Introduction

Poverty reduction remains the central focus of the development community, and significant progress has been made in reducing extreme poverty. Still, the world’s poor are financially isolated and lack access to basic financial services. According to the Global Findex, a database created by the World Bank that tracks global adult financial behavior, around 1.7 billion adults remain unbanked, “without an account at a financial institution or through a mobile money provider” (World Bank, 2017).  As a result, the poor have no choice but to resort to informal moneylenders (local wealthy individuals) who charge astronomically high interest rates. Such high borrowing costs are detrimental to the savings of the poor, and often capture borrowers in a perpetual cycle of debt. In recent decades, many development economists have focused on improving access to formal credit markets for the poor, and lowering the cost of borrowing through microfinance. Initially embraced by Bangladeshi economist Muhammed Yunus, microfinance seeks to promote financial inclusion by providing small-scale loans and other financial services to the poor, who are excluded by the traditional banking system due to their unpredictable income and risky financial behavior. Microfinance includes many different financial services like microcredit (a loan to start a business or pay for emergency medical expenses) and microinsurance (crop insurance to protect against volatile weather cycles).

Many posit that microfinance is a promising development tool that fosters entrepreneurship and offers opportunities for the poor to break out of the ‘poverty trap’. An analysis of microfinance at the village level in Bangladesh finds that “microfinance continues to reduce poverty among poor borrowers” and it “raises per capita household consumption” (Khandker, 2005). Another group of economists argue that microfinance institutions are inherently unsustainable due to extremely high operating costs and a poor operating model. Moreover, many assert that the growing commercialization of the microfinance sector has led to coercive lending practices and the exploitation of the poor. There is an ongoing debate around the true impact of microfinance programs, many arguing that microfinance fails to truly help the poor. This paper will seek to weigh the merits of both sides through comparative analysis. Essentially, by reviewing past microfinance literature, this paper explores the long-term impacts of microfinance programs on individuals and societies, analyzes the efficacy of microfinance institutions (MFIs), and proposes strategies that would help MFIs achieve their goal of promoting financial inclusion.

Long-Term Impacts on Individuals and Societies

Microfinance offers economic opportunities to poor consumers through microcredit, which promotes the financial well-being of the poor, especially women. Microfinance can significantly benefit women who typically lack access to economic resources and have very little household decision-making power. Microfinance programs that lend to women result in women “taking a greater role in household decision making, and having greater access to financial and economic resources” (Pitt et al., 2006). Standard economic theory explains household power dynamics in the following manner: the person who contributes to the household income and controls economic resources has the most decision-making and negotiating power. Under this framework, it is completely logical for women to have more power in household decision-making when they contribute to the household income. Similarly, a review of microfinance programs in rural Bangladesh, where women were given membership to the Grameen Trust (a MFI), found that membership in the program had a significant positive impact on female empowerment (Hashemi et al., 1994).

In addition to economic growth, microfinance has a positive impact on female health services and overall household well-being. A review of a microfinance program focused on lending to women found that “women are more likely to use modern methods of contraception when they participate in microfinance” (Murshid & Ely, 2018). One plausible reason for such a finding is that access to microfinance provides women with more discretionary income that they can spend on products such as contraceptives. From a policy perspective, these findings have significant implications as increased contraceptive use lowers fertility rates, which allows for better allocation of household resources. Furthermore, less children allow for parents to invest more in their children’s education and health, which improves the overall well-being of the household. Many researchers have focused on evaluating the impact of microfinance on individuals, and questioned whether there are spillover effects for the entire household. A recent review of household well-being after being involved in a microcredit program found that “longer participation in microcredit was associated with greater household food security and reduced likelihood of childhood anemia” (Hamad et al., 2014). Therefore, there is a clear spillover effect, and the benefits of microfinance extend well beyond the borrower. In fact, there is a ripple effect as well. When childhood health improves, educational outcomes are also likely to improve. Hence, policymakers must consider the primary and secondary (spill-over) impacts of microfinance when considering its effectiveness.

Efficacy of Microfinance Institutions (MFIs)

Despite its numerous benefits, microfinance has drifted away from its initial goal of uplifting the poor due to commercialization. There have been many instances where MFIs have exploited the poor for their own profits and often exacerbated poverty. Moreover, MFIs often use coercive techniques to make the poor participate in certain loan refinancing schemes that harm borrowers. David Hulme, a professor of development studies and executive director of the Brooks World Poverty Institute at the University of Manchester, and Mathilde Maitrot, a research associate at the Brooks World Poverty Institute, argue that microfinance “has lost its moral compass” because MFIs “have increasingly focused on financial performance and have neglected their declared social mission of poverty reduction and empowerment” (Hulme & Matrot, 2014). Hulme and Matrot propose that central banks should regulate MFIs to create more transparent institutions. Similarly, Jayati Ghosh, a Professor of Economics at the Jawaharlal Nehru University in New Delhi who researches development programs and macroeconomic policy, shares a similar viewpoint to Hulme and Maitrot. Ghosh finds that microfinance programs often have “high interest rates, short gestation periods and (increasingly) coercive methods used to ensure repayment” (2013). Essentially, even when borrowing from MFIs, “many of the poor struggle to follow NGO repayment schedules' and eventually “they fall into a cycle of multiple debts and further poverty” (Ali, 2014). Essentially, MFIs cannot keep lending to the poor at extremely low rates, and continue to operate when not paid back by borrowers (which is often). Microfinance skeptics posit that MFIs are inherently unsustainable due to their business model; hence, the growing commercialization of the microfinance industry is inevitable.

In addition to growing commercialization, MFIs are poorly regulated and government authorities fail to hold MFIs accountable for exploitative practices. For example, many borrowers in Andhra Pradesh (AP), a state in India, resorted to taking multiple loans from different MFIs to pay for their initial loans, and this led to overindebtedness and eventually many borrowers committed suicide. An analysis of the MFI collapse in Andhra Pradesh found that “lending institutions resorted to coercive measures for loan recovery” and this “coupled with the absence of adequate regulatory mechanisms, resulted in over-lending to the poor”, which caused a microfinance crisis in AP (Ghalib & Priyadarshee, 2012). In response, the Andhra Pradesh state government passed the MFIs Ordinance of 2010, which mandated all MFIs to register with a government authority and declare critical information regarding their lending practices. Many development experts have argued for stronger regulation of MFIs and increased oversight. One specific solution to regulate MFIs is for central banks to create sub-committees focused on MFIs and their operations to ensure safe transactions (Nair, 2011). Legislation and government oversight can be effective measures to improve the efficacy of microfinance programs in the status quo and promote equitable lending practices.

Conclusion

Despite the shortcomings and flaws in the microfinance infrastructure, it remains a promising approach to promote financial inclusion and improve the lives of the poor. Muhammad Yunus, the pioneer of microfinance and a Noble Peace Prize winner for founding the Grameen Bank (the first ever MFI), strongly argues that “microfinance is effective in helping poor people to use their own efforts and creativity to meet their basic needs” (2004). Many in the development community have adopted Yonus’s view that microfinance can promote development without making the poor dependent on external actors. However, many continue to oppose this optimistic perspective and argue that microfinance is counterproductive and exacerbates poverty. Despite disagreement around the impact of microfinance, there is widespread consensus that building a legal framework can be an effective method to improve current programs. Sustainable development requires a comprehensive solution, an financial inclusion through microfinance has the potential to bring the poor one step closer to economic and social prosperity.

Akshat Juneja is a senior at Conard High School in West Hartford, CT. He is interested in issues concerning international development and poverty alleviation. He has written previously on development issues like the impact of fertility rates on development. He is extremely interested in pursuing a career in development and plans to study economics in college.

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