The Effect of Microfinance on Poverty Reduction in Developing Economies

The Effect of Microfinance on Poverty Reduction in Developing Economies

Christopher Boachie (Central University College, Ghana)
DOI: 10.4018/978-1-5225-0097-1.ch013
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The study explores the contributions of microfinance to poverty reduction. The study used a descriptive design to establish the relationship between sales performance and access to credit in the SME sector in Ghana. Cross sectional survey was used to gather relevant data. The target population was the micro businesses in Madina in Ghana with a sample size of 200. The study reveals that microfinance has a positive impact on micro businesses. There exist a significant relationship between microfinance and sales. It was also found out that, the dependency burdens on micro entrepreneurs coupled with the low credit access from the microfinance institution for productive activities lead them to deploy the credit to meet the demand of both the business and household.
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It is often argued that the financial sector in low-income countries has failed to serve the poor. With respect to the formal sector, banks and other financial institutions generally require significant collateral, have a preference for high income and high loan clients, and have lengthy and bureaucratic application procedures. With respect to the informal sector, money-lenders usually charge excessively high interest rates, tend to undervalue collateral, and often allow racist and/or sexist attitudes to guide lending decisions. The failure of the formal and informal financial sectors to provide affordable credit to the poor is often viewed as one of the main factors that reinforces the vicious circle of economic, social and demographic structures that ultimately cause poverty. It is imperative to understand the ways in which finance contributes to economic growth and poverty reduction. This provision of funds in form of credit and microloans empowers the poor to engage in productive economic activities which can help boost their income level and thus alleviate poverty in the economy. Microfinance institutions (MFIs) are important, particularly in developing countries, because they expand the frontier of financial intermediation by providing loans to those traditionally excluded from the formal financial markets (Caudill, Gropper, & Hartarska, 2012). Microfinance is an effort to improve the access to loans and to savings services for poor people. It is currently being promoted as a key development strategy for promoting poverty reduction and economic empowerment. It has the potential to effectively address material poverty, the physical deprivation of goods and services and the income to attain them by granting financial services to households who are not served by the formal banking sector.

Microfinance is an effective development tool for promoting entrepreneurship and poverty reduction. Financial services enable poor and low income households to take advantage of economic opportunities, build assets, and reduce their vulnerability to external shocks that adversely affect their living standards. Yet, much remains unclear about whether, and how, microcredit can help the poor to improve their lives. Answering these questions is particularly important now that the microcredit industry is changing in various ways. Microcredit encompasses many different models and modalities and the evidence on the relative effectiveness and on the role played by different components is limited. One important recent trend has seen increased scale and professionalization leading a number of established MFIs to move from group or joint-liability lending, as pioneered by the Bangladeshi Grameen bank in the 1970s, to individual micro lending. This chapter provides evidence from a randomized sampling of 300 from both beneficiaries and Masloc. The aim of this chapter is to assess the impact of microcredit on the performance of small scale enterprises in Ghana. The paper contributes to the literature on microfinance by answering two questions: what is the impact of microcredit on the performance of micro enterprises in Ghana. How do the micro enterprises deploy the credit? The remainder of this chapter is organised as follows: section 2 discusses the related background on microfinance. It specifically looks at the poverty situation and the use of microfinance to alleviate poverty and its relative success. Section 3 focuses on the field study, section 4 presents the results and discussion and conclusion follows in section 5.

Key Terms in this Chapter

Loan Agreement: A written contract between a lender and a borrower that sets out the rights and obligations of each party regarding a specified loan.

Group Lending: A lending mechanism which allows a group of individuals - often called a solidarity group to provide collateral or loan guarantee through a group repayment pledge. The incentive to repay the loan is based on peer pressure, if one group member defaults, the other group members make up the payment amount.

Micro Savings: Deposit services that allow people to store small amounts of money for future use, often without minimum balance requirements. Savings accounts allow households to save small amounts of money to meet unexpected expenses and plan for future investments such as education and old age.

Solidarity Economics: An economics based on efforts that seek to increase the quality of life of a region or community through not-for-profit endeavours.

Credit Union: A non-profit, member-based financial intermediary. It may offer a range of financial services, including lending and deposit taking, for the benefit of its members. The basic credit union is composed of a group of people having a ‘common bond’ who may be resident in the same neighbourhood or employed at the same place of work, or it can be a religious or ethnic grouping. The principal reason for the emphasis on a common bond is that the social pressure of the group is considered a very important condition as security for loans. It is a form of collateral which is not available in conventional finance. While not regulated by a state banking supervisory agency, it may come under the supervision of regional or national cooperative council.

Collateral: An asset pledged by a borrower to secure a loan, which can be repossessed in the case of default. In a microfinance context, collateral can vary from fixed assets such as a car, a sewing machine to cross-guarantees from peers.

Accumulating Savings and Credit Associations (ASCAs): Informal savings groups. All members regularly save the same fixed amount while some participants borrow from the group. Interest is usually charged on loans. ASCAs require bookkeeping because the members do not all transact in the same way. Some members borrow while others are savers only, and borrowers may borrow different amounts on different dates for different periods. If members pay interest on their loans, the return to savings has to be individually calculated and fairly shared among the group.

Compulsory Savings: Savings payments that are required as part of loan terms or as a requirement for membership, usually in a credit union, cooperative, microfinance institution, and village bank or savings group. Compulsory savings are often required in place of collateral. The amount, timing, and level of access to these deposits are determined by the policies of the institution rather than by the client. Compulsory savings policies vary: deposits may be required weekly or monthly, before the loan is disbursed, when the loan is disbursed, and/or each time a loan instalment is paid. Clients may be allowed to withdraw at the end of the loan term; after a set number of weeks, months or years; or when they terminate their memberships.

Bankable: People who are deemed eligible to obtain financial services that can lead to income generation, repayment of loans, savings, and the building of assets.

Microloan: A loan imparted by a microfinance institution to a micro entrepreneur, to be used in the development of the borrower’s small business. Microloans are used for working capital in the purchase of raw materials and goods for the microenterprise, as capital for construction, or in the purchase of fixed assets that aid in production, among other things.

Microcredit: A small amount of money loaned to a client by a bank or other institution. Microcredit can be offered, often without collateral, to an individual or through group lending. The incentive to repay is based on peer pressure; if one person in the group defaults, the other group members make up the payment amount.

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