Separate and Unequal

• Author: Raghuram Rajan
• Position: Economic Counsellor and Director of the IMF's Research Department

Instead of focusing on microcredit for the poor, we should make financial services available to all

Microfinance is increasingly being touted as a miracle cure for poverty. If it is, why isn't it more widespread, and how can it be extended? Although microfinance has been around in various forms for thousands of years, its modern incarnation is most closely tied to Mohammed Yunus, the Grameen Bank founder. In his autobiography, he described how, as a professor in Bangladesh, he came to understand the importance of finance for the poor. Horrified by the consequences of a recent famine, he left the sheltered walls of the university to find out how the poor made a living.

In a neighboring village, he struck up a conversation with a young mother making bamboo stools. He learned that she needed 22 cents to buy the raw material for the stools. Because the young mother didn't have money, she borrowed it from an intermediary, to whom she was forced to sell the stools as repayment. She made a profit of only 2 cents. Yunus was appalled: finance would enable her to sell directly to customers. But the intermediary wouldn't offer her finance, for then he would lose his hold over her. For want of 22 cents, the woman's labor was captive.

In this vignette, many see the worst evil of capitalism: exploitation of labor by capital. But this situation couldn't be further from the essence of free market capitalism: free access and competitive markets. It's the lack of access to a competitive financial market or to a friendly financial institution where the poor can borrow at a reasonable rate that keeps their labor captive.

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So why don't the poor have access to finance-loans, savings accounts, cash withdrawals, and insurance? Let's dispense with one explanation immediately: active discrimination against the poor. In a world hungry for profits, it's hard to imagine financial firms forgoing any customers. But passive discrimination may be one explanation: when a financial institution caters to the middle class, it may exclude the poor. Some slum dwellers in Chennai told me they felt uncomfortable entering a bank; they were awed by the better-educated and better-dressed bank clerk. Social distance may matter. A study by the Federal Reserve Bank of Chicago found that minority households, alike in all ways but race, were turned down for credit more often than others. A...