Debate about the impact and benefits of microfinance has shifted over the course of the last 25 years, since microcredit began to capture the public’s imagination as a tool to bring access to finance to poor people who had previously been excluded from the formal economy.

The dominant impact narrative for microcredit rests on loans to capital-constrained microentrepreneurs who earn a steep return on marginal capital and thus can repay a relatively high interest rate and reinvest to grow out of poverty. Access to credit for this segment remains an important development tool. But not every borrower is a microentrepreneur, and poor households clearly have other financial services needs beyond credit.

To assess the impact of access to financial services, the key questions are, therefore, what are the underlying financial services needs of clients, and, what impact is achieved when the appropriate financial instrument is used?

A growing body of empirical evidence shows that access to the right financial service at the right time helps households build assets, generate income, smooth consumption, and protect themselves from risks.

Several researchers are studying the various new ways access to financial services might positively impact poor households’ welfare, leveraging insights from the field of behavioral economics. In parallel, a new body of empirical evidence is emerging using methodologies similar to medical trials where access to specific new services is randomly assigned, and the impact of a change in access on one customer group is compared to a second group without that same access. Such randomized evaluations need a certain sample size and timeframe to be meaningful, and only a handful has been completed to date in access to finance. Across various financial services, here are some of the highlights of this new evidence from randomized evaluations:

Credit. Beyond providing working capital loans to microentrepreneurs, borrowing money can help households manage cash flow spikes and smooth consumption. Cutting-edge behavioral research also suggests that the mere peace of mind associated with the knowledge that credit is available can help households make better decisions that improve welfare in the long run. New empirical impact studies have shown positive effects on the income of existing microbusinesses (in India and the Philippines), diversification of livestock (in Morocco), and reduction in the spending on temptation goods, such as tobacco (in India and Morocco). These studies, which had one- to two-year time horizons, however, did not find evidence for a direct effect of higher spending on health or education relative to the control group.

Savings. Accumulating savings also helps households manage cash flow spikes. Researchers think that saving small amounts at home is difficult for poor households given multiple, immediate demands of various household members. When mechanisms for high-frequency, low-balance deposit services are available, results could be strong. One randomized evaluation found that access to a new savings service to women in Kenya enabled them to mitigate the effect of health shocks, increase food expenditure for the family, and increase microbusiness investments by 40% relative to the control group. These results are very positive, but it is important to remember that there is currently just one randomized evaluation on savings.

Insurance. Insurance helps poor households mitigate risk and manage shocks. By definition, insurance seeks to broaden and diversify risk pools and is hence inherently inclusive. Challenges so far have been to find mechanisms that are helpful to poor households, yet manageable from an actuarial and operational insurance perspective. A recent randomized evaluation of weather-based index insurance showed strong positive impact on farmers as the assurance of better returns encouraged them to substitute away from subsistence to crash crops (in India and Ghana). In Ghana, insured farmers bought more fertilizers, planted more acreage, hired more labor, and had higher yields and income, which led to fewer missed meals and fewer missed school days for the children.

A 2011 synthesis paper summarizes in more detail the findings from this body of work. While still based on a relatively small number of studies, the work of researchers and participating microfinance providers is bringing new knowledge about how clients use capital, what helps them to save, and what constraints they face that prevent them from benefiting more from financial access. The overall message from this body of work is that poor people face various limits, and their ability to capitalize on opportunities varies greatly.

From a broader perspective, microfinance and financial inclusion can help develop a more inclusive financial system. A more inclusive system that reaches all citizens in turn allows for more effective and efficient execution of other social policies, for example in health and education. At the macro level, World Bank research shows that deeper financial intermediation in an economy leads to more growth, and less inequality.

Topic Contact: Alexia Latortue

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29 April 2014
This paper proposes that the accumulating body of evidence supports policy makers’ assessments that developing inclusive financial systems is an important component for economic and social progress on the development agenda.
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01 November 2011
This paper reviews the main results from randomized evaluations that measure the impact of microcredit and microsavings on business investment and creation, consumption, and household well-being. It also presents evidence from evaluations of products and delivery design and discusses the evidence on microinsurance products.
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