Read Kathryn Mordeno’s second place winning essay in the First Annual Undergraduate Applied Social Justice Essay Competition —
the path to poverty alleviation
Despite the criticisms on and limitations of microfinance in poverty alleviation, the financial services offered by this innovative tool have powerful implications in promoting economic development among low-income population groups in the world. Based on different case studies conducted in developing countries, microfinance has been found to be a reliable and effective way of empowering the poor, most especially women, while also increasing their level of participation in the global economy. By providing the poor with access to credit, savings, mortgage loans, education loans, health insurance, among others, microfinance is able to facilitate the poor’s social mobility and enable the low-income populations to actively benefit from the financial sector. The poor can also acquire necessary entrepreneurship and risk management skills through trainings and information sessions provided by microfinance institutions, leading to an overall improvement in their human capital. Due to the positive impact effected by this poverty-reduction instrument, a greater interest has also arisen among developed nations to employ such a strategy in combating widespread poverty in their region.
Kathryn Mordeno presents a summary of her paper "Microfinance: the Path to Poverty Alleviation" at the First Annual Undergraduate Applied Social Justice Essay Competition Reception on Aril 15, 2010
Poverty is a pervasive problem in our society. Spanning across the world, poverty exists in different levels and various forms. At the current threshold of $1.25 a day, the World Bank estimates that around 25% of the population in developing regions lives below the poverty line (United Nations, 2009). This figure translates to 1.3 billion people living in poverty, or about 20% of the global population (The World Bank Group, 2010).
As the World Bank broadly defines it, poverty is a “pronounced deprivation in well-being,” (as cited in Khandker & Haughton, 2009, p. 2). The poor are deprived of basic necessities in life, such as food, shelter, clothing, and clean drinking water. They also lack access to health care, quality education, and employment opportunities that are important in improving their human capital and facilitating social mobility. Due to the profound impact that poverty has on the poor’s well-being, efforts have been made by various multilateral organizations, such as the United Nations, to address these problems and combat poverty. Through the years, different poverty reduction strategies and instruments have been developed in order to improve the poor’s standard of living and help the people break the vicious cycle of poverty.
One such poverty alleviation tool is microfinance, which has gained worldwide recognition since the 1990s and has been proven to have positive effects on poverty levels in developing countries (Hossain & Knight, 2008; Venkataramany & Bhasin, 2009; Chemin, 2008). Microfinance is the provision of financial services to the poor, aiming to empower low-income populations by providing them with access to credit and other financial services. Through microfinance institutions (MFI), the poor can obtain collateral-free loans at relatively low interest rates and use the money for creating microenterprises (small businesses owned by poor people), funding children’s education, and improving homes, among others. Aside from microcredit (small loans to the poor), MFIs have also developed numerous financial products, such as micro-insurance and micro-mortgage that are designed to accommodate the poor’s financial needs. Most of these institutions have also required their clients to open up savings accounts, which could be used for emergency and investment purposes (Carr & Tong, 2002, p. 82). Indeed, microfinance has so much to offer to the poor that it has now become a global phenomenon (Carr & Tong, 2002, p. 7).
Despite the success of microfinance in including the poor people in the financial sector, critics claim that this antipoverty tool lacks hard data to prove its positive impact on reducing poverty levels. Some researchers also question the real impact of microfinance institutions (MFI) in women empowerment, and argue that assistance from the public and private sectors must be made available to effectively improve the lives of the poor. Others are also concerned at how these institutions would be able to fulfill their social goals while trying to achieve long-term sustainability.
In this article, I focus on the key features of microfinance and outline its positive effects on poverty levels, women empowerment, and psychological benefits. I also examine the main criticisms and issues raised by other researchers with regards to microfinance’s real capability of effectively facilitating social mobility, and briefly discuss the challenges faced by microfinance institutions in industrialized countries.
MICROFINANCE: GROWTH AND FEATURES
The popularity and success of microfinance are evidenced by the formation of large microfinance institutions (MFI) across the world and the increased participation of non-governmental organizations (NGO) in this growing industry. According to Pearl and Phillips (2001), 7000 micro lenders currently exist all over the world, catering to about twenty five million borrowers, of whom mostly are women living in rural areas (as cited in Elahi & Danapoulos, 2004, p. 61). Multilateral organizations such as the World Bank and UN Development Programme, have also recognized the potential of microfinance as a poverty alleviation tool and have contributed significantly to develop its programs (Midgley, 2008, p. 470). The United Nations has also declared 2005 as the “International Year of Microcredit,” and openly acknowledges that provision of financial services to low-income populations is an important step towards realizing its number one Millennium Development Goal (MDG), which is to halve global poverty by 2015 (United Nations Capital Development Fund [UNCDF], 2005).
Microfinance’s worldwide recognition can also be credited to Muhammad Yunus, founder of the Grameen Bank in Bangladesh and recipient of the 2006 Nobel Peace Prize. Although microfinance was not his original idea, Yunus pioneered the implementation of joint-liability groups as a substitute to tangible collaterals when borrowing loans, and emphasized the role of women in managing credit and organizing microenterprises (Engler, 2009, p. 82). He founded the Grameen Bank in the 1970s as an effort to ameliorate the destitute poverty that plagued his country. He believes that the poor possess an “entrepreneurial drive” and are equipped with “survival skills” that allow them to become successful microentrepreneurs (Engler, 2009, p. 82). He also asserts that to develop tools and services that would greatly benefit the poor, their limitations must be carefully considered by institutions which fight poverty (Yunus, 2007, p. 20). As of now his Grameen Bank has more than 1,000 branches and 6 million members, and boasts a 98 percent repayment rate (Midgley, 2008, p. 471).
There is certainly much truth in what Yunus said about how MFIs should approach their target income groups and accommodate the limitations of the poor. For instance, most commercial banks believe that this portion of population is “unbankable” due to their lack of financial resources and assets that can be put up as collateral. And so, more often than not, the poor are excluded from the financial sector because banks are unwilling to lend out loans and offer other financial services to this population group. Most commercial banks believe that the poor entail high risks, and are more likely to default on loans compared to middle and high-income individuals.
Microfinance, on the other hand, departs from traditional banking services, which only target specific groups in the population. It eliminates the bureaucracies inherent in conventional banking by simplifying paper work and forms, and establishing banking centers in villages (Yunus, 2007, p. 20). Microfinance’s core principle lies on the assumption that the poor people are motivated to do anything to move out of poverty and better their lives (https://www.microplace.com/learn_more/microfinance).
Several key features of microfinance that differentiate it from commercial banking procedures are outlined by Elahi and Danopoulos (2004). They mention five characteristics of this poverty alleviation tool: 1) small loan size, which is determined by micro lending institutions and dependent on the country’s socioeconomic development 2) focus on women borrowers, who have little access to credit 3) emphasis on the utilization of loans to start microenterprises as they provide employment opportunities to clients 4) absence of tangible collateral, and formation of joint-liability groups to enforce payment, and 5) savings mobilization programs, which require borrowers to open savings accounts and accumulate financial assets (Elahi & Danapoulos, 2004, p. 62).
Along with these key features, training and group meetings are also essential elements in microfinance. Once an individual chooses to borrow loans from MFIs, she is required to attend these activities and participate in capacity building programs. Entrepreneurship and risk management skills, credit discipline, values formation, information on health and hygiene, among others are discussed and taught in these training sessions to equip the borrower with proper knowledge of effectively managing her small business and aid her in everyday living (Dowla & Barua, 2006, pp. 18-19). Through this approach, MFIs are not only able to provide financial capital to the poor, but they are also able to promote a sense of responsibility and drive to achieve success in entrepreneurial endeavors.
BENEFITS AND WOMEN EMPOWERMENT
Aside from obtaining access to credit and other financial services, and creating microenterprises that provide employment, the poor also gain additional benefits that contribute to their overall economic improvement and social mobility. In most third-world countries in which MFIs operate, women empowerment is one of the most important effects that microfinance generates in rural communities. By acquiring access to financial capital and starting their own family business, women increase their decision-making power in the household and are able to possess skills in entrepreneurship and financial management. They gain more knowledge in terms of running their own source of livelihood and do not remain as ordinary housewives solely tied to the responsibility of taking care of their families. They start to play important roles in their communities and receive respect from other people for proving their great capacity to effectively manage resources and organize microenterprises. The benefits that women obtain from microfinance are not only financial but also encompass gender empowerment and self-actualization. In rural areas and villages, which are traditionally patriarchal, women are given the opportunity to uplift their status in the society and prove their worth as capable members of their community.
The poor in general experience social mobility through microfinance. As they acquire access to credit and become included in the financial sector, they are able to improve their economic status and increase their participation in the domestic (or even global) market. Kathryn Imboden (2005) indicates in her research that there is a growing number of literature that can support the positive relationship between financial sector development and poverty alleviation. She notes that because financial sector development contributes to economic growth, it indirectly aids in alleviating poverty. Also, by providing access to finance, the financial sector has direct effects on the economic condition of the poor (Imboden, 2005, p. 68).
Additionally, microfinance provides psychological benefits to its poor clients by promoting a sense of “self-respect and dignity, much more than handouts and grants. . .Success, self-respect and dignity are basic ingredients in overcoming the conviction that they and their children are born losers, born to fail” (van Maanen, 2004, pp. 27-28). Knowing that they are able to take out a loan, start their own business, and repay the borrowed capital through their own efforts and hard work, the poor can convince themselves that they are capable of doing something that could certainly change their lives for the better. They do not merely depend on loan sharks or moneylenders, who charge them for exorbitant interest rates, to finance their daily needs. Moreover, they also do not have to constantly rely on welfare programs for financial support, as becoming self-employed through their own businesses allows them to have a more stable source of income. If effectively managed, these businesses could potentially grow, resulting to a higher amount of earnings for the poor’s household. And so, utilizing microloans to advance entrepreneurial endeavors makes the poor better off than simply relying on welfare and high-interest loans from moneylenders. As the old adage goes, “Give a man a fish and you feed him for a day. Teach a man how to fish and you feed him for a lifetime.” Providing the poor with the right financial tools and knowledge to start a microenterprise will help them long-term and allow them to become self-sustaining in the process.
CRITICISMS AND ISSUES
Like any other anti-poverty programs, microfinance is not without any controversy or criticism with regards to its real impact on poverty levels. Despite anecdotal stories of success and testimonies from female clients and other borrowers, a number of literature argue that microfinance lacks hard, quantitative data that accurately measure significant changes in the economic conditions of the poor (Midgley, 2008, p. 472). They also indicate that although participants improve their incomes, it is not clear whether this benefit accrue to the society and positively affect other people in the community and national levels (Midgley, 2008, p. 473). Clients and borrowers may indeed acquire benefits from microfinance, but its impact on alleviating poverty at the global level is still debatable. Other critics believe that market-based solutions are still more effective in uplifting the economic status of the poor. Aneel Karnani (2008, p. 23) for instance, believes that employment and increased productivity are ultimately the most practical solutions in poverty alleviation. He also emphasizes the role of government in providing programs and services that could significantly impact the lives of the poor.
Another equally important issue on the role of microfinance as a poverty alleviation tool involves sustainability. Because MFIs usually rely on donations from different organizations, foundations and governmental agencies, their operations and financial services are clearly dependent on the frequency and amount of monetary support that they receive from donors. Since donations can be unreliable, a trend towards self-sustainability has become more evident among MFIs because this allows them to better serve their clients and keep up with the high costs associated with their operations (Husain, 2008, p. 40). The Grameen Bank best illustrates this idea of a sustainable microfinance institution, charging only a modest interest rate of about 20 percent to its customers (Engler, 2009, p. 84). Muhammad Yunus believes that this rate is just enough to maintain the sustainability of his bank (Yunus, 2007, p. 22).
The problem lies, however, on those MFIs that charge higher-than-normal interest rates to the poor. Of course, this raises the question of what is the normal and acceptable rate that can be charged to borrowers. But either way, when MFIs start charging their customers high rates in order to cover costs, and perhaps even earn profit, the customers inevitably suffer and are thus faced with increased difficulty in repaying higher interests and loans. When MFIs shift direction and aim at becoming profitable, or more than sustainable, they develop a tendency to hurt the very same group people that their institutions depend on for operations. The real aim of fulfilling social goals may be overshadowed by pure economic interests if MFIs would continue to pass on the burden of costs to their customers by charging high interest rates.
Despite its significant impact on poverty levels in third world countries, microfinance faces challenges in effectively alleviating poverty in developed countries Although it has been proven to improve the lives and increase the income of people across Asia and other developing countries in the world (Hossain and Knight, 2008; Chemin, 2008), it has faced difficulties in significantly impacting the poor in more advanced countries, such as the United States. A study conducted by Schreiner and Morduch (as cited in Carr & Yi Tong, 2002) reveals that there are two important factors which affect the performance of MFIs in the United States. They are: 1) the structure of U.S. economy, which is rather more complicated than those of developing countries and have more barriers to entry for microentrepreneurs, and 2) the small size of microenterprise sector in the country. Because of these factors, which make establishment and management of microenterprises difficult, a number of MFIs have closed down because borrowers could not repay their loans. Therefore MFIs in the United States (and other industrialized countries as well) must adapt a diversity of approaches to achieve the best structure of MFIs that can work well in countries, which greatly differ from developing nations (as cited in Carr & Yi Tong, 2002, p. 55). By analyzing the differences and difficulties faced by microentrepreneurs in various regions of the world, MFIs can become more effective in accomplishing their social and sustainability goals as they develop methods and services that can further help their clients.
Microfinance is defined as the provision of financial services to the poor, offering products that range from microloans, mortgages, insurance, and education loans, among others. It has been recognized by the World Bank and other multilateral organizations as an effective method of alleviating global poverty. A number of case studies conducted in Bangladesh, Indonesia, Africa, Latin America and other countries have already proven the positive impact of microfinance on the economic status of the poor, while recognizing its ability in empowering women, aiding social mobility, providing new knowledge through training, and contributing psychological benefits to these people.
Despite the positive benefits incurred by the poor, microfinance has its own issues and criticisms. Microfinance’s real impact on alleviating poverty at the global level is not supported by rigorous research, as critics claim. Stories of success are also not enough to accurately measure the extent to which microfinance has impacted the poor. MFIs are also criticized for charging high interest rates in the pursuit of becoming self-sustainable organizations because this decision ultimately affects their impoverished clients and borrowers. Meanwhile, MFIs in developed countries face challenges in effectively helping the people, as microfinance has not yet become the main tool in fighting poverty in these places. Because of more complicated economic structures, MFIs must adapt new approaches to be able to effectively serve and address the needs of their customers.
When understanding the capability of microfinance as an anti-poverty tool, it is important to remember that microfinance is not the only solution to global poverty. One cannot expect microfinance to singlehandedly eradicate poverty in the world as there are other variables aside from economic factors that contribute to the prevalence of poverty in our society. Just like any other anti-poverty program, microfinance has its own limitations and weaknesses, but this does not mean that efforts in promoting this financial tool must be completely abandoned. So far, it has improved the lives of thousands of families in various countries. That in itself is a great feat that is just as crucial as any other effort directed towards poverty alleviation. By empowering the poor and instilling in them a sense of self-respect, motivation, and drive to move out of poverty and achieve success, microfinance is definitely an effective poverty alleviation tool that has important implications in the future of the world’s low-income populations.
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