In my last post (# 35), I proposed a departure from the classic microfinance theory of change to reflect the greater use of microfinance to support household resilience for poverty alleviation than to invest in microenterprise development for poverty reduction. Here is the revised theory:
People from poor households tap microfinance services to smooth consumption and build assets to protect against risks ahead of time and cope with shocks and economic stress events after they occur—leading to poverty alleviation.
Not that poor households do not invest in income-generating activity (IGA). Certainly they do, but mostly to diversify sources and timing of income to smooth cash flow through the year, so they can be more food-secure, pay for other regular expenses and save for emergencies and big-ticket purchases.
An entrepreneurial minority of client households and individuals manage to turn one or more of their IGAs into viable businesses that grow and generate substantial increase in income for their households. Some microfinance providers with serious microenterprise development objectives focus on recruiting and supporting such entrepreneurial clients and thereby greatly increase the proportion of clients who succeed at business. But the majority of providers are not so selective (often to achieve more massive scale and outreach to the poor), and so their clientele are mostly aiming to build household resilience against risks.
This is the narrative that emerged with the release in March 2000 of the synthesis paper of the USAID Assessing Impacts of Microfinance Services (AIMS) Project: Microfinance, Risk Management, and Poverty by Jennefer Sebstad and Monique Cohen. A decade later, it is also the narrative coming out of the financial diaries reviewed by Portfolios of the Poor and the research summarized in More Than Good Intentions, Poor Economics and Due Diligence. A new theory of change has emerged for microfinance. Not only is it shaped by the results of research. More or less independently of that research, the microfinance industry has been adjusting in this direction as it has become more sensitive to client demand – by moving toward a mix of loan, saving and other services and greater flexibility and choice to accommodate the use of microfinance for supporting resilience rather than focusing just on the needs of microentrepreneurs.
However, the research to date has been testing mainly the classic theory of change, not the new narrative. What is the evidence so far to support the emerging theory of change? What would that evidence look like?
For guidance, I find the Sebstad-Cohen paper still the best reading. It is long and often tedious, but it is comprehensive and thorough in its treatment of risk and vulnerability among the poor. Here are their research questions:
- Whom do microfinance programs reach?
- What is the nature of the risks facing microfinance clients?
- What strategies do clients use to protect against risk ahead of time and cope with losses afterwards?
- What is the role of financial services in mitigating risk and coping with loss?
The first question refers to depth of poverty outreach, which is supremely relevant because high risk and vulnerability almost define the lives of the poor. The poorer the household, in general, the higher the risk and vulnerability. As Poor Economics makes clear, the most common characteristic of highly vulnerable households is lack of salaried employment. This is the type of household we focus on here. Deeper than that I don’t go with this question about the poverty outreach of microfinance until Theme Nine.
The second question about the nature of risk is answered by Sebstad and Cohen in brief on page 33:
Defined as the chance of a loss or a loss itself, risk has many sources—(1) structural factors such as seasonality, inflation, or the vagaries of weather; (2) unanticipated crises and emergencies such as sickness or death of a family member, loss of employment, fires, and theft; and (3) the high costs associated with life cycle events such as marriage, funerals, and educating children. Likewise, risks are associated with (4) operating an enterprise and with (5) taking a loan.
They elaborate at length on these sources of risk. More interesting here is “vulnerability,” which they define as the ability of an individual or household to deal with risk. Which takes us to the third question about household strategies to protect against risk ahead of time and cope with losses afterwards. The fourth question asks how microfinance can or does support these strategies and shifts the mix of risk- management strategies used by the household from those that reduce long-term resilience to those that enhance resilience in the future. I will structure the posts of this Theme Four around the Sebstad and Cohen classification of risk-management strategies, outlined here:
Income-Smoothing The aim is to diversify income sources and stabilize, even increase income flow.
Asset-Building The aim is to build and maintain a solid and mixed base of financial, physical, human, and social assets.
Loss Management Strategies
Consumption-Modifying Strategies Reduced consumption enables households to reallocate existing income flows to manage the shock or economic stress directly. Alternatively, it enables households to borrow a chunk of money to cope with the shock or economic stress event and to use a portion of existing income flows to repay loans.
Income-Raising Strategies To raise income in response to a shock or economic stress event, clients can employ two strategies: mobilizing their labor and selling physical assets.
Personal Financial Intermediation In response to a shock or economic stress event, clients can use the strategy of personal financial intermediation, which includes drawing on savings deposits, drawing on insurance, and taking loans.
I will explore the evidence that microfinance supports or enhances each of these five general strategies of risk management in the next several posts.