Impacts of microfinance on poverty reduction

Background studies

Microfinance refers to loan provided to poor peeople in order to combat poverty. The loans are usually small so that the poor can start off their own businesses, thereby walking out of poverty. Besides loans, microfinance also supports the poor by helping them in the sense of savings and basic health care such as insurance.

Microfinance is usually funded by loans, grants, guarantees and investments from individual, philanthropists, social investors, local banks, foundations, governments and international institutions. Microfinance is different from commercial financial service as there is no collateral required and it is repaid within a short period of time. According to Grameen Foundation, microfinance clients boast very high repayment rates, averaging between 95 and 98 percent, better than that of student loan and credit card debts in U.S.

1.1 Defining Poverty

The earliest attempt to define poverty line for Malaysia was undertaken by the Ministry of Welfare in 1974. A common method used to measure poverty is based on incomes or consumption levels. A poverty line set at $1 a day has been accepted as the working definition of extreme poverty in low-income countries. Extreme poverty in Malaysia is defined as those living with incomes below half of Poverty Line Income (based on household minimum consumption requirements for food, clothing and other items, such as rent, fuel and power). [110] According to Chamhuri (1988), poverty is defined as a syndrome affecting people in situations characterised by malnutrition and poor health standards, low income, unemployment, unsafe housing, lack of education, inability to acquire modern necessities, insecure jobs and a very negative outlook on life (Jamilah 1994 p.3).

According to Siwar and Kasim (1997), poverty line income (PLI) used in measuring poverty incidence in Malaysia are RM405 per month for a household size of 4.8 in Peninsular Malaysia, RM582 for household size of 5.1 in Sabah and RM495 for household size of 5.1 in Sarawak. The very poor are defined as those having half the PLI income. Thus, those with a per capita income of less than RM50 per month were determined to be the very poor. The non-poor are those with per capita income of more than RM100 per month. [112]

Malaysia has adopted three concepts pertaining to poverty. They are absolute poverty, absolute hardcore poverty and relative poverty. Absolute poverty is defined as a condition in which the gross monthly income of a household was insufficient to purchase certain minimum necessities of life such as clothing and footwear, rent, fuel and power, transportation and communication, health care and education.

Absolute hardcore poverty is defined as a condition in which the gross monthly income of a household is less than half of the PLI. Relative poverty is defined as group whose mean income is less than another groups. Relative poverty is measured by using income disparity ratios of income groups (top 20 and bottom 40), ethnic groups (Bumiputera, Chinese and Indians) and urban and rural dwellers. [14]

1.2 Defining Microfinance

According to Conroy (2002), microfinance is the provision of small-scale financial services to people who lack access to traditional banking services. The term microfinance usually implies very small loans to poor people for self-employment, often with the simultaneous collection of small amounts of savings. Some of the poor already have the business skills they need and what they need the most is the cheapest source of credit [11]. By accessing to the credit, the poor will be enabled to work themselves out of poverty by investing in microbusinesses, which in turn will feed into economic growth. Thus, Salehuddin (2009) has concluded that the main objective of microfinance programs is to increase employment and to enhance income adequate to lift the poor above the poverty line on a sustainable basis. [113]

According to Goldberg and Karlan (2006), many microfinance programmes offer services beyond credit. The most basic service is savings. One of the reasons that people could not get rid of poverty is money management, especially savings. The poor always could not hold on to the money although they used various savings mechanisms. Thus, savings is one of the microfinance programmes where MFIs require mandatory savings each week from each borrower as well as each group. Some of these programmes also collect voluntary savings, allowing clients to deposits as much as they like each week [11]. Besides savings, there are also insurance schemes such as life insurance or health insurance, friendly societies with largely paid sick benefits, payments or money transfer services, business development skills training and remittances are also part of microfinance services [13].

Without access to microfinance, most poor households continue rely on meagre self-finance or informal sources of microfinance such as loan shark which limits their ability to actively participate in and benefit from the development opportunities [34].

McGuire. Conroy and Thapa (1998) stated that Bank Negara restricted the spread between base and maximum lending rates in the commercial banking system to 4 percent, less than would be required to cover extra costs associated with microfinance lending. In the case of some loans guaranteed by CGC the permissible spread was only 2 percent, reinforcing this effect [37].

Microfinance products offered by the financial institutions in Malaysia typically have the following features:

Small loan size ranging between RM500 — RM50,000.

For ease in obtaining microfinance, there is no collateral requirement, minimum documentation and simple procedures.

Fast approval and disbursement of financing (as fast as 2 days)

Flexible tenures (from 1 month to 10 years)

Widely accessible via branches and/ or other alternative distribution channels (e.g. post offices) of financial institutions.

1.6 Problem statement

This study intends to provide a comprehensive picture of impacts of microfinance on poverty reduction. This study also aimed at answering the questions:

Is microfinance a solution to poverty alleviation?

How did it help pulling large segments of the poor population out of poverty?”

How are the lives of the participants different relative to how they would have been if they did not participate in the programs.

1.5 Research Objective

The main purpose of the study is to test whether microfinance reduces poverty in Malaysia. The effectiveness and efficiency of microfinance products in Malaysia will be analysed and investigated. Upon examining microfinance in Malaysia, ways to improve microfinance programmes will then be suggested. The issues that will be examined are:

The extent to which microfinance services have made a lasting difference in pulling households out of poverty;

The extent to which awareness of microfinance services by the community;

The extent to which the effectiveness of microfinance products in reaching the poor, thereby reducing poverty;

The extent to which the involvement of urban households in microfinance activities;

The growth and development of microfinance in Malaysia;

The performance of microfinance in the sense that the extent to which the success of microfinance services against their primary objective.

Impact evaluations are not simply about measuring whether the program is having positive effect on participants. It also provides important information to practitioners and policy makers about the types of products and services that work best for particular types of clients. Thus, another objective of the paper I to explore why top performing programs have the impact that can help policy makers develop best policies for MFIs to adopt. In addition, it also allows us to benchmark the performance of different MFIs. [11]

1.6 Methodology

The study will be investigating the role of Microfinance programmes in eradicating poverty in Malaysia. A survey questionnaire will be conducted to evaluate the effectiveness of microfinance programmes. The questionnaire will be including sections such as demographic information, household living conditions, expenditure and income of respondents, loan characteristics and microfinance programmes that respondents involved in. the questionnaires will then be analysed and evaluated in order to investigate the effectiveness of microfinance in reaching the poor and its impact in reducing poverty [49].

The survey data obtained from the survey will then be analysed. For each hypothesis, a quantitative impact variable will be defined. Impact variables will be compared between clients and non-clients. Cross-section differences will be examined and evaluated for statistical significance using analysis of variance (ANOVA).

1.7 Project outline

The paper is organized in five sections. The first chapter presents an overview of history of microfinance and poverty level in Malaysia. The chapter starts with definition of terms.

Chapter two presents the poverty level, theoretical background and development of microfinance in Malaysia. Besides, a few concepts of microfinance and its products in Malaysia are also discussed in the chapter. The chapter moves on by presenting the literature review of previous studies on the impact of microfinance on poverty reduction in Malaysia and other countries.

Chapter three is the methodology which describes the survey design and data. Key concepts and few definitions of terms are presented as a brief introduction. The descriptive statistics and key characteristics of the study groups are presented. The research design and strategy, sampling design, research instrument, location selections, data collection, sample selection and data analysis tool are also discussed in the chapter. The chapter ends with the discussion of research limitations.

Chapter four explains the treatment effect model. It analyses the survey questions and data collected. The chapter moves on by comparing the data collected from clients and non-clients of microfinance programs. The chapter ends with summarizing the findings and comparisons.

Chapter five concludes observation, summarizes results and presents recommendations and suggestions for further research. The chapter begins by summarizing the research problem, the study’s contexts and the methodology employed in the study, followed by answering the specific research questions.