Is Microfinance the Best Solution to Poverty?

Microfinance has become a standard pillar of the buzz-word arsenal in community development. But many of us, if we’re honest, struggle to understand what, exactly, it is and how all the variants work.

Microfinance is actually quite multifaceted; for the purpose of this article, I’ll try to narrow my discussion to only a few key terms and references. By the way, I quickly googled, “words associated with microfinance” and up popped a “Microcredit and Microfinance Glossary” (The fact that a glossary is necessary might be an indicator of the complexity of this topic).

Microfinance refers to loans, savings, insurance, transfer services and other financial products targeted at low-income clients.

Microcredit is a small amount of money loaned to a client by a bank or other institution.

Microloan is a loan imparted by a microfinance institution to an entrepreneur to be used in the development of the borrower’s small business.

Savings and Loans Group is group of people who save together and take small loans from those savings.

An oversimplified explanation may be to think of microfinance as the overarching umbrella and then, under that umbrella, various options of either lending or saving.

I remember working on my first WASH (Water and Sanitation) project in Uganda. During my training we learned about different technologies and methods of water purification. We talked through factors that need to be considered when choosing a purification method. Criteria could include anything from cost and sustainability, to environment and local resources.

I learned through this experience that it’s important to consider all these factors before determining the appropriate purification method to use. (As we all know, one can be a diehard for using hand pumps but, if a particular area doesn’t have the resources to fix the pumps when they break, then it hardly seems worth considering!)

I feel, in many ways, that the dialogue around microfinance is similar. You have to consider all the factors at play in a community before choosing an appropriate method to encourage economic development. It’s easy to fall into the trap of needing to defend one solution over another. The debates, discussion, and, let’s be honest, the criticism over the years has been prolific. People seem to be fairly divided into their own camps, with each group quick to hail their method as THE ONE that will solve the problems of poverty.

But let’s face it. There is no cure-all for poverty. There is no simple solution.

Recently, I watched a great documentary on Netflix called, “Living on one Dollar”, that highlighted the many challenges to those living in extreme poverty. You recognize through the storytelling of two international development students that those living in extreme poverty are tremendously susceptible to unforeseen emergencies or plain “bad luck”. Because of their vulnerability, there is no financial room to adjust for costs associated with illness, change in employment, or the impact of natural disasters. There often is no lifeline, back up plan, or system to catch people as they’re falling.

For example, imagine you are living on the thin edge of extreme poverty, recognizing you have no savings, and you take out a loan to start a small chicken farm. Now imagine that in that same year avian flu sweeps through the community and wipes out all your chickens. What then? Now you have no chickens to make a profit and, to add insult to injury, you owe money to a third party. What are you going to do?

For an organization like Food for the Hungry (FH) Canada, the microfinance options seem endless. So when choosing the best method, we have to look closely at the communities where we work – communities in which people are considered some of the most vulnerable in our world. Their margin of error is razor thin.

This is why FH Canada primarily chooses savings and loans instead of the alternatives I listed at the beginning.

Savings and Loans Groups tend to protect that vulnerable population on the edge because they encourage growing capital instead of digging yourself into a hole with debt. A group of neighbours, who already share social capital, comes together to pool their resources and create shared monetary capital. Together, they learn basic accounting skills and business practices, and decide which members get small loans to start small businesses. As a business grows, the owner replaces the capital they borrowed, plus re-invests some of their growing income back into the savings group so that the amount available for start-ups and emergencies increases.

How does this method take care of you when avian flu hits? Well, first of all, because you paid into the initial pot, you don’t “owe” the entire amount you borrowed. Secondly, because members regularly put money into the central pool there is always a growing amount of shared capital that can afford to take a hit and still support its participants. Lastly, because you share social capital with the group, you don’t have a loan shark banging down your door, you have neighbours concerned about your wellbeing – economically tied to your wellbeing – and willing to be patient and help lift you out of the hole. In essence, you have a safety net.

Now hear me out – this isn’t to argue that savings and loans are the ONLY solution to poverty; it’s just to say that, given the factors at play in FH communities, the savings and loans method often proves to be the most appropriate for the people we walk alongside.

Written by Melissa Giles

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Melissa Giles is the Director of Programs for MCC BC. She wrote this article while serving as the FH Canada Training Manager. Melissa has extensive fieldwork experience in West Africa and is passionate about smart development and poverty education.