Poverty and Microfinance

Here we define poverty as an income (or more broadly welfare) level below a socially acceptable minimum and micro finance as one of a range of innovative financial arrangements designed attract the poor as either borrowers or savers. In terms of understanding poverty a simple distinction can be drawn within the group ‘the poor’ between the long-term or ‘chronic poor’ and those who temporarily fall into poverty as a result of adverse shocks, the ‘transitory poor’. Within the chronic poor one can further distinguish between those who are either so physically or socially disadvantaged that without welfare support they will always remain in poverty (the ‘destitute’) and the larger group who are poor because of their lack of assets and opportunities. Furthermore within the non-destitute category one may distinguish by the depth of poverty (how far households are below the poverty line) with those significantly below it representing the ‘core poor’, who are sometimes categorized by the irregularity of their income.

In principle, micro finance can relate to the chronic (non-destitute) poor and to the transitory poor in different ways. The condition of poverty has been interpreted conventionally as a lack of access by poor households to the assets necessary for a higher standard of income or welfare, whether assets are thought of as human (access to education), natural (access to land), physical (access to infrastructure), social (access to networks of obligations) or financial (access to credit) (World Bank 2000:34). Lack of access to credit is readily understandable in terms of the absence of collateral that the poor can offer conventional financial institutions, in addition to the various complexities and high costs involved in dealing with large numbers of small, often illiterate, borrowers. The poor thus have to rely on loans from either moneylenders, at high interest rates, or friends and family, whose supply of funds will be limited. Microfinance institutions attempt to overcome these barriers through innovative measures such as group lending and regular savings schemes, as well as the establishment of close links between poor clients and staff of the institutions concerned. As noted above, the range of possible relationships and the mechanisms employed are very wide.

The case for micro finance as a mechanism for poverty reduction is simple. If access to credit can be improved, it is argued, the poor can finance productive activities that will allow income growth, provided there are no other binding constraints. This is a route out of poverty for the non-destitute chronic poor. For the transitory poor, who are vulnerable to fluctuations in income that can bring them close to or below the poverty line, micro finance provides the possibility of credit at times of need and in some schemes the opportunity of regular savings by a household itself can be drawn on. The avoidance of sharp declines in family expenditures by drawing on such credit or savings allows ‘consumption smoothing.’ In practice the distinction between the needs of the chronic and transitory poor for credit for ‘promotional’ (that is income creating) and ‘protectional’ (consumption smoothing) purposes, respectively, is over-simplified, since the chronic poor will also have short term needs that have to be met, whether it is due to income shortfalls or unexpected expenditures like medical bills or social events like weddings or funerals. In fact, it is one of the most interesting generalizations to emerge from the micro finance and poverty literature that the poorest of the chronic poor (the core poor) will borrow essentially for protectional purposes given both the low and irregular nature of their income. This group it is suggested will be too risk averse to borrow for promotional measures (that is investment in the future) and will therefore be only a very limited beneficiary of microfinance schemes (Hulme and Mosley 1996: 132).³

The view that it is the less badly-off poor, who benefit principally from micro finance, has become highly influential and, for example, was repeated in the World Development Report on poverty (World Bank 2000:75). Apart from the risk aversion argument noted above a number of other explanations for this outcome have been put forward. A related issue refers to the interest rates charged to poor borrowers. Most microfinance schemes charge close to market-clearing interest rates (although these will often not be enough to ensure full cost-recovery given the high cost per loan of smallscale lending). It may be that, even setting aside risk-aversion argument, such high rates are unaffordable to the core poor given their lack of complementary inputs; in other words, despite having a smaller amount of capital, marginal returns to the core poor may be lower than for the better-off poor. If the core poor cannot afford high interest rates they will either not take up the service or take it up and get into financial difficulties. Also where group lending is used, other members of the group may exclude the very poor because they are seen as a bad credit risk, jeopardizing the position of the group as a whole. Alternatively, where professional staff operate as loan officers, they may exclude the very poor from borrowing, again on grounds of repayment risk. In combination, these factors, it is felt by many, explain the weakness of micro finance in reaching the core poor.⁴

Even where micro finance does reach the core poor, when (as in many instances) donor or government funds are required to subsidize the microfinance institutions involved, it is not inevitably the case that this is an efficient strategy. As funds are fungible within households, the use of the loan is not the issue and what matters is the cost of transferring the funds through a micro credit institution per dollar received by the target group, as compared with the benefit-cost ratio for alternative schemes for reaching the core poor, such as food subsidies, workfare, integrated regional development initiatives and so forth. Such comparisons must take account of not just the administrative costs involved, but also the leakage rate (that is the benefits to the non-poor).

Given the new trends in the sector and their possible effect in diluting the original poverty focus of MFIs the question of their impact on the poor (and particularly the core poor) is clearly of great policy interest. It might be thought that if such institutions are designed to serve only poor clients and if repayment rates are high, no further detailed analysis is needed. Such a view is misleading for a number of reasons. First, there is no guarantee that only the poor will be served unless strong eligibility criteria (like land ownership) are enforced. Often the aim is to dissuade the non-poor with the inconvenience of frequent meetings or the stigma of being a member of a credit group of the poor. Such disincentives need not work and eligibility criteria where they exist may not be enforced. Second, high repayment rates may be due to social pressure within a group or family and may not reflect the capacity to repay (if for example loans from moneylenders have to be taken out to repay the micro credit). Third, even if the poor are genuinely served by MFIs, as long a public funds are required to finance the MFI there is the issue of how cost-effective this means of reaching the poor is compared with alternatives. Hence for these sorts of reasons, there is a strong case for attempting to assess the impact of such loans on the welfare of the target group.

Nonetheless assessing the true relationship between microfinance services and poverty reduction is not straightforward. It is not simply a case of looking at a group of borrowers, observing their income change after they took out micro credits and establishing who has risen above the poverty line. Accurate assessment requires a rigorous test of the counterfactual—that is how income (or whatever measure is used) with a micro credit compares with what it would be without it, with the only difference in both cases being the availability of credit. Empirically, this requires a control group identical in characteristics to the recipients of credit and engaged in the same productive activities, who have not received credit, and whose income (or other measure) can be traced through time to compare with that of the credit recipients.⁵ Furthermore, to allow for changes over time, in principle assessments should allow for the possibility of reversals, with households slipping back below the poverty line if the productive activities financed by the credits are unsustainable. Studies based on a rigorous counterfactual find much smaller gains from micro finance than simple unadjusted ‘before and after’ type comparisons, which erroneously attribute all gains to micro credit.

Here we examine some of the recent ‘scientific’ studies on the impact of MFIs based on various survey data. We do not report the results of work based on more qualitative or participatory approaches.⁶ Table 2 [ PDF: 93kb | 4 pages ] summarizes the results of the studies surveyed here.

3. Morduch (2003) points out that, although this argument may be true, the data in Hulme and Mosley’s book cannot be used to infer this since the arithmetic basis for their comparison of income changes for different categories of borrowers, biasing their results in favor of their conclusion.
4. An important attempt to address this problem has been the Income Generation for Vulnerable Group Development (IGVGD) program run by BRAC in Bangladesh, which combines measures of livelihood protection (food aid) with measures of livelihood promotion (skills training and micro credit). Hence, micro credit is provided as part of a package approach. Matin and Hulme (2003) survey the evidence on how far the benefits of this program actually reach the core poor and conclude that although the program was more successful than more conventional micro credit schemes, nonetheless many target households were still missed.
5. Coleman (2001) has a useful non-technical explanation of the difficulties of applying this approach and eliminating ‘selection’ and ‘placement’ bias in micro credit studies.
6. See Hulme (1999) for a discussion of different approaches to impact. He points out that despite their cost in funds and time, such scientific studies involving detailed sample surveys are the most common approach where the aim is to establish impact for policy or investment purposes.

The views expressed in this paper are the views of the author/s and do not necessarily reflect the views or policies of the Asian Development Bank Institute nor the Asian Development Bank. Names of countries or economies mentioned are chosen by the author/s, in the exercise of his/her/their academic freedom, and the Institute is in no way responsible for such usage.

Post a Comment

We welcome your feedback on this publication. Post a comment. ADBI is not obliged to acknowledge or publish comments and may abridge or edit them before web posting.

Comment(s)

There are [4] comment(s) for this entry. Post a comment.

1. altafsamo
   (posted 27 March 2008 / 01:42:42 PM)
   
   I think micro finance if implemented in true spirit can do wonders but in countries like Pakistan the impact has not been so impressive although several studies has shown its positive impact. On the ground realities are very different and these need to be addressed by these multilateral donor agencies.
   Most of the loans are not properly utilized.
   Special emphasis is needed to be given on the capacity building of the prospective borrower. Let the borrower train to catch fish themselves by building capacity to utilize the borrowed amount for investment that will benefit them in long run. This will help decrease poverty.
2. muneeb seyal
   (posted 09 November 2007 / 08:42:14 PM)
   
   Well, I guess microfinance is doing a great work.
   Normally banks are not interested in providing funds to poor people.
   It's proved in history that poor are more honest than the rich.
3. Eric
   (posted 26 September 2007 / 10:35:57 PM)
   
   Whereas Micro finance holds the key to poverty education, it is not just the provision of the financial services that matters, information on where to invest and manage the business is equally needed.
4. Syed Shah
   (posted 22 April 2007 / 12:50:06 AM)
   
   Well I think micro finance can play a power full role in poverty alleviation, nature conservation and biodiversity conservation because it has the potential to diversify the source of income for the poor people and hence can result in reducing the pressure on exploitation of natural resources.