It’s been almost five decades and microfinance has been implemented in many different countries to achieve its goal of providing financial services to low-income individuals to ultimately allow them to become self-sufficient. Because microfinance has become so big, some are believing that it is having extreme positive or negative effects on communities when in reality there have been no transformative effects. Microfinance is not making economically disadvantaged communities self-sufficient because there is a lack of financial education, loans are used for everyday essentials, and the financial services provided are not geared to the needs of each specific community.
What is Microfinance?
Before we look into microfinance we need to understand what being unbanked means.
Microfinance was created to provide banking services such as micro-insurance, micro-savings, and microloans to those who have no access to banks. The concept of microfinance can be seen below:
Through more available services, impact investors expect individuals to create businesses to increases household income and improve overall well-being.
Lack of Financial Education
Even if loans have become more readily available, those without the knowledge of managing money will have a hard time saving and growing. The poor are engaged in various income-generation activities which require them to make financial choices, so the deficiency of financial literacy will have a negative impact on their financial welfare like going into debt instead of escaping poverty. After taking out a loan, they will have to manage both business and household expenses and this is where the importance of financial education is highlighted (Mali, 2022, p.112). Further developing this idea, Lyons, Garbie, and Zeng (2019) indicated a study that showed higher levels of financial literacy were associated with better financial inclusion. The effects were mostly seen in countries with lower income levels, less developed financial sectors, and fewer bank branches (p.8). Increasing financial inclusion isn’t helpful if the poor aren’t educated because education is what will allow them to fully utilize the benefits of microfinance.
Benefiting Entrepreneurs Over The Destitute
As you can see above, “Gung-ho” entrepreneurs, which are individuals who already have businesses, are benefiting from microloans by getting more profit and business activity than those who actually need it. In a study that included seven countries, five showed an increase in revenues, investments, and assets. Profits only increased by 22 percent in Morocco and India; the ones who benefited the most were big businesses and those who owned livestock (Martin, 2018, para.11). Also, data collected from a survey done by BIDS and the World Bank in 1991-1992 showed that the extremely poor did not benefit from microfinance as much as the moderately poor did (Westover, 2008, p.6). Microfinance is not having transformative effects because those who are poor don’t have anything to invest in.
Used For Everyday Consumption
What most impact investors did not take into account is that the poor are using loans for basic necessities throughout the day like a sudden big purchase, emergencies, paying back other loans, or putting food on the table. This is similar to the idea of borrowing from relatives, neighbors, and friends except that microcredit is more reliable and consistent. They can depend on this financial service when they are in need and then take their time to pay it back slowly (Wykstra, 2019, para.34). A study that covered almost 2000 households in Bangladesh showed that those who are able to borrow did not have higher consumption levels than control households. They also had lower variation in labor supply, so you can see that microfinance mainly helped reduce financial vulnerability, not poverty (Westover, 2008, p.6). Though Mohammed Yunus believed that all humans are born entrepreneurs, most individuals in economically disadvantaged communities will put more importance on surviving another day than innovating.
Possible Solutions
For microfinance to achieve its goal, it needs to begin with changing and increasing the services that are available. Things like changing policies and regulations, producing more flexible lending products, creating micro-saving and micro-insurance services, and holding mandatory financial literacy classes may help decrease poverty more than how microfinance currently is. Researchers found that giving loaners 2 months before they have to start repaying allowed them to invest more into their businesses resulting in higher income in three years. For communities that are agriculture-based, making financial services tailored to that context can improve the impact of microfinance (Martin, 2018, para. 23). It is crucial to make financial literacy classes available to the impoverished through the different microfinance companies. From there you can enforce a policy that potential borrowers have to take the classes before they are allowed to take out loans ensuring that there is transparency and that the loaners know what they are getting into. But as Costello (2023) states, “financial services are not a silver bullet to solve poverty.” Many of the problems that economically disadvantaged communities are facing are drought and famine. These things can’t be solved by loans. Instead addressing the specific issue through infrastructure-level projects by the government might be more helpful. In some areas, charity or grants might have more of an impact to take a whole community out of poverty. To make the necessary changes in microfinance services, it is important to do research in each community it is implemented because they all have different needs.
Other Viewpoints
Some argue that microfinance is having positive transformative effects to the point where it is taking people out of poverty. This belief comes from many anecdotes of success stories. For example, in a recent letter from FINCA, an organization that does microloans in small countries, Benita Chikaluma’s told her story of how microloans saved her from poverty. After her husband died, she had to start making money herself, so she took a $25 loan and built a business. Now she owns a home of her very own (Casselman, 2015, para.1). Anecdotes like this are very powerful and inspiring, however, success stories like these are often chosen for their emotional appeal and it does not represent the majority of borrowers (Haase, 2013, p.4).
Others believe that microfinance doesn’t alleviate poverty but instead puts them into a vicious debt cycle. This is because of news that banks are pressuring borrowers to sell their land and homes to repay their debt. Some also believe that the recent increase in suicide rates are also a cause of microfinance (Finch, et al., 2022, para.7). In reality, there has been no research done to show that microfinance and the suicide rates are correlated. Also, six microcredit studies that were done in six different countries in 2015, showed results that proved there was “a consistent pattern of modestly positive, but not transformative, effects” (Wykstra, 2019, para.28). This counters the backlash microcredit has been facing because it proved that microfinance did not have a negative impact like trapping people in debt and putting them in a worse financial position.
Conclusion
Microfinance has blown up considerably since its making but unfortunately, it still has not reached its goal to alleviate poverty once and for all in economically disadvantaged communities. There have been some positive effects like decreasing financial vulnerability for the poor but the reason for no transformative effects is because of the lack of financial education, loans are used for everyday essentials, and the financial services provided are still not tailored to the specific situation in each community. We need to address these problems to achieve the goal of microfinance giving poor individuals a chance to escape poverty.