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Microcredit: A Tool for Poverty Alleviation Essay



The eradication of poverty is one of the major goals of the United Nations and governments all over the world. Despite this, poverty has continued to plague many nations; impeding economic development and reducing the quality of life for many.

This poverty crisis which has had the biggest impact on developing nations has resulted in a need to come up with workable solutions to alleviate it. While many solutions have been proposed and tried out, microcredit has come out as a workable way to fight poverty. Microcredit has demonstrated the capacity to deliver financial services to the poor therefore delivering significant benefits to the community. This has been through the offering of credit services to the poor.

Traditionally, the middleclass and rich members of society have had access to loans from financial institutes while the poor have been left out since they lacked possessions which the banks could use as collateral. This status quo resulted in the economic growth of the people the middle income and rich class while the poor remained impoverished.

Through microcredit, the poor have been given the much needed capital and enabled them to engage in income generation. This result underscores the impact of microcredit in the fight against poverty. This paper shall argue that micro credit is one of the most important and effective weapon in the fight against poverty since it provides the poor with a way out of poverty.

To reinforce this claim, this paper shall perform a concise yet informative review on micro credit and how they might help someone to move out of poverty. The paper shall begin by defining microcredit and proceed to show why the poor need microcredit services. The manners in which microcredit can help one to overcome poverty will then be articulated. To provide a balanced view, the paper shall also document some of the setbacks of microcredit.

What is Micro Credit?

Microcredit involves the “organized supply of very small, fixed term, renewable loans, secured by unorthodox forms of collateral, normally in aid of self-employment” (William 2002, p.146).

The concept of microfinance traces its roots to the 1970s experiments of availing small loans to the poor in society by NGOs in the Asian and South American continents. Micro-credit institutes are primarily dedicated to “provide savings and loan facilities to clients neglected by the conventional formal banking sector” (Hanak 2000, p.304). This neglecting is as a result of lack of property by the client that the banking institute can use as a loan guarantee or collateral in the event that the client is unable to pay up.

Annim (2008) states that as a result of the 1970s experiments; there came about a realization that the poor could in fact borrow, use and repay loans just like the other clients using the services of conventional banking institutes. In recognition of the role that microfinance’s can play in the eradication of poverty and hence the achievement of the Millennium Development Goals, The UN duped 2005 as the “year of microcredit”.

There exist many models followed by microfinance institutes (MFIs). The Grameen bank model developed by the renowned Nobel Peace Prize winning personality, Muhammad Yunus, is the most emulated by micro-finance institute all over the world. The huge successes achieved by this bank which is a microfinance institute established in 1976 resulted in worldwide attention on the potential of microcredit by donors and policy makers alike.

Microcredit institutes are build on the ideology that commercial banks undersupply credit products to the poor who may be creditworthy but lack relevant collateral to qualify for loans. Microcredit set out to fill in this void by adopting lending technologies such as the peer-supported loans which renders collateral unnecessary.

A significant difference between microfinance and normal financial services providers is that the transactional cost to the clients is very low. This results in lower interest rates on loans for the borrowers. Microcredit loans are primarily offered to enable people take part in productive activities. This is because most MFIs adhere to an ideology of “solidarity based on reciprocity” as opposed to being charitable or philanthropic (Palier 2005 p.49).

Microcredit has at its very core the unique lending mechanism, the “peer-supported loan”. This lending mechanism organizes debtors into groups which are categorized as self help groups (SHGs). Each member of the group has a responsibility for repayment of the loans taken by the other members.

Williams (2002, p.150) notes that microfinance transactions “draw explicitly on sociability or social capital to mediate access to financial services”. The microfinance participants police their peers so as to ensure that they repay their loans and in turn, they are policed by their peers. This is because future access to finance services from microcredit depends on the overall performance of the group.

Why the Poor Need Micro Credit

The poor are especially in need of microcredit for a number of reasons. To begin with, MFIs which offer the loans do not require land or other possessions as collateral. This means that the credit services are available to the poor who are mostly land-less and lack property that can be used as collateral. As such, microcredit presents a way for the poor to obtain the much needed capital which would otherwise be denied of them due to their poverty state.

A major consideration before one is afforded a loan is their creditworthiness. Commercial banks require that one have an attractive credit report as well as a proven record of business success before then can be afforded a loan (Snow 1999, 66). This places the poor at a disadvantage since most of them are struggling and hence highly unlikely to boast of any successful business endeavor.

The commercial lender is therefore predisposed to view the poor as unviable credit risks therefore denying them of credit services. Microcredit does not require any prior business success and the poor can therefore benefit from loans since the institutes are wiling to take the risk by lending the poor.

MFIs present a source of capital of women who would not have any other source of capital. Women in most developing nations are disadvantaged as a result of gender discrimination and inequalities which make them take second place to men in society. As a result of this, women count among the poorest and lack the means to involve themselves in income generating activities.

This is in spite of the fact that secluding women from economic affairs results in the decreased economic growth of a country. Helping women is therefore a sure way of contributing to economic growth and development in a country. While the informal economy presents a forum for women to participate in income generation, lack of capital prevents them from doing so. Microcredit comes in and gives the women the much needed capital hence empowering them economically.

Credit as the ticket out of Poverty

It has long been acknowledged that access to capital is the prerequisite to income generation and hence financial stability for an individual. However, the poor lack this very capital and therefore the means through which to generate income. Burgess and Pande (2003, p.1) authoritatively cite lack of access to finance as the core reason why the poor are unable to breakaway from their poverty.

It therefore stands to reason that access to finance will present a way through which the poor can work their way out of poverty. Micro-credit institutes propose to do just this by making capital available to the poor who would otherwise lack access to it. Muhammad Yunus asserts that “Micro-credit helps to create self-employment and put the poor, particularly women in the drivers’ seat” (Kar 2008, p.17).

The fact that micro-credit institutes mostly target women is significant since the level of poverty among female headed households in developing countries was significantly higher than in male headed households (Annim et al. 2008, p.94). The reason for this is that there exist structural constraints that place women at a disadvantage.

Good saving habits enable one to finance income generating projects as well as have a safety net in case of problems. The poor traditionally exhibit poor saving habits mostly as a result of their low earning powers. This combined with the lack of membership to financial institutes meant that the poor do not have any savings.

MFIs promote savings and deposits among their clients since this is a source of funding for the sustainability of the institute as well as a prerequisite to acquiring loans by the members. A research by Kar (2008) observed that after joining a self help group the savings habit of the members improved. This saving resulted in a marked increase in the quality of life for the members as compared to non-members.

Microcredit programs act as a precursor to access to commercial sources of working capital for the poor. They do this by making small amounts of capital accessible to the poor. Snow (1999) asserts that these small amounts would not be accessible to the person through commercial lenders who are risk aversive. The MFIs then offer training for entrepreneurs therefore offering them the tools with which to expand their businesses up to a level where the individual can be eligible to access credit facilities from commercial banks.

Microcredit has a wider impact than just the presenting of capital to the poor. Findings from a research by Pitt and Khandker (1998) on the impact of microcredit programs in Bangladesh indicated that a 1% increase in credit from an MFI to women raised the probability of the girl-child being enrolled to school by 1.86%.

These findings demonstrated that microcredit indeed has a positive impact on education. Reporting on the impact of MFIs in India, Neponen (2003) found positive impacts by comparing old members to incoming members. The old members were seen to have a higher standard of living and their sons and daughters recorded higher attendance rates to schools as well as better income.

The poor are typically plagued by significant consumption variations which result in uncertainties and debts. Microcredit programs shield the poor from this by reducing the variability of consumption and therefore leading to consumption smoothing. Research on Bangladesh households which were beneficiaries of microcredit programs revealed that consumption across seasons reduced by 47% (Morduch 1998). By smoothing consumption, microcredits offer the poor a more stable life and therefore result in poverty elevation.

Arguably the primary cause of poverty is unemployment. For this reason obtaining employment is seen as the most effective way to overcome poverty. Goldberg (2005, p.26) asserts that the effects of MFIs on poverty are resounding. A study by Dunn and Arbuckle (2001) indicated that as a result of microcredit membership by 40,000 participants, 17,414 full time jobs were created with some 6259 jobs being availed to non-members.

This highlights the ability of microcredit institutes to create jobs for the individual therefore giving them the means by which to break free from poverty. The study also demonstrates that MFIs alleviate poverty in non-participants through the spillover effect where the non-participants benefit from the economic vibrancy that result from the microcredit.

Microcredit result in the development of a community by giving the members economic empowerment. Research underscores the relationship between access to financial services and poverty alleviation. Findings by Burgess and Pande (2005) indicated that access to credit as well as savings mobilization resulted in a reduction of poverty in rural areas.

This is because the availability of the microfinance facilities enabled rural households to accumulate capital as well as obtain loans that were utilized for productive purposes. MFIs therefore provide a way for people to increase their earning power hence get out of poverty. This is a sentiment shared by the president of the World Bank, Walfensohn James who asserted that.

Micro-credit programmes have brought the vibrancy of the market economy to the poorest villages and the people of the World. This business approach to alleviation of poverty has allowed millions of individuals to work their way out of poverty with dignity (Kar 2008, p.17; Microcredit Summit, 1997).

Most of the opponents of microcredit assert that these institutes only tie down the poor in debt. They propose that by providing the poor with loans, the poor end up in a vicious cycle and are hence held in perpetual poverty. These claims are substantiated by Kar (2008) who reveals that some of the recipients of microcredit loans used the money to pay off other debts.

While it is true that some borrowers end up using their loans to pay off debts, a study carried out by Chen and Snodgrass (2001) revealed that clients of an MFI who borrowed for self employment ended up better off than those who only saved and those who did not participate in the program.

These findings are corroborated by a study on the impact of microcredit in Peru by Dunn and Arbuckle (2001). This study revealed that MFI clients earned an average of $503 more than non-clients in a year. It is clear from these revelations that microfinance presents an effective way of promoting income growth among the poor.

Negative impact of Micro Credit

While micro credit institutes are regarded as the way out of poverty, they sometimes have the reverse effect of plunging the client even deeper into poverty. This is the case when the micro-credit loans are used for unproductive purposes.

Findings from a study conducted by Kar (2008) revealed that loans obtained by members of Self Help Groups from microfinance institutes were used to repay debts from informal moneylenders. As many as 85% of the SHG members revealed that they used their loans for repayment despite knowing that the loans were to be utilized for productive purposes (Kar 2008, p.23). Such behaviour results in a scenario where the micro-credit clients are trapped in a vicious circle of poverty.

Kar (2008, 24) states that the reason for this cycle is since microfinance institutes seldom provide finance for health care or other non-productive ventures. This obligates the poor to rely on the informal moneylenders who express little interest in the manner in which the borrowed money will be utilized.

Microcredit programs in some contexts end up being harmful to the poor clients. In developing countries, the loans obtained from FDIs are channeled by poor traders to the same kind of business activities.

Buechler (1995, p.15) states that “if too many micro-entrepreneurs who are making the same products are receiving loans, competition is created to bring prices down, thus negating any benefit from the loan”. In such scenarios, access to microcredit is detrimental since it results in too much competition therefore making the poor traders earn even less than they would have without microcredit.


The success of MFIs in reducing poverty has resulted in the institutes being looked at as a feasible means to battle poverty. Data from the Grameen Bank which offers microcredit services indicated that 55% of their clients had crossed the poverty line in a 7 year period (Goldberg 2005, p.12). This has been primarily because, most microfinance institutes limit their credit support to productive purposes only; as such loans are mainly provided for trade, agriculture and other income generating activities.

The success of micro-credit in helping people get out of poverty comes from the notion that access to finance can enable people to engage in productive activities hence exit from poverty. Microcredit has been of great importance in jumpstarting small enterprises. While micro-credit institute have been a huge success in improving the quality of life for the poor, they can still do more to enhance their success even further.

As has been noted, the institutes encourage the productive use of loans by their clients. Kar (2008, 24) notes that in most cases, the clients lack ideas of productive utilization of the availed funds and as such end up misusing the money. Guidance for the use of the funds by the micro-credit institutes would result in better ideas and hence more productive utilization of credit by the clients.

Critics are generally opposed to the focus on profit by MFIs since if the institutes focus on profit, they will have no difference from the mainstream financial institutes. While it is acceptable that MFIs should avoid emphasizing on profitability, they must have the means to sustain themselves. The sustainability of the MFI is important since only such institutes can attract findings which are necessary for growth and the provision of services for the poor people.

Snow (1999, p.66) articulates that a microcredit program can only be termed as sustainable when “net benefits to the community exceed total costs. Even so, focus on credit would make MFIs no different from commercial lender. The fate of Microfinance is best articulated by Lewis (2010, 8) who declares that microfinance will lose its essence if it “deviates from its higher and loftier objectives, drifts away from its noblest aspirations for economic justice”.


This paper set out to argue that micro credit is one of the most important and effective weapon in the fight against poverty since it provides the poor with a way out of poverty. From this paper, microcredit has been seen to be a major agent of development since it results in the usage of labor and capital resources in poor societies. Without the microcredit, these resources would mostly remain unused.

The evidence from multiple researches into MFIs has shown that microcredit in majority of the cases results in a raise in the standard of living for the individual and therefore gives them the means through which to overcome poverty. The paper has demonstrated that the claims that access to formal subsidized credit has undermined rural development and increased poverty amongst the poor is a gross generalization and does not apply universally to micro finance institutes.

From the discussions presented in this paper, it is evident that microcredit programs can increase income and therefore help families move out of poverty. In addition to this, microcredit has other impacts such as increasing the school enrollment rate amongst the children of the poor. The potential of microcredit in terms of community and individual development is great and for this reason, government and donors alike should work towards improving MFIs so as to achieve the ultimate goal of poverty eradication in the world.


Annim, K. S. Awusabo-Asare, K. & Asare-Mintah, 2008, “Spatial and socio-economic dimensions of clients of microfinance institutions in Ghana”, Journal of Geography and Regional Planning Vol. 1(5), pp. 085-096.

Buechler, S. 1995, “The key to lending to women micro-entrepreneurs”, Small enterprise development, Vol. 6/2.

Burgess, R. & R. Pande (2005) “Do Rural Banks Matter? Evidence from the Indian Social Banking Experiment,” American Economic Review, Vol. 95, No. 3,pgs. 780?795.

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Lewis, J. C., 2010, Obama Calls out Microfinance: Taking the Measure of Microfinance. Web.

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Neponen, H. 2003, ASA-GV Microfinance Impact Report 2003, India: The Activists for Social Alternatives.

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Palier, J. 2005, Defining the concept of empowerment through experiences in India, French Institute of Pondicherry.

Pitt, Mark & Khandker, S.,“The Impact of Group-Based Credit Programs on Poor Households in Bangladesh: Does the Gender of Participants Matter?” Journal of Political Economy 106 No. 5 (1998): 958-996.

Snow, D. 1999, “Microcredit: an institutional development opportunity”, International Journal of Economic Development, 1(1), pp. 65-79.

Williams, T. 2002, “Requiem for microcredit? The Demise of a romantic ideal”, Banking & Finance Law Review, vol. 19.

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