The Impact of Microfinance

How poor is the world?

In 2013, 10.7% of the world’s population lived on less than US$1.90 a day. By fall 2015, for the first time in history, less than 10% of World's population was living in extreme poverty — down from 37% in 1990 and 44% in 1981. For its latest estimates, The World Bank used an updated international poverty line of US $1.90 a day, which incorporates new information on differences in the cost of living across countries (the PPP exchange rates). The new line, however, preserves the real purchasing power of the previous line (of $1.25 a day in 2005 prices) in the world’s poorest countries. 

While poverty rates have declined in all regions, The World Bank emphasizes that the progress has been uneven :

• The reduction in extreme poverty between 2012 and 2013 was mainly driven by East Asia and Pacific (71 million fewer poor) — notably China and Indonesia — and South Asia (37 million fewer poor) — notably India. 
• Half of the extremely poor live in Sub-Saharan Africa. The number of poor in the region fell only by 4 million with 389 million people living on less than US$1.90 a day in 2013, more than all the other regions combined. 
• A vast majority of the global poor live in rural areas and are poorly educated, mostly employed in the agricultural sector, and over half are under 18 years of age. 
• As for the US — more than 45 Million Americans are still living below the poverty line.

Extensive poverty in absolute numbers is both a significant inhibitor of harmonizes global growth and an opportunity for businesses and governments to expand the consumer realm without sacrificing long-term prosperity and wellbeing of the poor of the world.

Over the past decades, financial institutions have been developing a range of products to meet the diverse needs of this broad and underserved market across regions. Efforts in public and private sectors lead to nearly 1.1 billion people being able to move out of extreme poverty since 1990. 

The emergence of microfinance as the answer to poverty

Microfinance — the provision of financial services to low-income people — has long been considered to be a strong tool in facilitating financial inclusion and building long-term resiliency in the face of unexpected hardships for vulnerable individuals and households around the world — in developed and developing countries alike. In 2016, banks catered to only \ of the 33% total number of borrowers for microfinance globally.

According to the Convergences Microfinance Barometer Statistics, the global micro lending landscape has been experiencing a slow but steady growth. In 2016, microfinance institutions (MFIs) reached 132 million low-income clients with a loan portfolio worth US$102 billion. The total number of borrowers in the global microfinance space is estimated to reach 151.2 million in 2018.

Consultative Group to Assist the Poor (CGAP) describes typical microfinance clients as having low incomes and often being self-employed in the informal economy, conditions that together typically deny them access to banks and other formal financial institutions. They commonly run small stores or street stalls, create and sell items they make in their homes, and in rural areas, microfinance clients may be small-scale farmers and those who process or trade crops and goods. 

Microfinance clients are often just below or above the poverty line, commonly defined as earnings of US$1.25 a day (the updated line is at US $ 1.90, and women constitute a majority of borrowers.

Microfinance is associated with the name of a Nobel Peace Prize winner Muhammad Yunus, a Bangladeshi social entrepreneur, banker, economist, and civil society leader, who pioneered work in giving tiny loans to millions of poor people no commercial bank would touch -- to destitute widows and abandoned wives, landless laborers, rickshaw drivers, sweepers, and beggars. As the NY Times reported in 2006, the Nobel Committee praised Mr. Yunus, who was 66 at the time, and the Grameen Bank (Bank for the Poor, as it titles itself), which he founded in 1983, for making microcredit a practical solution to combating rural poverty in Bangladesh and inspiring similar schemes across the developing world.

“Yunus was one of the early visionaries who believed in the idea of poor people as viable, worthy, attractive clients for loans,” said Elizabeth Littlefield, who at that time led CGAP. “That simple notion has put in motion a huge range of imitators and innovators who have taken that idea and run with it, improved on it, expanded it.”

It’s interesting that the impact of microfinance varies depending on where in the defined poverty group the beneficiary is. Microfinance projects in their waves and iterations had very mixed results for financially challenged, excluded and highly disadvantaged groups, as well as economies of developing nations where extensive studies have been conducted in the past decade. 

While the concept of microfinance has noble roots, the only way to understand just how far does it go in helping the poor of this world is by looking at real-world examples of extensive studies performed to examine the impact of microfinance on individuals, households, and their communities.

The impact of microfinance — going beyond formal poverty lines

Microfinance projects have been studied and measured for decades, leaving little to no ambiguity regarding their impact on individuals, communities, and economies. Some of the well studied and analyzed projects include the ones from Bangladesh (the cradle of the concept), Philippines, Uzbekistan, Pakistan, Canada and Ghana. 

The universal measurement of success in the microfinance space has been the number of people formally lifted from poverty (leave on means above the established poverty line) in the period after the period the funds are delivered. Because income and expenditure are the basic measures of household welfare, the evaluation of the impact of microfinance almost always relies on changes in these variables.

This measurement, however, does not take into account qualitative results, or long-term implications of microfinance initiatives. It also does not consider cultural and household structure hallmarks, and the impact of the way funds are used — whether they multiply future income or end up being a one-time injection that accumulates debt. 

There is an abundance of data on how microfinance initiatives impacted the financial standing of the borrower and his/her household, while the qualitative results and long-term impact remain largely in the shade. 

In a paper called Understanding the Effects of Microfinance on Female Empowerment in Bangladesh, researchers outline a wide variety of dimensions along which the impact of microfinance can be measured to reveal the complexity of that impact — with both expected positive and unexpected negative implications. 

A microfinance initiative run by the Bangladesh Rural Advancement Committee (BRAC) and its partners to extend access to funds to women found that the males in the family were the actual main utilizers of the borrowed money in the households. Almost all of the female borrowers of BRAC relinquished their capital to their male family members — 53% of women who had a microfinance loan didn’t actually use their loans themselves. 

In contrast, results of a study in the Philippines revealed that women received either all or most of the cash of households. More than half of the women participating in the focus groups said that cash was mostly controlled by women while almost a third said that it was done jointly by men and women.

Given that BRAC only gave money to women if they could prove that they had a male family member who is able to work, the result for BRAC’s microfinance initiative may are not entirely unexpected — the terms of providing microfinance put the target audience in a highly disadvantageous position from the get-go. As a result, when a husband or a son gets ill and is unable to work, the women have difficulty paying back their loans. Researchers found that 55% of women enrolled in a microfinance program, were contributing financially to their households. 37% of women not enrolled in a microfinance program earned money with non-household activities. Further qualitative research even revealed that household violence became more adamant when women joined a microfinance program and gained (financial/social) independence.

The problem with deep inequality is not necessarily a microfinance problem, as a different project and study show : in Bangladesh, participation in the Participatory Livestock Development Project was reported to have helped the women start or sustain income-generating activities.

Different studies on the impact of this microfinance project on reducing poverty had mixed, but consistently moderate results: in the earlier study, 5% of the participants were able to escape poverty annually. In a subsequent study, the corresponding impact was an 8.5% reduction in moderate poverty and an 18% reduction in extreme poverty. Evidence was also found of positive spillovers on non-program participants in the villages.

One of the interesting findings of numerous studies was that women in compromised household statuses, as the researchers called divorcees, were able to empower themselves economically by starting a business because of their positions. Household consumption increases by about 20% after a microfinance loan is taken by a woman and used primarily by a woman.

A different paper — Effect of Micro finance Operations on Poor Rural Households and the Status of Women by the Asian Development Bank (ADB) assesses the results of a range of microfinance projects that took place over decades in Bangladesh, Philippines, and Uzbekistan. 

Studies on the impact of microfinance in mentioned countries measure the impact on per capita income, per capita expenditure, and per capita food expenditure. They found that that the impact declines with age, but the rate of decline slows down. Another important result is that per capita income, per capita expenditure, savings, and per capita food expenditure is positively affected when the gender of the reference person (or head) of the household is female — results that have been confirmed in other assessments. 

ADB’s research paper also outlines the role of the level of education — the effect was significantly different from those without education only when the reference person has a college education. The impact was only found for per capita income and per capita expenditure. 

Studies also found that changes in income or expenditure do not necessarily translate into increased investments in human capital. In fact, there was no significant difference in the education and health variables between the households that had access to microcredit and those that did not.

One of the most important results shared by ADB on the overall impact of microfinance across socio-economic groups (divided into four quartiles depending on per capita income) is that a significant positive impact was evident only for the households in the top quartile while there was a negative impact on the poorer households. The results were similar for the per capita expenditure, savings, and food expenditure. The impact on savings is significant for all except the third quartile in contrast to the insignificant impact for the whole sample.

Explaining why the impact on the lower income households is lower (or negative), the study outlines the following possible reasons:

1. The problem clients are concentrated among the poorer households.
2. The average size of loans may be smaller for poorer households. The average loan size for poorer households is smaller. This may prevent them for venturing into more productive activities that would require more capital.
3. There may be a preponderance of diversion of loan proceeds from production to consumption.
4. If there is no diversion, the projects of poorer households may be less productive.

The regressive relationship provides further evidence that microfinance projects should not be designed to target the ultra poor. Additional debt may make their lives worse, not better, the study emphasizes. 

In fact, most microfinance projects have rather restrictive qualifiers, either deepening inequality within a household, or requiring them to have an operating business to be eligible. Unless criteria and terms are changed to target specifically the poorest of the poor, microfinance projects are still somewhat close to traditional credit products in the ability to facilitate inclusion and alleviate poverty. 

Even if projects are starting out with the goal to assist the poorest of the poor, absence of clear socio-economic definitions and inability to assess the target audience (which is mostly in rural areas) across pre-defined criteria pushes projects towards the enterprising poor — households with operating businesses. 

Going back to the evaluation of the impact of microfinance, worth mentioning some of the (more positive) financial results in Uzbekistan: In Uzbekistan, 85% of the sample microfinance clients that participated in non-ADB supported projects responded that their incomes increased after joining the program. Expansion of existing enterprises and sales increases were the main reasons cited for the income increases. About 71% reported that the quantity of food intake increased after receiving a loan. In terms of financial assets, the respondents reported that more capital was invested in their businesses and saving increased.

In Uzbekistan, the measurement of asset acquisition and ownership indicated an increase in physical asset ownership after the women joined the microfinance program.  . They were able to purchase appliances, livestock, improve the business premises, and repair their houses. Prior to participation, these women relied on their husband’s salary. After receiving microcredit, they were able to augment household income through their businesses. However, this business income was reported to be unstable. Additionally, in Uzbekistan, prior to participation, women had secondary roles in making expenditures and saving for decisions. After gaining access to microcredit, most of these women took on greater responsibilities as they contributed more to financing household needs such as education, health, and food.

Studies by ADB and a great variety of other organizations have the depth and breadth in their assessment of the impact of microfinance across variables beyond the ability to life households above poverty lines. Some of the most important learnings from these studies are that the impact of microfinance on reducing poverty and empowering highly disadvantaged groups of the population varied greatly depending on a range of qualitative and quantitative factors. Culture, religion, marital status, education, country — all of this impacts the results dramatically. 

Additionally, there is a reasonable doubt that microfinance has a positive impact on the poorest of the poor. Currently, over 800 million people globally experience extreme poverty. Whether microfinance is the answer for them is still not entirely proven because historically, microfinance projects had qualifiers that the extremely poor cannot meet. 

Does microfinance have the actual capacity to reach the poorest of the poor?

"Money begets money. If you don't have that, you wait around to be hired by somebody at the mercy of others. If you have that money in your hand, you desperately try to make the best use of it and move ahead. And that's generating income for yourself.”

This logic is not universally applicable for at least the following reasons:

1. A desire to make the best of available funds is a very broad spectrum. For some, making the best out of credit is buying food, for others — repairing the roof above one’s head, covering other debt (for example, losses from a low harvest or lost crops), etc. However, access to microcredit did not have a significant impact on nonfood expenditure.
2. To generate income from credit requires one to have at least basic financial literacy (we are not talking about any entrepreneurial skills as they do not guarantee positive results), ability to access other essential financial products (insurance, for example), and at least an ability to responsibly manage own business if the money is intended to ensure independence. 

To put into context one the most basic things a microfinance service benefactor needs to have to turn credit into sustainable income — financial literacy, — even in the countries with the highest financial literacy rates (which are Australia, Canada, Denmark, Finland, Germany, Israel, the Netherlands, Norway, Sweden, and the United Kingdom) more than a third of adults do not fall into the category of financially literate (only about 65% of adults are financially literate in those countries). On the other end of the spectrum, South Asia is home to countries with some of the lowest financial literacy scores, where only a quarter of adults - or fewer - are financially literate.

Findings of a study published by NYU almost 20 years ago still seem quite relevant when it comes to the effect of microfinance; similar results have been found in different, decade-long, studies in the developing world. While there was evidence to support the positive impact of microfinance on poverty reduction, especially on income smoothing and income increases, researchers expressed doubts about the actual capacity of MFIs to reach the poorest of the poor. 

Following were some of the key findings with regards to the effects of microfinance on poverty reduction:

• Microfinance is not for everyone. Sick, mentally ill, and destitute are not good candidates for MFIs, but they should instead receive direct assistance;
• Microfinance can be effective also for the poorest because there is no proof of either an inverse relationship between a client’s level of poverty and their entrepreneurial skills or minor inclination to save among the poorest;
• It is not true that only people with an existing entrepreneurial activity can benefit from microfinance;
• MFIs enable the poorest to improve their socio-economic conditions only if an appropriate program design and targeting are implemented;
• Impact of microfinance can increase when it is provided together with other social services such as education and health.

One thing remains broadly valid — while access to microcredit seems to have an overall positive effect on income and education, results differ substantially across countries and programs both in magnitude and statistical significance and robustness. Overall, the positive impacts on income are more significant for better off borrowers..

“Whilst microfinance clearly may have had positive impacts on poverty it is unlikely to be a simple panacea for reaching the core poor. Reaching the core poor is difficult and some of the reasons that made them difficult to reach with conventional financial instruments mean that they may also be high risk and therefore unattractive microfinance clients.” -

Opportunities

What wasn’t explicitly expressed by researchers is that the most significant impact of microfinance is in a different dimension, — it goes beyond creating a new class of financial products and selling it in a traditional manner. Microfinance redefined the way the banking system sees its customer base. Low income individuals are now understood to be proactive customers who demand value, and serving them requires improved and agile business models.

What’s more important, microfinance as a concept paved the way for financial technology (and just technology) companies to enter the big world of institutional banking in a form that we see in 2018 (a potpourri of solutions all entering the finance world from the back door, and redefining consumer markets). Tech companies built a bridge into finance exactly as microfinance became a "thing" by targeting a very unusual demographic. Whole sectors have been invented and developed as a result of this new push to bring new potential consumer demographics into the light, connecting them to the world of financial services and products.

Overall, MFIs and FinTechs face common key challenges such as the crucial importance of building trust around new digital financial services and appreciating that doing so takes time, and ensuring reliable and stable service delivery. 

The World Bank emphasizes that the latter is often limited by poor telecommunications and energy infrastructure, especially in remote areas. Providers should establish communication channels and complaint resolution mechanisms that can address their customers’ risk perceptions and issues, including the inability to transact during network downtime, complex and confusing user interfaces, poor customer recourse, and opaque fees. 

The World Bank suggests that MFIs and FinTechs should also consider using approaches such as assisted digitization (step-by-step demonstrations of processes, showing transactions in passbooks or receipts) to help the clients transition to digital financial services.

“As new customers engage with formal financial services, they build the capability to interact responsibly with these services. But instilling these customers with trust and confidence in the provider, and in formal financial systems, is not automatic. Trust and confidence are outcomes of a successful design and an embedded customer-centric approach.” - Revolutionizing Microfinance: Insights from the 2017 Global Symposium on Microfinance, The World Bank

Conclusion

Mixed results of microfinance projects around the world support what CGAP emphasizes as the link between microfinance and financial inclusion: poor households need access to the full range of financial services to generate income, build assets, smooth consumption, and manage risks — financial services that a more limited microcredit model cannot provide. The term microfinance in its traditional sense is no longer adequate in addressing the needs of the poor, and, as extensive studies have proved it, can have an adverse impact on individuals and communities where a mere extension of funds deepens inequality and weakens long-term opportunities for the financial wellbeing of poor individuals and families.