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Alleviating Poverty through Microfinance

Updated on July 22, 2013
Microfinance meeting in South Africa
Microfinance meeting in South Africa | Source

Microfinance has often been quoted as one of the solution for poverty in developing countries. The most famous example is Grameen Bank, founded in Bangladesh by Muhammad Yunus. This caused social transformation in the country and led him to win the Nobel Peace Prize in 2006. How does microfinance help in alleviating poverty? First we will examine why the poor are trapped financially because of the banking system.

Poverty Trap and Cycle

The poor and needy are often excluded from the mainstream financial system, since the cost of borrowing small amount of money will be very high. More often than not, they don't have collateral, which restrict their access to the capital market. The current financial system is based on risk management and lending money to the poor is deemed to be risky. Further, some degree of literacy is needed to fill up the application form of loans, but the impoverished are often lacking in literacy and numeracy. Without the availability of credit, this will only create poverty trap, even when the impoverished family aspire to success. This top-down approach by most financial system will only create further income inequality: the rich get richer and the poor get poorer. Instead, microfinance works with bottom-up approach: empowering the poorest of the poor so they can improve their quality of life.

What happen when they face this difficulty in getting credit and loan sharks offers them "easy credit"? Without substantial knowledge of the consequences, they will take this offer, not knowing that they are being charged ridiculous amount of interests. If they are unable to pay, their debt will be mounting higher and higher, often passed on the next generation and hence repeating the poverty cycle.

Muhammad Yunus, a nobel peace laureate, developed the concept of microfinance that is widely used worldwide. He founded Grameen Bank, a community development bank that gives small loans to the poor.
Muhammad Yunus, a nobel peace laureate, developed the concept of microfinance that is widely used worldwide. He founded Grameen Bank, a community development bank that gives small loans to the poor. | Source

How Microfinance Helps

Here we will take the majority of our example from Grameen Bank model. They disburse small amount of loans to the poor with a condition that they need to form a group of five people. This form of solidarity lending will create both supports from other group members as well as peer pressure for giving repayments to the loan, which is done weekly. This group will meet weekly to discuss with each other on their use of the loan (normally for business), get feedback and education from the bank staff, and also to make the weekly repayments. This can save substantial amount of administrative and management costs, which usually will be very high if the bank staff needs to travel to rural areas and collect money individually. The interest rates charged is about 10-30% for Grameen Bank, compared to >100% for loan sharks.

Depending on the microfinance institution, some used joint liability on the group so they can collect money from the group even if one member defaults. More importantly, there is no collateral applied to the loan application, hence giving access for credit to the poor people. This "no collateral" approach seems to be risky and criticized by other financial institutions at first, but surprisingly Grameen Bank has managed to attain a repayment rate of 97-98%, which is very high compared to formal banking institutions. The social group seems to exert mutual support, pressure, and also nurture a healthy culture for repayment.

Community-based savings bank in Cambodia. The core feature of the microfinance is the community of lenders that support each other, which is important in promoting a healthy culture of responsibility to work and repay.
Community-based savings bank in Cambodia. The core feature of the microfinance is the community of lenders that support each other, which is important in promoting a healthy culture of responsibility to work and repay. | Source

A thing to note is that the group composed almost entirely of women. It has been suggested that social pressure is more effective among women compared to men. Further, many women are underprivileged and their role are often repressed in many developing countries. Grameen Bank has changed the way the society thinks on the role of women in family and society. How about the number of people in the group? Five people are often quoted as the best number for a very human reason:

  • 1 person: no mutual support and no peer pressure
  • 2 persons: there is a possibility of one-to-one dispute and it may compromise the integrity of the group.
  • 3 persons: there is a possibility of two-versus-one dispute. The one alone will be ostracized and the group may break off.
  • 4 persons: there is a possibility of two-versus-two dispute. Again, conflict can cause the group to discontinue functioning.
  • 5 persons: five persons group seems to be the ideal. It's easily managed because it's not too big; it's also not too small that it may cause unnecessary clashes.

How does the availability of credit helps to break the cycle of poverty? Actually, many impoverished people are aspiring to open their own business as entrepreneur. With money in their hand, they can buy seeds for farming, threads for sewing, buy rickshaw for their husband to operate, etc. Their small business will produce return that is used to repay the loan and save money for consumption and reinvestment in their business. All these are the necessary step before they can become financially sufficient. The poor are generally uneducated and therefore finding a job is difficult. Even if they work for others, they will likely get a ridiculously low wage. Hence, entrepreneurship funded through microfinance loan may be a better way to help the poor to achieve success.

Why don't we just donate?

Microfinance has done a good job in helping the poor to get credit, which is just the first step. The next step, of course, is for them to use the money wisely, for opening small businesses, paying education for their children, etc. Money donation, on the other hand, may nurture a culture of dependency. We give them money, they happily receive the money, and they will want more money without working since they can get it for free anyway. Giving donation alone may not be the best solution for alleviating poverty for this reason. Donations are good especially for temporary relief of the situation. But temporary relief should not be the main goal in fighting against poverty. We need to create a self-sustaining environment. We help people who want to help themselves. If they are unwilling to help themselves, our efforts are fruitless. We need to sever the dependency culture amongst the poor, help them to help themselves, and we can break the cycle of poverty. There is a Chinese proverb that says: "Give a man a fish and you feed him for a day. Teach a man to fish and you feed him for a lifetime." Microfinance combined with education may be the key to better help the poor break the cycle of poverty.


Ruben D. Canlas Jr. Thinking Micro: Poverty Alleviation through Microfinance, Social Capital and Gender Equality in Bangladesh.

Yunus, M., & Jolis, A. (2003). Banker to the poor: micro-lending and the battle against world poverty. New York, NY, PublicAffairs.


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    • suniscontact profile image


      6 years ago from INDIA

      Nice article sharing your thoughts here, in India some areas it was failed because taking loan is easy but repaying is very diffcult when loan amount is misutilise among group memebers mutual understanding loan recovery agents more pressuring repaying amount when they couldnt pay people attemting suicide how they utilising amount also important to look then this concept works well

    • edmob1 profile image


      6 years ago from United Kingdom

      Very interesting article. It seems logical once you have set it out here. Your remark is best the financial aid with education empowers people.


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