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This blog post by Quanda Zhang explores how microlending could end extreme poverty.
A slight boost in microlending to the developing world could lift more than 10.5 million people out of extreme poverty.
Currently, 836 million people – or 12% of the world’s population – experience extreme poverty, living off less than US$1.25 a day. Using data from 106 developing countries between 1998 and 2013 to examine the efficacy of microlending as a poverty-reduction tool showed that a 10% increase in the gross microfinance loan portfolio per client could cut this number by 1.26%.
While the world has seen some progress over the past 15 years in reaching the UN Millennium Development Goals (MDGs), which placed eradicating hunger and poverty on top of the global agenda, extreme poverty remains a pressing challenge. It continues to be a priority in the 2015-2030 Sustainable Development Goals.
By 2015, the proportion of the world’s population living in extreme poverty dropped to 14% from 50% in 1990, according to MDG Monitor. But in Sub-Saharan Africa, more than 40% of the population lives on less than US$1.25 a day. And extreme poverty appears to have increased in Western Asia.
Microfinance and poverty reduction
Giving small loans (as little as US$10 or as much as $US500) to the very poor, alongside other financial services such as savings accounts and financial training, was the brainchild of economist Mohammad Yunus. In the 1970s, he began offering credit to poor women in the village of Jobra, Bangladesh, so that they could launch income-generating projects to help support themselves and their families. In 2006, those experiments won Yunus and his microcredit-focused Grameen Bank a Nobel Peace Prize.
Access to credit enables poor people to become entrepreneurs, increasing their earnings and improving their quality of life. Many lenders accompany their small loans and financial services with peer support, networking opportunities, and even health care to improve their clients’ odds of building a successful small business. In doing so, many economists submit, show that microfinance has a powerful potential to reduce poverty.
Officially, poverty is measured using two World Bank indicators: the poverty headcount ratio (which measures the percentage of the population living below the US$1.25 a day mark) and the poverty gap (which assesses how far below that line people fall, on average, and is expressed as a percentage).
The critical variable of significance in my analysis is participation in microfinance programs. I defined this in two ways for each country studied. They are:
Using microfinance data from the Microcredit Summit Campaign and MIX Market, a microfinance auditing firm, the proportion of total clients as a share of the national population and the average loan size (gross loan portfolio over clients).
I found a negative relationship between microfinance participation and poverty, meaning that the more people in a given country received small loans, the less poverty it registered. Thus, increasing the gross loan portfolio per client by just 10% in the average developing nation could reduce the extreme poverty rate by 0.0126 percentage points. I also found that microfinance minimizes the depth of poverty, shrinking the gap between a person’s daily budget for living and the current US$1.25 per day definition of extreme poverty (the non-poor have a 0% shortfall).
Policy implications
Microfinance is no panacea. Numerous studies have shown that country-specific and cultural factors determine how microfinance will interact with poverty. There are occasionally devastating tales of failure in which the inability to repay a minimal loan has plunged households into desperate poverty.
Overall, however, my study suggests that more microcredit would benefit developing countries. National governments and international development agencies can continue to promote microfinance as a tool for reducing poverty while bearing in mind the limitations of any single strategy in tackling an entrenched global problem.