Role of Microfinance in Poverty Alleviation

Poverty is a universal undeniable fact. It is supposed to be the most injurious economic and social problem of mankind since inception and is the mother of all human rights violations. It not only effects individuals but also the whole society in a very destructive way. The international poverty line is currently set at $1.90 a day which is the universal standard for measuring global poverty. This line helps measure the number of people living in extreme poverty and helps compare poverty levels between countries. According to the World Bank estimates out of 7.9 Billion of world population about 9.2% of the world population i.e. 726 million people, lives in extreme poverty, on less than $1.90 a day.

Role of Microfinance

Poverty is a complex problem that must be addressed at all levels of society. The World Bank’s poverty reduction experts work within many areas and programs to meet their goals. Out of 12 key areas of focus, Microfinance is the most important one.

Microfinance offers poor people access to basic financial services such as loans, savings, money transfer services and micro-insurance. People living in poverty, like everyone else, need a diverse range of financial services to run their businesses, build assets, secure smooth consumption, and manage risks. Well-managed microfinance programs can also help lift people out of poverty, for example when a borrower uses small loans to start and grow a new business. Definitely, Microfinance can be a very useful apparatus in human, social, economic, political and national development. Microfinance has been established to fill the gap of a missing credit market for the poor. Among all other anti-poverty strategies, it has become one of the most important and successful tools for poverty elimination throughout the world. The position of microfinance institutions in the financial system is as an intermediary between banks (formal sector) and the informal sector. It is called microfinance because its clients operate at a small scale (despite the fact that this group of clients is the majority of the population). This institution can also be a social intermediator, facilitating group establishment, confidence development, and management and financial training within the newly formed groups. Microfinance institutions combine a social and commercial mission.

Provision of Financial Services

Definitely, Microfinance institutions provide a strategic role in the provision of financial services, especially for low-income communities and small and micro entrepreneurs. Most micro and small business still rely on self-sourced capital, which makes their business remain in an under capacity condition. In addition, problems of bank ability, collateral principle, and procedural complexity are factors that make access to loans difficult for poor people. Therefore, the role of social capital has become an important factor in establishing relationships between microfinance institutions and poor communities. It is also frequently found that the relationship pattern between creditor and debtor is a patron-client relationship and it can become a catalyst for poor communities.

Microfinance institutions can be Non-Governmental Organizations (NGO’s) savings and loan cooperatives, government banks, commercial banks, or non-bank financial institutions. Their clients are characteristically entrepreneurs with low incomes located in both cities and villages. They are merchants, peddlers, farmers, and service providers such as barbers, craftsmen, blacksmiths, and tailors, whose activities are producing a source (or sources) of stable income yet remain vulnerable to poverty.

In their decision making, microfinance institutions must consider two long-term objectives: outreach and sustainability. Outreach means serving those who are not handled by formal financial institutions, and sustainability is the institution’s ability to survive by collecting adequate income to cover its operational expenses. In its effort to anticipate poverty and empower small businesses, microfinance institutions are grouped into two types according to their approach, Institutional approach and a welfare approach. Several studies have focused on the role of microfinance institutions in eradicating poverty, and have generally seen them have positive results. Microfinance institutions increase financial sustainability, which is achievable together with poverty counter measures. In this approach, sustainable effort to reduce poverty can be achieved by using a double strategy, increasing the productivity of the poor and providing basic social services for them. Microfinance institutions are believed to be instrumental in increasing the productivity of the poor by focusing its attention on the failure of credit market to serve this population and by maximizing market opportunities. More than just providing financial services for micro businesses and poor families, it is a holistic strategy to decrease poverty level using several different methods.

Social Capital

It is an ambiguous concept with multiple definitions and has grouped definitions of social capital into two large groups. The first group emphasizes social networks bound by information ownership, trust, mutual understanding, value similarity, and mutual support, while the second emphasizes traits embedded in individuals involved in a social interaction. However, the Social capital was not a singular entity but a plural and varied entity that consists of a social structure that facilitates the conduct of certain actors in the structure. Moreover, competitiveness as the ability to maintain market share, which is determined by competitive price. Both factors can be achieved by having and using the ability to innovate. Competitiveness influences productivity improvement and market access expansion, which leads to increases in sales turnover and business profitability.

The Pakistan Scenario

Since the creation of Pakistan in 1947, poverty has been the most challenging issue. The poverty trend in Pakistan has been fluctuating heavily over time. According to Pakistan’s Economic Survey 29.50 percent of the population is living below the poverty line. In Pakistan, most of the people are residing in villages and their livelihood is based on the agricultural sector of the economy. Specifically, rural people are living in a very pathetic condition due to a shortage of basic facilities like drinking water, basic education, health facility, roads, energy, communication and unemployment.

In Pakistan, 24.3% of the population lives below the national poverty line. The proportion of employed population below $1.90 purchasing power parity a day is 1.3%.

The Economic Survey 2020-21 has revealed that the literacy rate in the country remains stagnant at 60 per cent and education-related expenditures witnessed a decrease of 29.6pc in the year 2019-20. The literacy rate measures the percentage of people aged 15 and above who are able to read and write. According to the Pakistan Social and Living Standards Measurement (PSLSM) district level survey 2019-20, the literacy rate of population (10 years and above) is stagnant at 60 per cent in 2019-20 since 2014-15. With this poor literacy rate, the policy makers are trying to take decisions in order to help the people that are living below the poverty line. The Logistic Regression model implies that poverty has a negative association with the duration of microfinance, education and existence of a market in the locality, whereas it is positively related to family size and gender of the respondent. The findings reveal that microfinance imparts a vital role in poverty eradication where the poverty level has decreased from 42.67% in comparison household (CHH) to 29.33% in the program household (PHH). It was found that there is a negative association between the provision of microfinance and poverty level of the household. The availability of micro financing facilities to the poor has declined the poverty rate from 42.67% to 29.33%. In Pakistan, poverty can be said as double edge razor because, on the one hand, poor people have low income while, on the other hand, they cannot access basic requirements of life like clean drinking water, basic education, health facilities and sanitation.

In Pakistan, microfinance has also earned great popularity among the public as well as policy makers fighting against poverty. Therefore, different studies have been designed to investigate the impact of microfinance on poverty eradication over time. After examining the literacy on microfinance and poverty, the conclusion is that microfinance is one of the most important and effective tools being used for poverty alleviation all over the world nowadays. The results of some studies may differ from one another due to different methodologies deployed in different studies.

Also, all the above selected studies are analyzed because they are studying countries or areas that have common characteristics for poverty and microfinance programs like Pakistan.

No policy could be implemented in isolation

The relationship between microfinance and poverty is not so simple, which is why microfinance should be used very consciously. Microfinance is not a miracle solution. It is not for everyone and is not solely responsible for poverty alleviation. Microfinance must also be coupled with other social programs that are flexible to meet the diverse needs of destitute families. The effectiveness of microfinance can be enhanced by simultaneously taking some other steps. Therefore, along with the provision of microfinance services to the poor people, subsequent policy measures are suggested for policy makers to use microfinance as a valuable tool in poverty reduction. There is a need to minimize the interest rate and the cost of borrowing must be reduced to a minimum. Special attention should be given to educating the borrowers to utilize loans in a better way.

Epilogue

The role of micro financing in poverty elimination. Perhaps no one would argue against the notion that microfinance can be a very useful apparatus in human, social, economic, political and national development. It is very easy to determine that microfinance has a vital and noteworthy contribution to the lessening of poverty.

One other important finding is that higher cost of borrowing impedes borrowers from using the fund in the most effective way. The high rates of interest, surge cost of borrowing, complicate the repayment schedule and their inefficiency to manage or inability to utilize the amount of loan are major reasons of default. The fruits of microfinance are highly sensitive to the interest rates. It has a vital role in determining the effectiveness of microfinance in poverty reduction. The poor are taking micro loans and investing them in small enterprises. Their small businesses are already operating at an inefficient level and when a high rate of interest is charged, it becomes very difficult for the borrowers to ripen the fruit of microfinance in an appropriate way.

There is a negative association between provision of microfinance and poverty level of the household. With the availability of micro financing facilities to the poor, the poverty rate has come down from 42.67% to 29.33%. Hence, almost 14% of the borrower households have got rid of poverty by availing micro financing.

The author, Nazir Ahmed Shaikh, is a freelance columnist. He is an academician by profession and writes articles on diversified topics. Mr. Shaikh could be reached at [email protected]

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