Microfinance and poverty

In developing economies and particularly in rural areas, many activities that would be classified in the developed world as financial are not monetized: that is, money is not used to carry them out. This is often the case when people need the services money can provide but do not have dispensable funds required for those services, forcing them to revert to other means of acquiring them. In their book The Poor and Their Money, Stuart Rutherford and Sukhwinder Arora cite several types of needs:

Lifecycle Needs: such as weddings, funerals, childbirth, education, home building, widowhood and old age.
Personal Emergencies: such as sickness, injury, unemployment, theft, harassment or death.
Disasters: such as campfires, floods, cyclones and man-made events like war or bulldozing of dwellings.
Investment Opportunities: expanding a business, buying land or equipment, improving housing, securing a job, etc.
People find creative and often collaborative ways to meet these needs, primarily through creating and exchanging different forms of non-cash value. Common substitutes for cash vary from country to country but typically include livestock, grains, jewelry and precious metals. As Marguerite Robinson describes in The Micro finance Revolution, the 1980s demonstrated that "micro finance could provide large-scale outreach profitably," and in the 1990s, "micro finance began to develop as an industry" (2001, p. 54). In the 2000s, the micro finance industry's objective is to satisfy the unmet demand on a much larger scale, and to play a role in reducing poverty. While much progress has been made in developing a viable, commercial micro finance sector in the last few decades, several issues remain that need to be addressed before the industry will be able to satisfy massive worldwide demand. The obstacles or challenges to building a sound commercial micro finance industry include:

  • Inappropriate donor subsidies
  • Poor regulation and supervision of deposit-taking micro finance institutions (MFIs)
  • Few MFIs that meet the needs for savings, remittances or insurance
  • Limited management capacity in MFIs
  • Institutional inefficiencies
  • Need for more dissemination and adoption of rural, agricultural micro finance methodologies
  • Members lack of collateral to secure a loan

Microfinance is the proper tool to reduce income inequality, allowing citizens from lower socio-economical classes to participate in the economy. Moreover, its involvement has shown to lead to a downward trend in income inequality (Hermes, 2014).