Microfinance improving their household economic welfare, and

Microfinance is ‘the provision of economic services to
low-income poor and extremely poor self-employed people’ (Otero, 1999).
Ledgerwood (1999) defines microfinance as, ‘certain monetary services that
principally include savings and credit, but may comprise of alternative
financial services such as insurance and payment services’. As outlined by
Schreiner and Colombet (2001), microfinance is an effort to improve access to payments
and credit for poor households that are mistreated by banks. Hence, microfinance
also includes monetary services such as savings, loans and insurance to poor
people who live in both urban and rural settings who are not capable of obtaining
such services from the formal business sector.

It is very important that if this topic is to be discussed
in detail, a distinction must be made between microfinance and microcredit;
words which are often used interchangeably but have contrasting definitions.
Microcredit is limited to the provision of a small loan to the poor (Sinha,
1998), while microfinance is a large umbrella, under which is also included
non-credit financial services such as savings, insurance, pensions and payment
services (Okiocredit, 2005). As a result, it can be said that microcredit is a
component of microfinance.

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Supporters of microfinance believe that it has a very large
role to play in development. They believe that microfinance helps the poor in
meeting basic needs and protecting themselves from risk, improving their
household economic welfare, and also helps to empower women by supporting women’s
economic participation (UNCDF, 2004). Otero (1999) states that microfinance
creates access to capital for the poor, and when this is combined with human
capital, education, training and social capital, it allows people to move out
of poverty. The aim of microfinance in line with Otero (1999) isn’t just concerning providing
capital to the poor to combat economic condition on a private level, it
additionally incorporates a role at an institutional level; it seeks to form institutions
that deliver monetary services to the poor.

On the other
hand, there are many who are skeptical about the idea that microfinance has
much of a role to play in the overall eradication of poverty. Hulme and Mosely
(1996), while recognizing the role microfinance can have in diminishing
poverty, determined from their study on microfinance that most of the modern
day microcredit schemes are less effective than they should be. Rogally (1996)
argues that microfinance is irrelevant to the poorest people, and because of
the oversimplified and simplistic definition that we have of poverty, it is
very difficult to actually measure how exactly microfinance impacts poverty. Poverty
is not an easy term to define, as it is so multifaceted. The World Bank
believes poverty is income-based, and that it should be measured based on the proportion
of people who live below a secure sum of money, such as US $1 dollar a day
(World Bank, 2003). On the other hand, Wright (1999) believes that poverty is
not just based on income. He justifies this by saying that even by increasing
the income of the poor, what the poor people do with this income is what
determines their poverty, as they may gamble it away or spend it on alcohol.

A real life example of microfinance that can be analyzed is
that of Vijayawada in India. Here, a system of saving up was involved; a
deposit collector called Jyonthi would collect money from slum dwellers, in
order for them to accumulate some sort of saving. Her rate of collection was
Rs. 5 per day from each person, and would collect for a total of 220 days. At
the end of the 220 days, each person would receive Rs. 1000. Lalitha (2003)
states that this project increased savings in this city by 55%. There are
advantages as well as disadvantages of using such a system. Slum dwellers are
usually unable to save money at home, and are unwilling to go to the hostile
and unfriendly country banks, so in this case microfinance is ideal for them. This
certain project also had other advantages; not only did it empower women, but it also gave parents
the ability to save money for their children’s education (Rutherford,
2009). One of the issues with this project was that while saving, customers were
losing part of their savings as interest to the deposit collector, who was
taking in 8% commission. Giving your savings to an informal deposit collector
also comes with an added amount of risk, but in this case, this was a risk that
the slum dwellers were clearly willing to take.

Despite an increase in savings,
this did not necessarily correspond to the decrease in poverty. According to a
study by Lalitha (2003), the size of Vijayawada’s slum areas have been rising
at an alarming rate of 12% annually per square mile. Also, even though the
population density of Vijayawada has increased between 1993-2003 by 30%,
healthcare spending by the city has only rose a meager 2%. It is said that 80% of
households are not economically stable, and only 4% of households are said to
be ‘happy’. As a result, it can be said that despite increased savings due to
microfinance, the city is still in an immense state of poverty.

Another microfinance project, which
involves ‘saving through’, takes place in Nairobi, Kenya via the Rotating
Savings and Credit Associations or ROSCAs initiative. The purpose of the
project is to help marginalized groups receive lump sums to fulfill needs or
further save. This small scale project involves groups of 15 people; 15 women
save 100 shillings daily, leaving a lump sum of 1500 shillings. Every day, one
of these women receives the large lump sum, and at the end of the 15 days, a
new cycle starts (Rutherford, 2009). This project is different from the one in
Vijayawada in the sense that there is no interest rate or commission involved,
as everyone receives back what they put forth.  Such a scheme requires a large amount of trust
and social capital, and so all members of the program must have good ethics and
understand reciprocity.  Converse to
Vijayawada, Nairobi has actually seen a decline in poverty (Alder, 2005). The
sizes of slums are annually decreasing, are being replaced by new residents in suburban
areas of Nairobi. Healthcare is on the rise; in the decade 1995-2005, spending
on healthcare rose by 22%.

Having studied both of these
examples, and assessing their contrasting results, I have come to the
conclusion that microfinance does have an effect on poverty and development,
but only to a certain extent. In both the examples stated above, microfinance
managed to increase the income and saving level of a city, but in one case, poverty
grew, and in the other, poverty diminished. Microfinance can be considered to
be a tool; a tool that helps give poor individuals the means to escape poverty
in the form of income and savings. What microfinance doesn’t not provide is a
reasonable blueprint for the poor on how to spend this money, what investments
to make, and what financial decisions to make that will ultimately push them
out of poverty. Until microfinance projects do not start providing this
blueprint, such a concept will remain as a ‘tool’, and not the ultimate,
complete solution to poverty eradication.

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