Women at a microfinance meeting in India. Photo: Mckay Savage (flickr)

Microfinance was once the poster child for poverty alleviation. Hailed as an alternative to dangerous loan sharks, it quickly gained momentum and support from governments and NGO's alike. But lately the microfinance glitter has been wearing off, and this once-globally praised idea has come under intense criticism. Some governments have even encouraged their citizens not to pay back their loans, causing lenders to experience a drop in payback. This is most notable in the Southern Indian state of Andhra Pradesh, where repayment fell from almost 100 percent to a mere 20 percent.

While much of the backlash has focused on India, the same problems could strike any community utilizing microfinance, making India an important lesson to learn from.

Andhra Pradesh, which has a population of almost 80 million people, accounts for one third of India's microfinance loans, reports The Economist. And it is in Andhra Pradesh where microfinance is taking the most heat.

Local governments have pointed the finger at microfinance institutions (MFIs), blaming them for farmer's suicides that occur as a result of severe debt, and castigating them as profiteering loan sharks. The motivations of these politicians, however may be more political than moral. Many of them have utilized the situation to gain votes from the poor, suggests The Economist article. These politicians may also see MFIs as competition to government-installed programs and their own popularity.

Microfinance has also come under fire in Bangladesh where Muhammad Yunus -- the father of microfinance -- was facing allegations of illegal financial transactions. The accusation made by a Norwegian film maker has since been retracted, but the prime minister of Bangladesh still seized the opportunity to damage Yunus' reputation. This is important considering much of her motivation in doing so could have to do with Yunus's proposal to start a political party, despite the fact that this party never materialized according to The New York Times. However, NPR has speculated that despite the attention this case is getting, it will not hinder Bangladesh's use of microfinance loans.

Other Latin American countries such as Nicaragua and Bolivia have also become entangled with the negative side of microfinance. And politicians in these countries have made similar statements to those made by their counterparts in India, encouraging the poor not to pay back their loans in order to gain support from the lower classes.

In truth, microfinance is not a magic wand. Like all financial institutions it is wrought with the ups and downs of the market. And any situation involving loan and credit is dangerous, especially when people are allowed to borrow irresponsibly. The failure of microfinance in India is largely due in part to MFI's shifting their focus from non-profit to profit-making industries and the corruption that follows thereafter. In addition to this, microfinance in India expanded way too quickly without the experience or infrastructure to support it. The boom led to landslide profits for microlenders but disaster for their borrowers.

It's important to remember that microfinance is just a tool that can be used in both positive and negative ways. And as The Economist notes, it is neither miraculous nor detrimental:

In fact, research suggests that it [microfinance] does work — for some people some of the time, as you would expect. It is not a magic bullet, but nor is it intrinsically harmful.

Still there is much hope for microfinance, but it needs strict monitoring and legislation to ensure that corruption and profiteering to not deter it from the original goal of poverty alleviation.

Almost all microfinance borrowers are women who utilize funds obtained to start and maintain small businesses, such as broom making. Photo: Michael Foley Photography (flickr)

Of the three main microcredit models; non-profit, commercial, and regulated full financial services, which is best equipped to help the poor?

The Clinton Global Initiative invited three heavyweights from the microfinance industry to debate this very question: Nobel prize winner and Grammeen Bank founder Muhammad Yunus, SKS Microfinance founder Vikram Akula, and Mary Ellen Iskenderian, the president and CEO of Women’s World Banking. You can listen to Planet Money's distilled version of the conversation below.

Yunus presented an argument against the profit-maximizing, commercial approach, contending that rich investors seeking profits should not be allowed to usurp capital from the interest payments of the poor. He argued:

Grameen Bank is a for-profit organization…We are not NGO, we are a bank. But ownership is the question. Grameen Bank is owned by the borrowers. So we make profit, profit goes back to them. So we protect that part. So what we are opposed to when you say profit or commercialization, it’s money of the poor going out to somebody else.

In contrast, Akula alleged that the only way to extend microcredit opportunities to as many poor people as possible is to follow a commercial model:

Women from more remote areas would often come and say ‘Can you start in our village?’ and we’d always have to say ‘No, you know, it’s grant run and so we don’t have funds,” and we’d have to turn them away and they’d walk away disappointed… I left my NGO and came up with the idea of using a highly commercial model so that you could access capital markets and go back to that [poor] woman or any poor woman anywhere in the world and say ‘Yes, you too can have an opportunity.’

The other panelist, Iskenderian, advocated extending full financial services to the world’s poor. She reasons that the poor need access to regulated, commercial institutions that provide credit but also accept deposits and protect assets. However, she acknowledges the difficulties of becoming a “microbank,” specifically that laws often prevent the formation of such institutions and that it is extremely expensive to run them.

In The Wealth of Nations, Adam Smith first articulated the notion that firms acting in self-interest and profit-maximization would unintentionally produce socially beneficial outcomes. But is it the best way to prioritize the needs of the poor? You decide.

October's comment of the month comes from James in Portland, Oregon. James commented on our story Poverty Isn't Always Ugly. He reminds us that poverty rears its ugly head in many forms — not just monetarily. For his efforts, we will make a $25 donation to a project of his choice on Global Giving.

There are definitely a few issues to consider and discuss relating poverty. In reading Muhammad Yunus' book "Creating a World Without Poverty". He felt, and I agree, that the definition of poverty isn't going to be the same from country to country. For Bangladesh the Grameen Bank developed there own definition of poverty for their internal purposes and to measure impact over time.

Many organization attempt to place a dollar amount of income/day to determine poverty, we've heard the $2.00 per day used frequently. Income isn't a solid method because it doesn't factor variables outside of money. Location and access to natural resources for instance are variables that change the need for money, or an individuals dependence upon it.

Bottom line, I think it's important to realize that poverty can't be defined the same way in every community we visit. Poverty includes physical need and extends into the mindset of individuals and how they view the world around them. It's also important to be culturally sensitive when working with people around the world. Sure, we have it pretty good here in the U.S. but we have problems too. We shouldn't seek to cookie cut our cultural values everywhere we go.

Keep writing in and share your though-provoking comments for a chance to win $25 towards the well-deserving charity of your choice!

* Lest anyone think $25 is not a lot, consider these figures from our affiliate Mercy Corps: $25 delivers clean, safe drinking water to 50 people in one of eastern Congo's sprawling displacement camps. $25 provides seeds to farmers in cyclone-devastated areas of Myanmar to plant five acres of rice. $25 gives traumatized children in Darfur 12 weeks of activities and psychological care to help them heal.

Microfinance has worked in the developing world, but will it work here? Photo: PetroleumJelliffe (flickr)

A few weeks ago microfinance pioneer Professor Muhammad Yunus was in Queens, New York. No, he wasn’t soliciting funding or international support for his Bangladesh-based microlending institution. He was cutting the ribbon on the brand new Grameen Bank America building.

Thousands of miles away from the original Grameen Bank, the American version will function much like its Bangladeshi counterpart: loaning to groups of women rather than individuals. Like the women who first participated in Yunus’ innovative banking scheme, American borrowers will convene at one member’s house to collect weekly dues. This type of group-lending model increases accountability, since defaulting on your loan affects your peers' access to credit as well as your own.

The Grameen Bank targets women because they're more reliable borrowers. To date, Grameen America has loaned upwards of $250,000 dollars to more than 100 women who are using their $500 to $3,000 loans to establish or expand businesses ranging from floral arranging to house cleaning.

But Yunus has some skeptics to win over. Many question whether the Grameen model will resonate with Americans. Microfinance expert Saiful Islam says "Bangladeshis, Indians, Latinos will follow it, but I don’t know about others." In 1985, a similar program started by Yunus in rural Arkansas at the request of then-Governor Bill Clinton failed due to mistrust among participants, according to Shorebank's Mary Houghton, who helped advise the microfinance experiment in Arkansas.

It does seem somewhat of a strange fit: banking targeted to empower the poorest of the poor in one of the most prosperous countries in the world?

The United States does have its fair share of people living in poverty, however. Immigrants in particular have a hard time accessing credit and are more likely to use predatory lending agencies that charge steep interest rates. What's more, the Center for Financial Services and Innovation, reports that approximately 40 million American households are considered underbanked.

Also, contrary to public perception, microcredit is not aimed at the poorest of the poor. "It’s actually supposed to help those below a certain poverty line who are looking for self-employment as a route out of poverty," says Raj Desai of the Brookings Institution.

In that case, the U.S.-based bank may run into trouble. Approximately 1 out of every 11 Americans work for themselves, while about 1 in 4 in Bangladesh are self-employed.

Yunus will need time to prove that the American model can be successful. It may be that American women need more than greater financial access to climb out of poverty. But Yunus' large following and wide array of awards — including a Nobel Peace Prize — suggest he has a fighting chance.