How Evidence Is Helping Reframe Our Perspective On Microfinance
Broader and deeper financial inclusion means that households have more financial management options. How does a household benefit from having more options?
There are many, many well-documented cases in which poor households invest their loans or savings or both in microenterprises that grow and yield enough profit to substantially increase the household’s income and consumption, sometimes even enough to rise above the national and international poverty lines. But these cases are a minority of the households that participate in microfinance. There are surprisingly few data on just how sizeable the minority is, but they are still a minority.
Benefits for enterprise development do not describe the full value of microfinance for the majority of poor households who participate. Yet participate they do – at least 150 million, maybe 200 million relatively poor households. What is in it for them? What in fact does microfinance reliably do for poor households? The answer provides the overall rationale for massive investment in the infrastructure and operations of microfinance.
In a recent post on The Evidence Project blog, I reviewed 12 reports of recent randomized trials and found that 10, maybe 11, offer solid evidence that people use microfinance to reduce their vulnerability; i.e., to manage the risk of consumption interruptions and financial shocks for their households. Enterprise investment can be seen as just one of a suite of tools that people use to reduce their vulnerability.
Unlike other risk management tools, investment in microenterprise can have the happy consequence of actually raising total household income, as well as smoothing income through the year as part of a diverse portfolio of revenue streams. However, as we know from at least two recent, excellent books, Portfolios of the Poor and Poor Economics, most households are not counting on this poverty-reduction effect of microenterprise investment; they just do business as one of several ways to keep the wolves of hunger and ill health at bay, to clothe and shelter themselves, and to have a little enjoyment in their lives, too. Call this poverty alleviation—reducing the uncertainties and stress of being poor. Not so many are using microfinance in a way that will raise them from the ranks of the poor—poverty reduction—because there just aren’t that many opportunities for thriving enterprise in the absence of robust local economic development.
What optimistic yet realistic theory of change can be crafted from this evidence? Consider this formulation (mostly drawn from page 93 of the year 2000 paper by Sebstad and Cohen):
People from poor households tap microfinance services to smooth consumption and build assets to protect against risks ahead of time and cope with shocks and economic stress events after they occur—leading to poverty alleviation.
This is also the narrative coming out of the financial diaries reviewed by Portfolios of the Poor and the research summarized in Poor Economics and Due Diligence. A new theory of change is emerging for microfinance. It is shaped not only by the results of research. More or less independently, perhaps in spite of that research, the microfinance industry has been adjusting in this direction toward supporting risk mitigation strategies of the poor as it has become more sensitive to client demand – by moving toward a mix of loan, saving and other services and greater flexibility and choice to accommodate the use of microfinance for supporting household resilience rather than focusing just on the needs of microentrepreneurs.
Many consider consumption smoothing, or even the resilience it reflects, a consolation prize at best in the quest to eliminate world poverty. But what could be more fundamental to poverty reduction than helping the poor make sure they have enough to eat and other basic necessities throughout the week, the month and the year? From that stable ground, the poor are in a much better position to seize whatever opportunities are provided by health and education services and a decent economy. Though financial services by themselves cannot provide these opportunities, they do seem quite capable of helping the poor provide the stable ground to stand and build upon. That is the significance of consumption-smoothing, risk mitigation and resilience in poor households.
Assuming more, confirming evidence will come soon from properly targeted research, we must pose this question to ourselves and the larger world we live in: Is this resilience-building benefit of financial inclusion enough to justify the massive investment of public and private funds in the infrastructure and operations of microfinance and related financial service providers? This question–and the underpinning research–prompt us to put financial services for the poor into proper perspective as part of the larger development narrative. The old narrative of the microentrepreneur who, by removing capital constraints, is enabled to grasp business opportunities and lift a whole family from poverty isn't wrong; it is just one way people use financial services.
--- The author is the former president of Freedom from Hunger and the editor of The Evidence Project.
Photo credit: Mohammad Ponir Hossain