The Economics of Microfinance.

• Author: Chatterjee, Prabirendra
• Position: Book review

The Economics of Microfinance By Beatriz Armendariz de Aghion and Jonathan Morduch. Cambridge, MA: The MIT Press, 2005. Pp. 352. $45.00.

The year was 1998: Professor Jonathan Morduch was visiting Princeton University and Professor Beatriz Armendariz de Aghion was visiting the Massachusetts Institute of Technology (MIT). Armendariz de Aghion had studied microfinance in Latin America (including founding Grameen Trust Chiapas in Mexico), and Morduch had researched microfinance in Bangladesh, Indonesia, and China. They both were concerned because their experiences in Asia and Latin America seemed to conflict with the theoretical literature. It was during this time that their common interest in microfinance prompted them to undertake a series of joint projects. One of these projects was to write the first draft of the initial chapters of a book entitled The Economics of Microfinance. Following this early start, it took quite a while--almost seven years--before the book was finished. In the meantime, there was an explosion of research on microfinance, greatly expanding the scope of the book. The popularity of microfinance as a poverty alleviation strategy also grew during this period, increasing the demand for published works on the topic. Sheer coincidence or not, both of these economists, as well as MIT Press, must have been very happy to be able to publish this book in 2005, the year the United Nations' designated as the International Year of Microcredit. The time was right to deliver this extensively researched, much-needed book.

The microfinance revolution, particularly the success stories of institutions like Grameen Bank in Bangladesh, Banco Sol in Bolivia, and Bank Rakyat in Indonesia, attracted several economists to study microfinance in the latter half of the 1990s. The authors themselves belonged to this group of enthusiastic people who were conducting both theoretical and empirical research on a topic that now forms an integral part of the new development strategies. However, for undergraduate and graduate students of economics, public policy, and development studies, there was a nagging problem--the plethora of mechanisms and institutions that fell under the label of microfinance were varied and complex, and there was no accessible source that presented all the material coherently. There were two excellent surveys of the literature--Ghatak and Guinnane (1999) and Morduch (1999)--but these were not exhaustive; in addition, many exciting new developments and innovations that subsequently occurred were not included. Moreover, attempts to translate various microfinance mechanisms from one country to another had repeatedly failed, and several theoretically promising mechanisms were ignored because practitioners were skeptical about implementing them. Therefore, even in the presence of several hundred research papers, students, researchers, and practitioners needed something more accessible and handy that provided a thorough understanding of the basic concepts, as well as extensive information about this growing development strategy. Without a doubt, Armendariz de Aghion and Morduch's The Economics of Microfinance is a one-of-a-kind book and fills this void admirably!

"Rethinking Banking," the introductory chapter of the book, is an overview. It begins by explaining the need for microfinance programs and whether such programs can be operated profitably. It is now well recognized that the development banks of the 1950s and 1960s were not very successful in helping the poor. Of course, given the myriad asymmetric information problems inherent in lending to the poor, formal credit institutions have shied away from providing credit to this group of borrowers, thereby setting the stage for microfinance. Early in this chapter, the authors distinguish between the words microcredit and microfinance. According to Armendariz de Aghion and Morduch, the notion of microcredit focuses on poverty reduction through loans and social change, while the newly coined term, microfinance, emphasizes the benefits to households of receiving a wider variety of financial services. These precise definitions are important, as they will help to reduce the extent to which both terms are misused. More importantly, by establishing this difference, the chapter makes abundantly clear the need for microfinance as a poverty-reduction strategy. It provides a cogent summary of the achievements and challenges of microfinance programs and forms the reference point for the ongoing debates in microfinance that are examined in subsequent chapters. Primarily, this chapter helps readers to understand how a simple but sound idea has led to fascinating new strategies that create a "win-win" situation for all.

In Chapter 2, the authors make a case for intervention in rural...