The world's poor are exposed to irregular income flows, and their needs are irregular too – ranging from unforeseen medical bills to having to pay more when food prices rise unexpectedly.

Microfinance refers to a large number of different financial products, including but not exclusive to

• Micro-credit - the provision of small-scale loans to the poor for example by credit unions
• Micro-savings – for example, voluntary local savings clubs provided by charities
• Micro-insurance- especially for people and businesses not traditionally served by commercial insurance businesses - a safety net to prevent people from falling back into extreme poverty
• Remittance management – managing remittance payments sent from one country to another including for example transfer payments made through mobile phone solutions

The concept of microcredit was first introduced in Bangladesh by Professor Muhammad Yunus who started the Grameen Bank (GB) more than 30 years ago with the aim of reducing poverty by providing small loans to the country's rural poor.

A key feature of micro-finance has been the targeting of women on the grounds that compared to men, they perform better as clients of micro finance institutions and that their participation has more desirable long-term development outcomes.

The Grameen Bank approach initially focused on small groups 'lending circles' of largely female entrepreneurs from the poorest level in the society. This became the widely accepted view of what micro finance is. In reality there are thousands of commercial microfinance institutions (MFIs) including some large international operators. Micro finance programmes also exist in advanced countries, such as Germany, the USA and also in Scotland in the United Kingdom.

• 1.Commercial micro-credit businesses – profit seeking
• 2.Not-for-profit micro-credit businesses – social enterprises, reinvesting profits for social purposes
• 3.Donor-supported micro-credit businesses – perhaps targeted at supporting the very poorest – an example being the savings schemes established by CARE international

Evaluation: Criticisms of Micro-Credit

Micro-finance has come under close scrutiny in recent years and there are many who argue that the positive effects of micro-finance have been exaggerated and that the rapid expansion of micro-credit has caused unintended consequences and limited benefits in reducing extreme poverty. Some of the criticisms are as follows:

Debt

• Many borrowers have been allowed to take on multiple loans - sub-prime style lending in poor countries - and charged exhorbitant rates of interest for these loans
• There is also evidence of coercive collection practices by some lenders

Savings

• Credit can help people in difficult times but sustainable saving from in-work income is more important in long run
• For this to happen, real incomes need to rise - this requires higher productivity

Cash

• Direct cash transfers and direct funding of skills training might have bigger effect than micro-loans to entrepreneurs setting up fledgling businesses
• Randomnised control trials by Banerjee and Duflo: Microcredit may not be the miracle claimed on it's behalf but it does allow households to borrow to help fund businesses

Risks

• The poorest countries are vulnerable to external shocks including extreme climate
• When natural disasters happen, interest on debt still needs to be paid
• Focus might need to shift towards micro-insurance rather than micro-credit schemes

Investment

• Credit is often used to finance consumption - the flipside of micro credit is micro debt
• Micro-finance cannot compensate for inadequate healthcare, education or hard and soft infrastructure in promoting sustainable development and poverty reduction

SKS Microfinance in India

In India the commercial business SKS microfinance was floated on the Indian stock exchange in 2010 but their share price has fallen by more than 90% since then. The Indian government responded to criticisms of alleged harassment of borrowers by SKS agents by introducing stricter controls on micro-credit. Several reported suicides of people in multiple and heavy debt to lenders had a damaging effect on the reputation of SKS. It made a loss of 13.61bn rupees for the year ending March 2012, compared with a profit of 1.12bn rupees in the previous year.

Micro-Insurance

This is a growing sector within developing country finance. The number of people covered by micro-insurance has increased almost 6.5 fold in five years, reaching nearly 500 million worldwide, with China and India leading the charge

Micro-insurance attempts to protect poor people against risks arising from accidents, illness, and a death in the family or the damage caused by natural disasters - in exchange for insurance premium payments tailored to their needs, income and level of risk.

Examples of micro-insurance include:

• An Indian fertiliser company providing free insurance with each bag of fertiliser bought
• Cattle insurance policies – small scale insurance policies that cover the death of animals due to accident, disease, foods, drought and other events
• Life insurance and accident cover bundled with farmers or other business people buying new trucks
• Pay-as-you-plant insurance for Kenyan farmers to insure inputs against drought and excess rain
• In South Africa, HIV patients can get life insurance providing they sign up to regular medical check-ups and adherence to taking courses of freely available antiretroviral treatments

Micro-insurance schemes can dove-tail with mobile money transfer systems such as M-PESA – for example farmers can have their insurance pay-outs sent directly through to them without having to trek into the nearest town or city.

Benefits from effective and affordable micro-insurance projects

Risk-taking behaviour

• Safety net will envourage less risk averse behaviour
• Insurance can be a spring-board as well as a safety net
• Insurance can help smooth volatility in income and spending

Schooling, Death and Saving

• More children from poorer families will be able to continue their education
• Many of the poorest spend large sums of funerals - insurance reduces this burden
• Life insurance schemes promote small scale saving

Risks and limitations of micro-insurance

Naturally there are problems with building insurance schemes for many of the world's poorest communities – some are standard economic arguments:

1. Moral hazard – insured people and businesses may take less steps to protect themselves against risks because they know they have the safety net of insurance
2. Adverse selection – the highest risk agents will tend to be those who bid for insurance products increasing the pooled risks of insurance everyone
3. Asymmetric information – often times, those seeking insurance have more information about their conditions than agents selling the insurance
4. Inertia and information gaps – until recently, the vast majority of people in developing countries had no access at all to formal insurance schemes, and those that were available could not be afforded save for the wealthy few. Many need to be educated about the basics of insurance and the costs and benefits of getting involved.

A good case study of the expansion of micro-insurance is the success of the financial inclusion fund set up by Leapfrog backed by JP Morgan and the George Soros Foundation.