Friday, December 7, 2007

Microfinance and extreme poverty

Poverty in Africa remains high. Microfinance can play a role, but does not yet live up to expectations. Why not? This is a field on its own, but here is a starter: Much more needs to be done on linking microfinance to the financial sector, on providing a proper regulatory environment, on raising awareness and understanding and on flexible product design.

Poverty in Africa
The share of the very poor in Africa remain persistently high at around 41% of the population . According to the World Bank they are even increasing in some countries such as South Africa. Providing a safety net through the provision of social grants is one strategy, but has the drawback of creating dependencies, perverse incentives and does not offer a real long-term solution to poverty.

According to the IMF, there is sufficient evidence that Africa's poor, particularly those in the rural sector, value both deposit and credit facilities. Believing that poor people may also be creative and entrepreneurial, one suggested way to escape from the poverty trap is to provide the poor with access to credit.

Microfinance as an option
Using micro finance institutions (MFIs) as a poverty alleviation strategy does hold some promise, but it is no silver bullet. Poverty remains a multidimensional challenge.

Does microfinance work in Africa? According to a report from the Micro Finance Information Exchange, micro credit growth is slow while growth in saving services are very high. This obviously falls short of implementing the idea of ignite Africa's entrepreneurial spirit through the provision of credit.

What needs to be done to improve micro financing?

According to the IMF: Linkages to the formal banking system are important. MFIs rely on banks for a variety of services, including deposit facilities, liquidity management services, and, in some cases, emergency credit lines to cover cash shortfalls. For banks, the benefits are the opportunity to expand their client base through MFIs, and to expand their operations through the network of MFIs (including in the rural sector). The linkages between MFIs and banks also help to strengthen the linkages more broadly between the economic activities in the formal and informal sectors of the economy, and provide opportunities for small entrepreneurs to graduate from micro credit to conventional bank loans.

In addition, NGOs and donors are important to provide support and best practice and governments to provide regulatory frameworks.

According to the Africa Micro Finance Network: Microfinance must be accommodated as part of the macro financial sector; Microfinance must be viewed as financial sector component and not as poverty or development program; Country level networks need to define framework for appropriate systems, effective and sustainable financial services; Donors should focus on microfinance sector as a whole, and not emphasize only on the strongest MFIs; Linkages with formal financial institutions must be increased to better serve the low income population; Appropriate vision that translates into reality thus impacting microfinance outreach in Africa needs to be developed; Information exchange across networks should be increased

According to an article on Voxeu more flexible is needed in the design of debt products: Being poor is not just about having too little income. It is about having insecure income...Contrast this with the single most salient fact of micro-finance: nearly all contracts are fixed in their repayment schedules. This mismatch between debt payments and income can create serious distortions...

Increased understanding and awareness of microfinance products has also been raised as a problem for women entrepreneurs in a study done by the IFC, FinMark Trust and DTI as an obstacle in South Africa.

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