4 Finance Essentials for Poverty Alleviation

4 Finance Essentials for Poverty Alleviation

"The financial circumstances of poor people are qualitatively, not just quantitatively, distinct," says Roodman. Picture: <a href="http://www.flickr.com/photos/34227370@N03/4972707245/">Melanie Dornier (Flickr)</a>
"The financial circumstances of poor people are qualitatively, not just quantitatively, distinct," says Roodman. Picture: Melanie Dornier (Flickr)

We can’t simply scale down traditional financial services to meet the needs of the poor. Poor households aren’t microversions of the rich—they’re fundamentally different.

David Roodman, whose recent book and blog investigates the microfinance industry, tells us why financial services must reinvent themselves to serve the poor:

Broadly, rich and poor are no different: all need to transact, invest, build assets, and sustain consumption. But the financial circumstances of poor people are qualitatively, not just quantitatively, distinct. Poor households are not just microrich ones, and microentrepreneurs are not simply microversions of the iconic entrepreneurs who perpetually roil the capitalist economy.

Roodman also speaks to the lack of appropriate financial services for the poor:

Just as more drugs exist for male impotence than for malaria, the financial services available to the rich outshine those for the poor in quality, diversity and cost.

Let’s take a deeper look into why—and how—the rich and poor use financial services to transact, invest, build assets, and sustain consumption.

1) To transact.

Financial services make everyday transactions less risky. <a href="http://www.flickr.com/photos/barsen/3714941137/sizes/m/in/photostream/">Photo: barsen (Flickr)</a>
Financial services make everyday transactions less risky. Photo: barsen (Flickr)

Cash is risky. Rich households use credit cards and checking accounts to keep cash safe. Financial services like direct deposit for paychecks, automatic payments and savings plans also make tasks more convenient.

Poor households often don’t have access to these types of services. They need different ways to transact. For example, many poor households are dependent on foreign earnings, or remittances from family members who have left to find work far from home. They need to transfer money over a distance. Money transfer systems, like M-PESA in Kenya and Western Union, link together dispersed families.

2) To invest.

A Marjah farmer in Afghanistan wheels out bags of fertilizer. Microloans enable farmers to make small investments to increase future income. Photo: <a href="http://www.flickr.com/photos/40927340@N03/4560677619/">United States Marine Corps (Flickr)</a>
A Marjah farmer in Afghanistan wheels out bags of fertilizer. Microloans enable farmers to make small investments to increase future income. Photo: United States Marine Corps (Flickr)

Rich households invest in the future with college and business loans. Increased earnings in the future are worth the cost of debt today.

When options are available, poor households also use financial services to make investments. Microcredit is used to invest in equipment and stock for businesses. Households use loans to diversify and improve control over sources of income.

3) To build assets.

It's harder for poor households to build assets. Home construction may take years to complete. Photo: <a href="http://www.flickr.com/photos/40595948@N00/4450609881/">A. Davey (Flickr)</a>
It's harder for poor households to build assets. Home construction may take years to complete. Photo: A. Davey (Flickr)

Assets, like homes and property, can be used as collateral for credit. Homeownership also provides security because one need not worry about being forced out by a landlord.

Poor households often build their assets literally brick by brick. Because banks are unlikely to take their savings or give them a home loan, the poor tend to build assets, like a house, a little at a time. However, this way of building assets makes poor households vulnerable if anything should happen before the house is completed.

4) To sustain consumption.

Poor households with volatile income must find ways to sustain daily consumption. Photo: <a href="http://www.flickr.com/photos/44124374403@N01/381233921/">Tim Johnson (Flickr)</a>
Poor households with volatile income must find ways to sustain daily consumption. Photo: Tim Johnson (Flickr)

Savings and insurance policies help households obtain necessities during rough times or in retirement. These kinds of financial services are a safety net for a household if a family member passes away, gets sick, or loses a job.

One important distinction between the rich and the poor is that the rich usually have salaried positions, while the poor are more likely to be self-employed. A steady paycheck means financial security. Poor households with volatile incomes need services to help them smooth shocks to continue daily consumption. The poor use moneylenders or microcredit when income falls below expenses. Some poor households have access to local savings clubs or commitment savings accounts. However, these types of savings plans tend to be less flexible than savings accounts offered by conventional banks. And commitment savings accounts do not pay interest, they charge it.

We know that financial services are essential for poverty alleviation. Let’s move beyond micro-thinking so we can have macro-effects.

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