MICROFINANCE PAPER WRAP-UP: Microfinance as a Poverty Reduction Tool – A Critical Assessment by Anis Chowdhury

Written by Anis Chowdhury, Professor of Economics at the University of Western Sydney, Australia and Senior Economic Affairs Officer at United Nations Department of Economic and Social Affairs (UN-DESA); DESA Working Paper No. 89; December 2009; 13 pages, available at www.un.org/esa/desa/papers/2009/wp89_2009.pdf

This working paper debates the effectiveness of microfinance as a tool for poverty reduction. The author begins by describing how there exist conflicting opinions and very few credible studies that have analyzed to what degree microfinance loans reduce poverty. Impact analysis in a limited number of previous studies has shown that microcredit loans do not decrease poverty. Instead, results show that, “a vast majority of [borrowing households] with starting incomes below the poverty line actually ended up with less incremental income after getting micro-loans, as compared to a control group which did not get such loans.” However, Chowdhury points out that credit is not the sole factor at play when determining microfinance’s success in boosting household income. There are, in fact, a plethora of complementary factors that are essential for microcredit loans to be more effective. On the supply side, these micro-loans are more beneficial when microfinance institutions (MFIs) also offer services for management, entrepreneurial, and basic education training. On the demand side, which still remains largely unrealized in the sector, small businesses require “a vibrant, well-functioning domestic market that encompasses enough people with enough money to buy what these enterprises have to sell.” Thus, microfinance loans, by themselves, cannot simply make poor households successful. Rather, they are most effective when combined with innovative complementary factors.

Chowdhury also discusses the heavy criticisms against the interest rates charged by MFIs. Critics of microfinance argue that these institutions charge far too high of an interest rate, which often ranges from 30 to 100 percent on an annualized basis. MFIs or non-governmental organizations (NGOs) that are able to charge lower interest rates are only able to do so due to subsidization. MFIs justify higher rates based on their arguments that high interest rates help attract investors, and that MFI interest rates are still far better than alternative options, such as borrowing money from local moneylenders at even higher interest rates. Other criticisms in the industry include arguments that MFIs are still exclusionary, since they fail to provide services to the poorest of the poor.

Despite such skepticism towards the effectiveness of microfinance programs, the author contends that microfinance has proven to be successful in encouraging consumption-smoothing behavior, and in providing a risk-coping safety net for those most susceptible to vulnerability shocks. It has also helped distribute financial power away from local loan sharks, empower especially female borrowers, and boost clients’ self-esteem.

Chowdhury concludes by claiming that impact analyses show that borrowers who hold advantages, such as business skills, entrepreneurship abilities, and education, are the borrowers that are most likely to succeed in rising above the poverty line. Thus, he argues that microcredit loans ought to be geared toward small businesses in the informal sector, rather than toward those who lack assets and entrepreneurship abilities. Finally, for such schemes to make a significant impact in poverty reduction, the author recommends that public policies ought to focus more on broad growth programs that intend to increase overall productivity and levels of employment. He calls to attention the importance of government involvement in designing and operating financial schemes, and believes that only through the combined efforts of the financial sector and government can poverty reduction be realized.

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