POVERTY AND MICRO-FINANCE

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Here we define poverty as an income (or more broadly welfare) level

below a socially acceptable minimum, and micro-finance as one of a

range of innovative fi nancial arrangements designed to attract the poor

as either borrowers or savers. In terms of understanding poverty a simple

distinction can be drawn within the group ‘the poor’ between the longterm

or ‘chronic poor’ and those who temporarily fall into poverty as a

result of adverse shocks, the ‘transitory poor’. Within the chronic poor

one can further distinguish between those who are either so physically or

socially disadvantaged that without welfare support they will always remain

in poverty (the ‘destitute’) and the larger group who are poor because of

their lack of assets and opportunities. Furthermore within the non-destitute

category one may distinguish by the depth of poverty (that is how far

households are below the poverty line), with those signifi cantly below it

representing the ‘core poor’, sometimes categorized by the irregularity of

their income.

In principle, micro-fi nance can relate to the chronic (non-destitute) poor

and to the transitory poor in different ways. The condition of poverty has

been interpreted conventionally as one of lack of access by poor households

to the assets necessary for a higher standard of income or welfare, whether

assets are thought of as human (access to education), natural (access to

land), physical (access to infrastructure), social (access to networks of

obligations) or fi nancial (access to credit) (World Bank, 2000: 34). Lack

of access to credit is readily understandable in terms of the absence of

collateral that the poor can offer conventional fi nancial institutions, in

addition to the various complexities and high costs involved in dealing with

large numbers of small, often illiterate, borrowers. The poor have thus to

rely on loans from either money-lenders at high interest rates or friends and

family, whose supply of funds will be limited. Micro-fi nance institutions

attempt to overcome these barriers through innovative measures such as

group lending and regular savings schemes, as well as the establishment of

close links between poor clients and staff of the institutions concerned.

As noted above, the range of possible relationships and the mechanisms

employed is very wide.

The case for micro-fi nance as a mechanism for poverty reduction is

simple. If access to credit can be improved, it is argued, the poor can fi nance

productive activities that will allow income growth, provided there are no

other binding constraints. This is a route out of poverty for the non-destitute

chronic poor. For the transitory poor, who are vulnerable to fl uctuations

in income that bring them close to or below the poverty line, micro-fi nance

provides the possibility of credit at times of need and in some schemes the

opportunity of regular savings by a household itself that can be drawn

on. The avoidance of sharp declines in family expenditures by drawing on

such credit or savings allows ‘consumption smoothing’. In practice this

distinction between the needs of the chronic and transitory poor for credit

for ‘promotional’ (that is income creating) and ‘protectional’ (consumption

smoothing) purposes, respectively, is over-simplifi ed since the chronic poor

will also have short-term needs that have to be met, whether it is due to

income shortfalls or unexpected expenditures like medical bills or social

events like weddings or funerals. In fact, it is one of the most interesting

generalizations to emerge from the micro-fi nance and poverty literature

that the poorest of the chronic poor (the core poor) will borrow essentially

for protectional purposes, given both the low and irregular nature of their

income. This group it is suggested will be too risk averse to borrow for

promotional measures (that is for investment in the future) and will therefore

be only a very limited benefi ciary of micro-fi nance schemes (Hulme and

Mosley, 1996: 132).3

The view that it is the less badly-off poor who benefi t principally from

micro-fi nance has become highly infl uential and, for example, was repeated

in the World Development Report on poverty (World Bank, 2000: 75).

Apart from the risk-aversion argument noted above, a number of other

explanations for this outcome have been put forward. A related issue refers

to the interest rates charged to poor borrowers. Most micro-fi nance schemes

charge close to market-clearing interest rates (although these will often

not be enough to ensure full cost-recovery given the high cost per loan of

small-scale lending). It may be that, even setting aside the risk-aversion

argument, such high rates are unaffordable to the core poor given their

lack of complementary inputs; in other words, despite having a smaller

amount of capital, marginal returns to the core poor may be lower than

for the better-off poor. If the core poor cannot afford high interest rates

they will either not take up the service or take it up and get into fi nancial

diffi culties. Also where group lending is used, the very poor may be excluded

by other members of the group, because they are seen as a bad credit risk,

jeopardizing the position of the group as a whole. Alternatively, where

professional staff operate as loan offi cers, they may exclude the very poor

from borrowing, again on grounds of repayment risk. In combination these

factors, it is felt by many, explain the weakness of micro-fi nance in reaching

the core poor.4

Even where micro-fi nance does reach the core poor, when (as in many

instances) donor or government funds are required to subsidize the microfi

nance institutions involved, it is not inevitably the case that this is an

effi cient strategy. As funds are fungible within households the use of the

loan is not the issue and what matters is the cost of transferring the funds

through a micro-credit institution per dollar received by the target group, as

compared with the benefi t–cost ratio for alternative schemes for reaching the

core poor, such as food subsidies, workfare, integrated regional development

initiatives and so forth. Such comparisons must take account of not just the

administrative costs involved, but also the leakage rate (that is the benefi ts

to the non-poor).

Given the new trends in the sector and their possible effect in diluting the

original poverty focus of MFIs the question of their impact on the poor

(and particularly the core poor) is clearly of great policy interest. It might

be thought that if such instititions are designed to serve only poor clients

and if repayment rates are high, no further detailed analysis is needed. Such

a view is misleading for a number of reasons. First, there is no guarantee

that only the poor will be served unless strong eligibility criteria (like land

ownership) are enforced. Often the aim is to dissuade the non-poor by the

inconvenience of frequent meetings or the stigma of being a member of a

credit group of the poor. Such disincentives may not work, and eligibility

criteria where they exist may not be enforced. Second, high repayment rates

may be due to social pressure within a group or family and may not refl ect

the capacity to repay (if for example loans from moneylenders have to be

taken out to repay the micro-credit). Third, even if the poor are genuinely

served by MFIs as long as public funds are required to fi nance the MFI

there is the issue of how cost-effective this means of reaching the poor

is, compared with alternatives. Hence for these sorts of reasons there is a

strong case for attempting to assess the impact of such loans on the welfare

of the target group.

Nonetheless assessing the true relationship between micro-fi nance services

and poverty reduction is not straightforward. It is not simply a case of

looking at a group of borrowers, observing their income change after they

took out micro-credits and establishing who has risen above the poverty line.

Accurate assessment requires a rigorous test of the counterfactual – that

is how income (or whatever measure is used) with micro-credit compares

with what it would be without it, with the only difference in both cases

being the availability of credit. This requires empirically a control group

identical in characteristics to the recipients of credit and engaged in the

same productive activities, who have not received credit, and whose income

(or other measure) can be traced through time to compare with that of the

credit recipients.5 Furthermore, to allow for changes over time, in principle

assessments should allow for the possibility of reversals, with households

slipping back below the poverty line if the productive activities fi nanced by

the credits are unsustainable. Studies based on a rigorous counterfactual

find much smaller gains from micro-finance than simple unadjusted

before-and-after type comparisons, which erroneously attribute all gains

to micro-credit.

Here we examine some of the recent rigorous studies on the impact

of MFIs based on various survey data. We do not report the results of

work based on more qualitative or participatory approaches.6 Table 7.2

summarizes the results of the studies surveyed here.