Microfinance and Poverty Reduction: Is Social Protection the Missing Link?

Abstract

An ever-increasing body of literature points out that microfinance, despite being widely acknowledged as an effective strategy for poverty reduction, is not reaching a majority of poor households and is, thus, not effective in reducing their poverty. Our current theoretical understanding indicates that this is largely due to demand deficit on the part of poor households for microfinance products and services currently on the offer. Such products and services are observed to be more suitable to the financial needs of richer poor than those of the poor and very poor households. Literature suggests that microfinance outreach to poor may be improved by altering their external environment or by modifying the microfinance products to suit the needs of the poor. Literature, however, largely overlooks recent developments in the arena of social protection that are impacting financial needs of the poor. On the basis of empirical findings from three Indian states, I argue that demand deficit for microfinance may be corrected if provisions of microfinance are built upon social protection programmes that are increasingly becoming a significant aspect of the financial environment of the poor. Empirical evidence suggests that financial services may be more useful and acceptable to the poor, and, thus, may have more potential to reduce poverty if they are linked with social protection programmes. In addition, the availability of financial services that substantially meet the needs generated by the social protection measures may also contribute towards deepening of the impact of such measures.