THE EFFECTS OF MICROFINANCE INSTITUTIONS ON

POVERTY REDUCTION.

Prepared by: SSENTOVU IAN

Preparation for Bachelors of Sciences in Business Studies

KYAMBOGO UNIVERSITY

Lecturer: NAME SURNAME

2nd September 2001

Abstract
Microcredit to the poor, particularly young people and women in rural areas, is a significant
role in poverty reduction through empowerment. The majority of research studies have found
that self-employment leads to increased job creation and higher income levels. There have
been hints of independence on the part of both women and youth, home expenditure on the
part of women and education expenditure on the part of youth who are able to supplement
their income through self-employment. Most researchers have employed at least two to four
models, with the most common ones being the Grameen solidarity group model, targeting
women groups' model, regular payback schedule model, and village banking model,
according to the researcher. The researcher has dealt with a number of topics, the most
important of which is that microcredit has been able to raise at least 55 percent of its clients
out of poverty, and that they have access to safe drinking water. It is also becoming evident
that the poorest of the poor are not benefiting because the majority of these people are unable
to repay their debts, causing them to lose much more than they already have.
CHAPTER ONE
1 Introduction
This chapter includes; background of the study, general objective of the study, specific
objectives of the study, scope of the study, significance of the study, conceptual framework
and definition of key terms.

1.1 Background of the study

Microfinance is a key policy strategy for poverty alleviation. Inadequate access to credit by
the poor has been identified as one of the contributing factors of poverty. To redress the issue,
the policy of increasing access to both production and consumption credit by the poor has
been articulated. The policy also emphasizes sustainability of microfinance institutions
(MFIs) that deliver services to the poor.

In Africa and specifically Uganda, the microfinance revolution has changed attitudes toward
assisting the poor, and in some countries, it has provided substantial flows of credit, often to
very low-income groups or households who would otherwise be excluded by formal financial
institutions. As a result, a large number of studies have attempted to assess the outreach and
poverty impact of such schemes.

This Report will examine the extent to which microfinance has achieved its own objectives to
reach the poorest of the poor, to ensure a positive measurable impact on the lives of clients
and their families, to build financially self-sufficient institutions, and to reach and empower
the women and the youth in society who are believed to be among the poorest in society.

1.2 General Objective

The general objective of this study is to examine the effect of Microfinance on poverty
Reduction.

1.3 Specific Objectives

 To examine the positive impact of MFIs in Uganda on poverty Reduction
 To assess the negative impact of MFIs in Uganda on poverty reduction.
 To determine the relationship of MFIs and Poverty.

1.4 Scope of the Study.

The study covers two types of scopes; Geographical Scope and content Scope.
1.4.1 Geographical scope
The study is limited to effects of MFIs in Uganda.
1.4.2 Content Scope
The study will examine the effect of Microfinance both posiive and negative on poverty
reduction.

1.5 Significance of the study

 The study may be used by MFIs to improve on their services and reduce on the
poverty rate
 Nationally, the study may provide significant information to the policy makers with in the
Government of Uganda that would be relevant to formulating policies to guide different
MFIs on how to handle Poverty Reduction.

1.6 Conceptual Framework

Independent Variable Dependent Variable

Microfinance Poverty reduction

Micro Credit
Savings Increase in Income
Insurance Employment
Training Self Confidence
Higher living Standards

Intervening Variable

Economic Conditions
Government Policy
Political Instability
1.6.1 Independent Variables:
Microfinance: Microfinance refers to provision of financial services to low income earners
and the poor in general to raise their income levels thus promoting their standard of life.
These include the following:
Micro-credit: These are the provision of small loans to clients for business purposes.
Savings: They are small amounts of money; the clients are encouraged to save in the financial
institutions.
Insurance: All entrepreneurs face risks in their businesses and therefore it becomes necessary
for financial institutions to insure various businesses by the use of different policies to reduce
the risks involved in running businesses.
Training & skills: Financial institutions offer various training programs to equip the clients
with the required knowledge and skills necessary to run their business efficiently.
1.6.2 Dependent variables:
Poverty reduction: The major objective of microfinance services is to empower the poor and
this is done by giving various financial services to their clients. The following are the factors
that contributes to the fulfilment of the above objective:
Increase in income levels: It is obvious that as employment opportunities comes up, the
unemployed will be able to get jobs which have been created and those who had temporary
jobs may now get permanent jobs and this will obviously lead to an increase in individual as
well as national income.
Creation of employment opportunities: Better utilization of the loans given to clients of
MFIs in most cases leads to expansion of businesses and this in turn will also lead to creation
of employment opportunities to the society.
Higher living standard: As the income of the people increases, individuals are able to
purchase goods and services which in return leads to increase in the standard of living.
Increase in the National income enables the nation to inject more money for the development
of infrastructural development which also will see the standard of the people increasing.
Self-confidence: When people have high incomes and their standard of living goes up, this
builds in them self-confidence, people psychologically feel recognized and self-worth.
1.7 Definition of key concepts.
1.7.1 Microfinance:
Microfinance refers to provision of financial services: loans, savings, insurance, or transfer
services to low-income households. Microfinance refers to provision of financial services:
loans, savings, insurance, or transfer services to low-income households. (Morduch, The
microfinance promise, 1996) further describes microfinance as small loans, savings
mobilization and training offered to the poor to enable them to create self-employment by
starting their own businesses and thus generating income.

1.7.2 Micro-credit
It is a component of microfinance and is the extension of small loans to the poor including
women and the youth in general who are too poor to qualify for loans in commercial banks,
especially in developing countries.
1.7.3 Poverty:
At a UN Summit on social development, 'the Copenhagen Declaration' 1995, poverty was
described as a condition characterized by severe deprivation of basic human needs including
food, safe drinking water, sanitation facilities, health, shelter, education and information.
To (The World Bank, 2008) a person is said to be poor when his or her consumption level
falls below the poverty line of $1 per day. Poverty is poverty as being complex and
interwoven, including a material lack and need for shelter, assets, money and often
characterized by hunger, pain, discomfort, exhaustion, social exclusion, vulnerability,
powerlessness and low-esteem.
1.7.4 Microfinance Institutions (MFIs)
In the context of Uganda, MFIs are the registered and Institutionalized microfinance providers
constituted mainly of NGOs, (both Local and Foreign), Savings and credit cooperatives and
even some commercial banks. They provide microfinance services to mainly small and
medium scale enterprises (SMEs).
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2 Literature Review
This section includes literature according to the research objectives. It was arranged in
relation to the study objectives.
2.1 Theoretical Review.
Despite the scarcity of statistics in the sector, it is obvious that different MFIs use a wide
range of implementation strategies. There are fourteen main microfinance models, according
to Grameen Bank, of which the reviewer will focus on the most frequent ones employed in
most research studies. The following are the specifics:
2.1.1 Individual lending model:
Individual loans are as follows: Individual loans are more flexible, although larger members
of credit groups are always granted minimum loan sizes. Loan sizes can be customized to the
borrower's activities and ability to pay within broad restrictions. As the applicant displays
quick repayment and reasonable loan usage, loan amounts and maturities grow. It has been
argued that group credit arrangements deteriorate over time, whereas individual lending can
improve over time if good institutions are in place to provide repayment incentives. Individual
ability to invest in viable businesses is also important, and this is where MFIs are supposed to
provide entrepreneurial training.
2.1.2 Village Banking Model:
Village banks are community-run credit and savings cooperatives set up by non-governmental
organizations (NGOs) to give access to financial services, foster community self-help, and
assist members in building savings (Holt, 1994). Since the mid-1980s, they have been in
existence. They typically have 25 to 50 members who are low-income people looking to
better their lives through self-employment. These members are in charge of the bank, electing
their own officers, establishing their own bylaws, disbursing loans to individuals, and
collecting payments and services.
The loans are backed by moral collateral which is the promise that the group stands behind
each loan (Global Development Research Centre, 2005). The sponsoring MFI lends loan
capital to the village bank, who in turn lend to the members. All members sign a loan
agreement with the village bank to offer a collective guarantee. Members are usually
requested to save twenty percent of the loan amount per cycle. Members’ savings are tied to
loan amounts and are used to finance new loans or collective income generating activities and
so they stay within the village bank. No interest is paid on savings but members receive a
share of profits from the village bank’s re-lending activities

2.1.3 Credit and collateral model:

Credit refers to a contractual agreement, in which a borrower receives something of value
now, with the agreement to repay the lender at some date in the future. Credit can benefit both
borrower and lender if the borrower has an investment opportunity with a higher expected
return of revenue than the cost of providing the loan. The lender provides a borrower with
capital in advance, under the expectation that they will pay back, with a price, the interest
rate. To the lender, the aim is to have the capital back with a return that covers its cost,
expenses and give some profit to the borrower. The borrower applies for the credit based on
belief that he can gain a return higher than the interest rate. However, lending involves a risk
of default. Defaults can be grouped into two types: involuntary default and strategic default.
Involuntary default is as a result of failure in investment which makes the borrower incapable
to repay the loan amount. Strategic default refers to a situation where the borrower has the
ability to repay the loan, but he does not find it in his interest to do so. This often happens,
especially in contexts where the legal system of loan enforcement is weak.

2.2 Link between Microfinance and Poverty Alleviation.

Poverty, measured by the proportion of population living below the poverty line, is observed
to be declining in Uganda Over time. Poverty in Uganda is a rural phenomenon, with 80% of
the poor living in rural areas. Poverty continues to be regionally concentrated in Uganda with
North and East having the highest percentage.
Credit is considered to be an essential input in increasing agricultural productivity, mainly
land and labor. Credit alleviates poverty since it boosts income levels, increases employment
at household level. Credit also enables the poor people to overcome their liquidity constraints
and undertake some investments especially in improved farm technology thereby leading to
increased agricultural production.

According to Navajas et al, the professed goal of microcredit is to improve the welfare of the
poor as a result of better access to small loans. Diagne and Zellar (2001) argues that lack of
adequate access to credit for the poor may have negative consequences for various household
level outcomes including technology adoption, agricultural productivity, food security,
nutrition, health and overall welfare. Access to credit therefore affects overall welfare
outcomes by alleviating the capital constraints on agricultural inputs. This reduces the
opportunity costs of capital-intensive assets relative to family labor productivity. Access to
credit in addition increases the poor households’ risk-bearing ability, improves their risk-
copying strategies and enables consumption smoothing over time. By so doing, microfinance
is argued to improve the welfare of the poor.

Rhyne and Otero (1992) argued that financially stable MFIs with high outreach have a greater
likelihood of having a positive impact on poverty alleviation because they guarantee
sustainable access to credit by the poor.

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Outreach is the number of clients served by an MFI.
Financial Stability on the other hand measures the extent to which the MFI covers its operational and financial
costs from internally generated revenues (interests and Commissions)
Conclusion

4. Recommendation

The information collected for this report provides a broad overview of key changes in the
Australian workforce. Further analysis would be possible if the relevant data for each year
from 1945-2000 was purchased from the Australian Bureau of Statistics. The reliance on
secondary sources has resulted in some patchy data. For example, it is not possible to
identify for any given year a breakdown of the Australian workforce by the following
categories:

• unmarried Australia-born women

• married Australia-born women

• unmarried Australia-born men

• married Australia-born men

• unmarried immigrant women

• married immigrant women

• unmarried immigrant men

• married immigrant men

Greater access to primary data would enable a more thorough analysis to be made.
3 References
Morduch, J. (1996). The microfinance promise. Journal of Economic Literature, Vol. 37.
Morduch, J. (1999). The role of subsidies in microfinance. Journal of Development
Economics.
The World Bank. (2008). World Development Report. Washington DC.
Non Government Organizations - NGOs
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Small and Medium scale Enterprises (SMEs)

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