Microfinance as a Poverty Reduction Tool
Lecture 7


Introduction
•Professor Mohammad Yunus, the founder of Grameen Bank in Bangladesh and the originator of the
concept of microfinance, believes that 5% of Grameen Bank’s clients exit poverty each year.
However, there are surprisingly few credible estimates of the extent to which microcredit actually
reduces poverty
•Entrepreneurship is the fundamental basis of the microfinance approach to poverty alleviation.
•As Bruton et al. (2013: 688) state, ‘market-based solutions such as entrepreneurship offer the
best opportunity to create substantial and significantly positive change within poverty settings’.

Definitions of Microfinance
•The Journal of Microfinance describes it as what “is arguably the most innovative strategy to
address the problems of global poverty” (Woodworth and Woller, 1999). The General Secretary of the
United Nations, Kofi Annan, stated in 2002 that microcredit is a critical anti-poverty tool and a
wise investment in human capital (Annan, 2002).
•“Microfinance has evolved as an economic development approach intended to benefit low-income women
and men. It refers to the provision of financial services to low – income clients, including the
self employed” (Ledgerwood, 2000).
•The word “microcredit” was not existent before the seventies. But now it has turn out to be a
buzz-word among the development practitioners. It is normally characterized as making small loans
available directly to small-scale entrepreneurs to enable them either to establish or to expand
micro-enterprises and small businesses. Microcredit is normally applied to target groups that would
otherwise not qualify for loans from formal institutions. This includes the majority of those
living below the poverty line (Commonwealth Secretariat, 2001).

Characteristics of microfinance
•Small amounts of loans and savings
•Short- terms loan
•Payment schedules attribute frequent installments (or frequent deposits)
•Installments made up of both principal and interest, which is amortized over the course of time.
•Higher interest rates on credit
•Easy entrance to the microfinance intermediary saves the time and money of the client and permits
the intermediary to have a better idea about the clients’ financial and social status.
•Application procedures are simple.
•Short processing periods (between the completion of the application and the disbursements of the
loan).
•The clients who pay on time become eligible for repeat loans with higher amounts.
•The use of tapered interest rates (decreasing interest rates over several loan cycles) as an
incentive to repay on time. Larger loans are less costly to the MFI, so some lenders provide large
size loans on relatively lower rates.
•No collateral is required contrary to formal banking practices.

The impacts of microfinance
•David Hulme and Paul Mosley (1996). Poor households do not benefit from microfinance; it is only
non-poor borrowers (with incomes above poverty lines) who can do well with microfinance and enjoy
sizable positive impacts
•More troubling is the finding that a vast majority of those 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
•Credit is only one factor in the generation of income or output. There are other complementary
factors, crucial for making credit more productive. Among them, the most important is recipient’s
entrepreneurial skills.
•Banerjee et al (2007) say, most poor people do not have the basic education or experience to
understand and manage even low level business activities. They are mostly risk-averse, often
fearful of losing whatever little they have, and struggling to survive

•Aneel Karnani (2007: 37) summarizes this point as follows: “Most people do not have the skills,
vision, creativity, and persistence to be entrepreneurial.
•According to Vijay Mahajan (2005), a social entrepreneur “Microcredit is a necessary but not a
sufficient condition for micro-enterprise promotion. Other inputs are required, such as
•identification of livelihood opportunities
•selection and motivation of the micro-entrepreneurs
•business and technical training
•establishing of market linkages for inputs and outputs
•common infrastructure and some times regulatory approvals.
•In the absence of these, micro-credit by itself, works only for a limited familiar set of
activities – small farming, livestock rearing and petty trading, and even those where market
linkages are in place.”

Criticisms to microfinance
•Microfinance led to increasing levels of indebtedness among already impoverished communities and
exacerbated economic, social and environmental vulnerabilities
•Inability to repay loans eroded the assets of the communities and led to poor health outcomes
while undermining household relations and social capital
•People mostly use credit for consumption purposes not investments
•