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WSJ Article: Debunking Myths about the Poor and Financial Services
by Suyash Rai & Sona Varma of IFMR Trust(Click here for the full article)
The power of finance to transform the lives of the poor is not well understood. Despite recent articles that raise concerns about microfinance, the evidence at large shows that successful microfinance institutions (and their list is growing) have managed to implement service delivery mechanisms that meet the needs of the poor, at a lower cost than most accessible alternatives.
The following noteworthy misconceptions are worth highlighting:
Myth 1: "The poor are not creditworthy"
Debunked: The micro credit experience of the last three decades decisively challenges this perception, showing that if suitable mechanisms are used, the poor can be as creditworthy as the rich. The poor’s lack of collateral can be overcome with joint liability within a group of borrowers, and this has resulted in very high repayment rates in micro credit over the last three decades. Micro finance institutions have consistently reported repayments upwards of 95% in a number of developing countries.
Myth 2: "Finance falls lower in the 'hierarchy' of needs for the poor, below health, education etc."
Debunked: Finance should ideally fall out of any such hierarchical ordering of 'inputs' into a household, because it is a cross-cutting tool that helps households' wellbeing across several dimensions. Empirical research shows that the poor use many financial instruments frequently, but due to absence and unsuitability of formal mechanisms, they have to rely mainly on unreliable informal service providers.
Myth 3: "Credit is the only financial service required by the poor"
Debunked: Studies clearly show that the poor need a range of services such as
a) Risk mitigation mechanisms, for example insurance, to protect against exogenous shocks;
b) Savings facilities to smooth consumption and get reasonable returns even on small amounts; and
c) Investment/risk management mechanisms that allow for wealth creation and diversification of risk.
A number of successful initiatives, such as those providing micro insurance or small ticket investments in mutual funds, re-affirm the hypothesis that the poor demand and can benefit from the same wide range of financial services that are routinely provided for the rich.
Myth 4: “The poor are not sophisticated in using financial services, so access to finance may end up damaging their livelihoods”
Debunked: On the contrary, research on the use of financial services by the poor shows that given the complexity in their financial lives, the poor are very sophisticated in their use of financial instruments. Due to the absence of well-designed formal services, they end up creating a complex mesh of informal financial mechanisms around their lives. It seems this is the only way they can meet multiple needs using informal instruments For example, financial diaries of the poor show how they creatively use a variety of loan sources to deal with the irregularity in their incomes and expenditures. Research also shows quite convincingly that on an average the chronic poor, i.e. those who fail to move out of poverty, do take initiatives to change their conditions. Failure to move out of poverty is primarily because of lack of access to capital and relevant networks. The recent evaluation of a micro credit program in India shows how entrepreneurial households consistently use credit to start successful new businesses or improve the profitability of existing businesses.
Suyash Rai is Senior Manager and Sona Varma is Senior Advisor with IFMR Trust, a private trust with the mission of ensuring complete access to financial services for individuals and enterprises in India.
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