Microfinance’s Viability as a Social Impact and Poverty Alleviation Tool

There is some debate regarding the actual impact of microfinance. One example of this can be seen if one simply compares the “escape from poverty rate” of borrowers and non-borrowers. In this case, one fails to consider the self-selection of borrowers, i.e. those with entrepreneurial tendencies will have a higher propensity towards borrowing (Chowdhury, 2009). This will naturally have a tremendous effect on the measurement of a fund’s impact. In addition, if one considers the “escape from poverty rate” to be the single meaningful measure of a fund’s success, one would be ignoring the other tenets of economic development, and thus disregarding some of economic development’s larger goals.

Poverty alleviation should have other positive corollary effects on society, namely an increase in the number of children enrolled in school, increase in public health metrics, etc. However, there is a number of contrasting research to be found in this area. In example, an extensive study found that 62% of school-aged sons from Grameen Bank borrowers attended school, compared to just 34% of non-borrowers (The Economist, 2009). In comparison, a 2009 study, by Banerjee, Duflo, Glennerster and Kinnan, determined that microfinance had no impact on current measures of health, education, or a woman’s decision-making in the slums of the Indian city of Hyderabad. Proponents argue that, given microfinance’s relatively short history and a lack of understanding of banks and financial services amongst target groups, one can only truly evaluate the success of microfinance in its most developed markets, where potential borrowers are familiar with the concept and loans of microfinance institutions are a ubiquitous part of the economy. In Bangladesh, the world’s most developed microfinance market, a study found that microcredit was responsible for 40% of the total poverty reduction in rural areas, and had positive corollary effects as it reduced moderate poverty at a rate of 1% annually, and extreme poverty at a rate of 1.3% (Khandker, 2003). Again, many economists and scholars find these numbers to be misleading, and believe that those involved in microfinance have dramatically oversold it as an anti-poverty tool. A 2006 World Bank Study found that Bangladeshi women, who received microcredit only experienced an annual income increase of 8 Taka (Bangladeshi currency) for every $100 borrowed, which represents a $0.03 per day increase in income. Consequently, a 1.5% increase in income for someone surviving on only $2 a day is seemingly insignificant (Khandker, 2006 and Roodman & Quershi, 2006).

The consensus amongst economists appears to be that microcredit and microfinance have potential as tools for development, but cannot considered to be a method that can replace the state’s important role in economic development (Chowdhury, 2009). Microfinance funds need to reassess their business models, as they should attempt to find successful microenterprises and microentrepreneurs and provide them with access to capital, as they are shown to be more successful than the very poor in properly utilizing their loans (Easterly, 2006). Additionally, microfinance funds cannot operate in a vacuum and must be cognizant of macro and microeconomic factors when investing (Chowdhury, 2009). Therefore, an examination of the four main issues regarding microfinance is required to gain a better grasp of the field.

Observations and Recommendations:

The problems surrounding microfinance seem to be a combination of several factors. Microfinance institutions fail to adequately assess and understand target markets, the prioritization of financial sustainability over social impact, the fact that borrowers are self-selecting, and funds generally fail to consider macroeconomic variables.

While microfinance institutions’ intentions are noble, they often fail to properly research and understand their target markets before beginning lending activities. Often, they fail to understand that microcredit only functions in areas with a well-functioning and growing domestic market, as without the requisite consumer base, there is no room for expansion (Pollin & Feffer, 2007). Simply having access to capital is useless, if there is no infrastructure in place, i.e roads, to support entrepreneurs and business activates. And because the majority of microfinance funds prioritize financial sustainability over social impact, they normally approve a number of loans that are far in excess of what the local economy can support, in order to diversify their investment (Bateman & Chang, 2009). While this practice is financially sound in developed economies, the same does not hold true in developing countries. By providing loans to such a great number of people, the fund floods the local economy with a plethora of in-efficient microenterprises, which must engage in cost-cutting measures to remain competitive. These cost-cutting measures usually hinder the development of, and take away, market share from more efficient local small and medium enterprises (SMEs), which, in the long-run, have much greater potential as a poverty-reduction tool (Bateman & Chang, 2009).

An example of this phenomenon can be found in a scheme to provide rural Bosnians with a microloan so that they can purchase a cow. The increase in the supply of milk contributed to a significant decline in the overall price. The combination of an oversupply with a price decrease, diminished the market share and income of larger local dairy farms, which in turn effected their ability to purchase and invest in new equipment, stock, and labor (Agripolicy, 2006). Consequently, this measure had an overall negative effect on development. It is quite clear that this fundamental misunderstanding of scale economics has the potential to destroy entire industries.

Therefore, funds need to reassess their lending policies and perhaps work with the local government, instead of bypassing it, to determine areas where microfinancing has the capacity to produce social impact. Funds would do well to focus on successful microenterprises that exist within the “informal economies” in developing countries. To this effect, Bateman & Chang argue that the economic development achieved by all nations throughout history, both in the 1800s and in the last couple of decades, was a product of government coordination, in monetary and fiscal policy, investment, and in some cases by state led capitalism –see the “tiger economies” (2009 and Witt, 2012). Providing established entrepreneurs with capital, after a critical assessment of the local market’s growth potential, would allow these SMEs to expand, and in the process, employ more people and bring more trade to the area (Ditcher, 2006). Utilizing such an approach also decreases the possibility that the loans are used for “consumption smoothing”, a process where the loans are not put to their intended purpose, but towards things like tuition fees, healthcare costs, and weddings (Bunting, 2011).

Concluding Thoughts:

Microfinance certainly has the potential to have an meaningful impact on economic development, especially in areas that are underserved by the current development programs operated by governmental and international organizations. The onset of the digital age will help solve a lot of the problems currently facing Microfinance and part two of the series will concentrate on how Fintech can redefined the industry, whilst simultaneously increasing Microfinance’s potential impact.

About the Author

Haden Garth Cosman is a master’s student in International Business – Strategic Management and Consulting at the CBS International Business School. In his current role at CASM, he is primarily responsible for the management and support of research and other assorted publications. He completed his bachelor’s in International Political Economy, with a focus on Economic Development, and German Language at Fordham University in New York, and has professional experience in the finance and consulting sectors on both sides of the Atlantic.


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