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Microfinance and poverty reduction nexus: a reality

Poverty is a multi-faceted fabric which involves economic, social, cultural and psychological dimensions. It is a worldwide phenomenon whose consequences are dehumanizing, devastating and traumatic. In the light of this, and recognizing the importance of the devastating effect of poverty and inequality, the awareness is much more favored at the international level of finance and governance. Poverty results from over population, low economic growth, unequal distribution of wealth and most importantly, low per capita income. This, coupled with poor health, people in third world countries get low productivity due to which they are mostly unemployed. Such poverty can only be reduced by investing in human and physical capital.

Poverty means deprivation from the basic essentials of life. The level of poverty is determined by the income level and degree of inequality among others. The roles of microfinance in poverty reduction have attracted various researchers to the extent that different opinions have been formed. For instance, while some researchers conclude that microfinance loans are mainly used for health, education of school children and production related expenses, others are of the opinion that microfinance has played a tremendous role in reducing the depth and incidence of rural poverty and serves as aid for shocks from natural disaster and health related calamities. Even microfinance reduces poverty at the macro level.

Microfinance has been adjudged as a reliable tool for poverty alleviation. It can be used to boost the investment which eventually entails the reduction of poverty and improves the standard of living of the poor. However, microfinance has been used on several occasions to reduce poverty, in rural areas in particular which are believed to harbor the poorest people in the world. It is an important aid that can improve the economic performance of the poor. The poor people need microfinance to improve their entrepreneurial skill and socio- economic needs. But the poor people could not meet up with the requirements of the conventional banks and microfinance is not reachable. They continue to wallop in abject poverty and vicious circle.

 

Microfinance can be an effective tool in the fight against poverty because it is an alternative to traditional finance that gives poor people access to funds allowing them to maintain their economic activities or create new ones. Microfinance offers a wide range of potentially beneficial products (from simple loans to complex financial interactions, e.g. savings, insurance, and money transfers) that can lead to improved access to health and education. It is now an effective tool for the development of economic activities and social promotion. Regarding the issue of the poor’s access to financial services, inequality is partly due to market imperfections in the financial sector; thus financial systems (like microfinance) that better include the poor are good vehicles for economic growth and reduction in inequality.

In order to make Microfinance Institutions (MFIs) more effective in the rural poverty reduction and to reach the target poor in the rural areas, the government should create more enabling environment by improving on the rural physical infrastructural facilities. Also, there has to be constant promotion of health and education facilities. All this would reduce the operational costs of MFIs and make their services in the rural areas more attractive.

Moreover, MFIs should always adjust their loan terms and conditions towards the situation of their potential rural clients. For instance, short term loan and weekly repayment may not augur well for a rural peasant farmer whose harvesting period is seasonal and the crop gestation period is a bit long. In essence, MFIs should endeavor to make flexible client specific repayment schedules. In addition, MFIs can reduce the cost of operation and improve on corporate governance by recruiting the local educated people that can earn less than their counterparts in urban centers. Officers from local areas are expected to understand rural poverty better and should be able to convince the poor to join microfinance programs.

The writer is a Karachi based freelance columnist and is a banker by profession. He could be reached on Twitter @ReluctantAhsan

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