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The impact of microfinance Print
By Shahid Khandker and Hassan Zaman

In the 1970s, three out of four Bangladeshis lived in poverty and the country was considered a test case for development. Rapid population growth, frequent natural disasters, and low economic growth throughout the 1980s suggested that a large number of households would remain trapped in chronic poverty.

Defying this outlook, Bangladesh began experiencing more sustained economic growth since the 1990s, which was accompanied by impressive poverty reduction. For example, in 1991-92, about 60% of the population was below the poverty line and around 50% was below the extreme poverty line. By 2005, those figures had gone down to 40% and 25% respectively.

The Bangladesh economy began experiencing structural changes in the 1990s following trade liberalisation and domestic market reforms. In urban areas, private sector growth and employment were spurred by rapid growth in garments exports while rural areas benefited from the deregulation of agriculture markets, boosting agricultural production. At the same time, relatively higher paying rural non-farm opportunities increased and the labour force slowly began to shift away from agriculture.

All in all, declining population growth rates, improved human capital, improved infrastructure, mainly in the form of more extensive road communications networks, and increased foreign remittance have been put forth as factors explaining Bangladesh's enhanced growth and declining poverty.

But what was the contribution of microfinance to this impressive performance? It is impossible to put an exact number but we can look at some published evidence to get a sense of where micro-credit is making a difference and where it may not be. The World Bank's 2008 Poverty Assessment has two findings in this context.

First, PKSF programme coverage data suggest that since 2000 microfinance has expanded more in areas that were poorer, presumably because the better-off geographical areas were covered in the previous decade. Secondly, the report shows that the reduction in poverty in rural Bangladesh has been much more in upazilas where microfinance membership increased more rapidly, after accounting for other factors which drive poverty reduction. There are other published papers which go beyond the geographical variation of microfinance coverage and effects.

Two well known studies assess short and medium-term microfinance impacts from the borrowers' point of view, using repeated household surveys carried out in rural Bangladesh. Using nationally representative data, their findings suggest that poverty reduction among the borrowers due to microfinance is 1.6 percentage points per year. Moreover, microfinance programmes have spillover effects on the non-borrowers -- their poverty level goes down by 0.3 percentage point a year.

Even without the income gains, the poor may still benefit from microcredit services if it helps them withstand income and non-income shocks such as an economic disaster resulting from the sudden death of a productive family member, the loss of an economic asset, or natural disasters. Without some form of insurance (either public or private), the poor may not be able to smooth consumption during those disasters, which may lead to sharp cut-backs in essential food and non-food expenditures.

Several studies confirm that micro-credit programmes help households partially insure against shocks so that they effectively play an important "safety net" role. One carefully designed study finds that microcredit borrowers are about 50% less prone to consumption fluctuation than their counterpart non-member poor households in Bangladesh.

Clearly, further innovations are required to strengthen this crucial risk-reduction role, and in general to offer flexible financial services catering to different types of poor households, in particular for the extreme-poor. One example is a micro-finance programme known as PRIME, implemented by PKSF, which offers a flexible repayment schedule and consumption smoothing, as well as production loans. As a result, a recent evaluation shows that PRIME is more effective than regular microfinance in reaching the ultra-poor, as well as the seasonal-poor.

The discussion on the impact of microcredit would be incomplete without referring to the broader package of interventions that are provided with it. MFIs in Bangladesh vary significantly in terms of their noncredit services though they typically include training, related business development services and social messages on education, health and civic rights. One published paper finds that these noncredit interventions raise self-employment profits in rural Bangladesh by 125% while the combined impact of credit and noncredit interventions on self-employment profits is 175%.

The impact evaluation literature on micro-finance in Bangladesh also contains some cautionary notes. For example, it is clear that not all borrowers benefit equally as it depends on their local economic environment, their entrepreneurial ability and the extent their income sources are diversified. A few studies also show that microcredit does little to change gender inequities by limiting female control over loans.

However, on balance there is more evidence suggesting that microcredit does influence gender relations positively. Most published papers show that access to microcredit leads to women taking a greater role in household decision making, having a greater access to financial, economic and social resources and having greater mobility in Bangladesh. .

It is clear that microfinance can protect households from shocks, contribute to changing societal norms about the role of women in society and lead to some households moving out of poverty. Overall, it has played its part in the impressive progress Bangladesh has made in poverty reduction over the past two decades. Clearly, not everyone utilises loans productively, and there is a risk of falling into over-indebtedness. So, the role of microfinance should be strengthened through further innovations which take into account these pitfalls.

Finally, microfinance is not a panacea and will clearly not eliminate all poverty in any country. Thus, the potential of microfinance can be best exploited by recognising the lessons from careful impact evaluation studies, strengthening programmes on the basis of this research and field experience, and by incorporating micro-finance programmess into Bangladesh's overall poverty-reduction strategy.

The writers are economists based in Washington DC, and both have carried out research on the impact of micro-credit in Bangladesh.


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