrepreneurial ventures typically associated with growth and wealth creation (Alvarez and Barney, 2014). Instead, microfinance loans may be used as a form of revolving credit much like a credit card. This enables the poor to gain access to necessities, after which the small credit is paid then more necessities are purchased (Roodman, 2012). While this may be a useful objective, it generally does not fall under the rubric of innovation and new venture creation, upon which economic development is based (Ahlstrom, 2010; McCloskey, 2013, 2016).

The lack of definitive research regarding the potential for microfinance to alleviate poverty and enhance entrepreneurship suggests that microfinance, as currently structured, does not have the capacity to universally reduce poverty. For example, microfinance practice is based on the assumption that the main factor preventing the poor from exploiting entrepreneurial opportunities is the lack of financial capital. As economists and management scholars have argued, such capital is necessary but is not sufficient for encouraging innovation and the creation of sustainable, growth ventures (Alvarez and Barney, 2014; McCloskey, 2011; Wang et al., 2008). That is, entrepreneurs in poor settings encounter more than credit constraints (De Mel et al., 2008; Liu et al., 2017), as other resources, such as human capital, social capital, and effective institutions, are needed (Acemoglu and Robinson, 2012; Berge et al., 2010; Karlan and Valdivia, 2011). Not all poor people are equally skilled at recognizing or developing entrepreneurial opportunities (Alvarez et al., 2013). Nor is it reasonable to assume that all poor people want to become entrepreneurs (Shane, 2008).

In spite of mixed findings from previous research, it would not be appropriate to conclude that microfinance has not had a positive impact on abject poverty. Clearly, the success of microfinance lenders and the large numbers of loans made over the last 30 years taps into a critical unmet need. However, whether or not MFIs and the loans they provide actually help to boost new enterprise and reduce poverty is less clear (Bruton et al., 2010), thus motivating the present Special Issue of International Small Business Journal.

Articles in the special issue

This Special Issue includes a range of work by both established and emerging scholars, beginning with an invited commentary by Chen, Chang, and Bruton, which sets the stage by reviewing management research on microfinance initiatives, entrepreneurship, and poverty. The commentary highlights prior work which has examined the effect of microfinance on new ventures, as well as the financial sustainability of lending organizations. Examining 32 articles from top journals spanning a decade (2005–2015), the authors highlight gaps in the literature and recommend an agenda for future research in this area.

The subsequent articles in the issue represent empirical work designed to address gaps in our extant knowledge on microfinance and entrepreneurship. As such, they first employ a range of methods, second, they feature both multi-country and regional studies, and third, they examine the outcomes of microfinance for nascent entrepreneurs and MFIs in less developed countries. The studies draw on samples from a wide range of countries in Latin America, the Caribbean, Africa, and East and Central Asia and apply methods including surveys, qualitative interviews, analyses of large multi-country datasets, and fuzzy set analysis.

A key issue addressed in the Special Issue is the influence of the institutional environment on the success of microfinance. Based on a fuzzy set qualitative analysis of 19 countries in Latin America and the Caribbean, Kimmitt and Muñoz examine entrepreneurship and financial inclusion from the viewpoint of instrumental freedoms. Reflecting the capabilities approach of Amartya Sen (1999), they explore the role of institutional arrangements, including political freedom, and the complex causal processes involved in financial inclusion. In doing so, they expand our understanding of the potential impact of microfinance amidst varied institutional systems.

Another issue addressed in the Special Issue is the effectiveness of different models of microfinance, for instance, regarding the configuration of lender–client relationships. While prior research suggests that benefits may accrue from long-term enduring relationships between lenders and microfinance-funded ventures, Shahriar and Garg argue that long-term lending relationships increase credit risk for lenders, threatening financial sustainability. Based on Microfinance Information Exchange data from 1087 lenders in 69 countries between 2003 and 2014, they find a U-shaped association between relationship-based lending and credit risk, as seen in increased defaults and delinquencies, indicating limits to the benefits of such ties. The risk is particularly acute for smaller MFIs and for those issuing individual loans, a significant finding given the shift away from group lending in recent years.

A further issue addressed in the Special Issue is how MFIs can assist micro-enterprises to exploit business opportunities. In their paper, McKelvie and Engstrom find that financial literacy is positively associated with two key measures of micro-enterprise performance. This demonstrates the importance of financial training for entrepreneurs in the informal economy, with which micro-lenders can assist.

The articles in this Special Issue aim to bring new insights to the important domain of microfinance and entrepreneurship. The present issue builds on the history that the International Small Business Journal has in publishing research on small- and medium-sized enterprise funding in emerging and transition economies (Adekunle, 2011; Newman et al., 2014; Shahriar et al., 2016; Siwale and Ritchie, 2012).We hope you enjoy reading the articles and will find them helpful.