Innovative micro finance strategies to tackle urban poverty

The Research Intelligence Unit – www.riunit.com

In a project that combines Poverty Alleviation, Micro Finance and Sharia Compatibility, Muslim Aid Sri Lanka (MUSL) along with Ammana Investments have launched a program aimed at addressing the plight of the urban population suffering from poverty. Here, some specialists from MUSL and the Pakistan office share their rationale for this timely intervention that has proved its effectiveness in other parts of the globe.


Urban poverty

As the world becomes increasingly urbanized, the issue of global poverty is moving to cities – a process now recognized as the urbanization of poverty (UN-Habitat 2003; UPE 2005; Ravallion 2001). By 2003, the world’s urban population had reached three billion people, a figure close to half of the total world population, and the urban population is expected to reach five billion by 2030 (McGranahan and Satterthwaite 2003; United Nations 2001). In the developing world, the urban population is expected to double to about four billion people during the next 30 years, whereas the rural population will barely increase and will start to decline after 2020 (UN-Habitat 2003).

Increasing population density through resident and non resident migration to urban areas and economic disparities has increased slums. Most slum dwellers have no access to formal financial, social and legal services. Instead they exist outside the law, living and working in expensive and inefficient parallel markets. The irregular income of the poor presents a risk for private financial institutions because of their uncertain ability to repay loans. In most cases, there is a lack of formal documentation entitling the occupants to use the land and the dwellings are often informally built or occupied without compliance to land-use regulations or construction codes. Therefore most of the urban poor are trapped in slums that are not shown on the map, where waste is not collected, taxes not paid and public services are not provided. Even if the poor have legal land tenure, collateral using land titles is often irrelevant for obtaining loans if they are not able to demonstrate adequate levels of savings or income. Further, the refusal or inability of government to provide community-level health care and emergency services means that the poor suffer disproportionately from illness and injuries. which in turn decreases their workdays and their income.

Traditional measures of poverty, based on whether individuals have adequate food, or the income to purchase it, fail to capture deprivation in terms of access to services that are essential for health and literacy as well as political and legal marginalization.

Urban poverty is different from rural poverty. Traditional measures of poverty fail to reflect the real extent of poverty in urban areas due to the fact that urban households may have higher incomes than their rural counterparts. However, their unstable, informally-earned incomes hardly cover the higher urban prices of food, transportation, health, and education. As a result, they live in under-served, overcrowded, and insecure housing conditions and face discrimination as well as spatial segregation. On the other hand, rural poverty is caused by lack of access to sufficient land on which to grow crops and raise livestock, or by lack of access to other non-cash assets. Where as urban livelihoods depend far more on income-earning opportunities from non-agricultural activities and far less on entitlements to natural resources.

Urban poverty is multidimensional and can be seen as comprising different and interrelated sets of deprivation that include inadequate or unstable income, inadequate or unstable assets base, limited political and legal rights, poor quality housing and insecure land tenure, lack of basic services and discrimination.

Micro finance and entrepreneurship

Micro finance is a very potent instrument of poverty alleviation. It fills the gaps which normally arise in macro type poverty reduction policies pursued by governments. The usual strategy adopted by governments to attack poverty has been the attainment sustainably high economic growth rates. With that growth, it is expected that the benefits of economic uplifting would trickle down to lower levels of the society. As a result, the overall economic conditions of all segments of the population would elevate to a higher level eventually. It will kill the absolute poverty levels. Some good examples are countries like Malaysia and South Korea. Both these countries were able to reduce absolute poverty from very high level of 50 percent to a very low level below 6 percent within about four decades.

So if macroeconomic growth can tackle poverty, then why should one be bothered about microfinance? The reason is very clear. When macro-policies are adopted, there are certain gaps that are created in the alleviation of poverty. As a result, some segments of the society would experience a worsening of their situation.

This because all the people in a society are not capable of moving along with the market at the same speed. Some move faster than the market. They are the super – performers and they stand to gain more. Some move at the same rate as the market. They attain a gain more or less equivalent to the market performance. There is no problem about both these categories. That is because they have the capacity to look after themselves. The problem arises in the case of people who are unable to move forward at the speed of the market. They become laggards and are left out. Hence, there should be a special strategy to bring them to the mainstream of economic life.

The normal strategy that had been adopted to address this issue has been the introduction of safety nets to capture them before they make a free fall to the ground. The safety nets so far introduced have taken different forms depending on the era or the country. About five decades ago, the safety nets took the form of providing outright grants to the poor people. The objective of the grant was to provide some relief to them, so that they could at least meet their food requirements. The weaknesses in this type of strategies are well known. It encourages poor people to remain in the safety net forever.

They have no incentive to move out of the net, because moving out would mean their having to work hard for a living. If at least the basic requirement of food is provided free of charge, then why would anyone want to work for the same? Economists have long named this problem ‘moral hazard’ problem. This problem simply says that, when one helps another, the person being helped does not have the incentive to adopt even the minimum safety measures.

Another pertinent issue involved in microfinance delivery is how to reduce the transaction costs and make available the loans at the time they are needed by the borrowers. The transaction cost is simply the additional resources which a person has to spend, other than what is paid to the supplier, in order to complete a transaction. In the case of borrowing, transaction costs include any payment which the borrower has to make other than the payment of interest to the lender. Such costs, therefore, comprises legal fees, application fees, loan processing fees any bribes or commissions payable, stamp duties and other taxes and, finally the opportunity cost of the time spent for pushing the application through bureaucracy and the waiting time.

Microfinance Institutions should therefore, strive to keep the transaction costs at a minimum and eliminate the possibility of incurring deadweight losses. The on-time delivery of microfinance loans is also a very important requirement.

Partnership to defuse urban poverty

Muslim Aid has stepped in to introduce a unique micro-finance scheme for Sri Lanka that works on the basis of charging no interest at all, in keeping with Islamic teachings, so that beneficiaries incur absolutely no costs. It plans to create a diverse range of tested, effective and sustainable micro-finance projects in the Island which are distinctively interest-free by 2010.

Having gained a wealth of experience in the field of international relief and development work, Muslim Aid is focusing on working in partnership with local community-based organizations. This approach has proven to be most cost-effective in poverty eradication and is also effective in building the capacity of local people to help themselves, re-gain dignity and become empowered.
Amana investments Limited, Sri Lanka’s premier provider of Islamic Financial Solutions, offers a range of World Class Sharia- compliant products to customers since 1997 and has emerged as a robust trendsetter in Sri Lanka’s financial services sector and shown remarkable growth in business. The company has a range of products that are interest-free and structured on the principles of equity and fairness and available to all persons, irrespective of their ethnicity. All products are approved by the Sharia Supervisory Council and subject to regular Sharia audits.

The partnership between Amana Investments Ltd and Muslim Aid is set to launch a microfinance scheme providing capital and training to a disadvantaged community in Colombo. Kompannaveediya mosque federation (KMF) which comprises of 10 mosques in the Slave Island area, and the Sri Lanka Malay Association, the convener of 43 Malay Association Island wide have come forward to collaborate as local partners for this project. The beneficiaries have already been identified and the loans are expected to be disbursed sometime in September 2007. The Research Intelligence Unit is expected to start its monitoring and evaluation of the program in September 2007.

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