Microfinance as a Poverty Reduction Tool: A Critical Assessment

Examining the limits of financial interventions in alleviating poverty
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This paper critically analyzes the effectiveness of microfinance as a universal poverty reduction tool.

Microfinance has developed some innovative management and business strategies, but its impact on poverty reduction remains doubtful. Microfinance certainly plays an important role in providing a safety-net and smoothening consumption. Microfinance borrowers possibly also benefit from learning-by-doing and in terms of self-esteem. The paper states that:

  • Microfinance advocates have usually focused on supply side factors, paying little attention to the demand side;
  • Microfinance ignores the crucial role of scale economies;
  • Too many microenterprises due to a constant inflow of new MFI-financed entrants cause market saturation, and a hyper-competitive situation;
  • Businesses funded by microfinance will most likely replicate a barter economy in the absence of a vibrant domestic market.

Supply-side factors, such as good infrastructure and entrepreneurial skills, are needed to make microenterprises more productive. The potential for increased productivity, however, will not be realized in the absence of demand-side factors. Finally, without a supportive macroeconomic, trade and industry policy framework, microenterprises will remain small, with no back¬ward or forward linkages or employment creation possibilities.