Bringing

Development Back,
into Microfinance
by Maria Otero
Microfinance is the provision of financial services to low-income,
poor, and very poor self-employed people. From its inception in the
1970s, microfinance has evolved in astounding ways, incorporating
into its practice social and economic development concepts, as well
as principles that underlie financial and commercial markets. This
combination has led to the creation of a growing number of sus-
tainable microfinance institutions around the developing world. As
microfinance continues to evolve as a development strategy, it will
be successful only if it is able to strike the right balance between the
two frameworks--development and finance--that underlie its prac-
tice.
The purpose of this paper it to explore three points at which
microfinance intersects with development, to argue why these three
intersections make microfinance compelling from the perspective of
development, and to explain why practitioners, donors and others
involved in the microfinance field tend to forget the connection
between the two.
As the approach to development has shifted over the last decades
(from the emphasis on developing infrastructure and financing large
 Bringing Development Back into Microfinance

capital intensive projects in the 1960s, to the focus on meeting the

basic needs of people in poor communities in the 1970s, to the pri-
ority on structural adjustment and stabilizing economies in the
1980s, to today’s attempt to construct a sustainable development
framework against the background of increasing globalization) two
related and underlying debates have remained constant:
• First, are development efforts affecting poverty levels? Are
they reaching the poor? All development approaches, regardless
of their shortcomings, have attempted to address poverty, to
alleviate it, to eradicate it. While spirited, and at times fierce,
debates on the relative merits of various development
approaches prevail, no task has commanded a higher priority for
development institutions and professionals than that of reducing
global poverty.
• Second, what is the role of foreign assistance (i.e., donor
funds) in development? The major issue has focused on when
external resources--in the form of capital or technical exper-
tise--should be introduced into a development project to make
it work. The dominant approach throughout development has
been to introduce donor money at the beginning, the middle,
and the end of any project--to inject it whenever possible, and
to bring in the expert to solve the problem.

These two areas of debate that have dominated development are also
very applicable to microfinance and help frame the discussion
below.
As a way of defining the relationship between microfinance and
development, it is useful to identify how microfinance directs itself
toward development objectives. This paper suggests that there are
three points at which development and microfinance intersect, and
that it is microfinance’s ability to connect in all three of these
points that make it so compelling as a development strategy.
...........................................................................
Maria Otero is currently executive vice president of ACCION International. As of
January 1, 2000, she will become the president and CEO of this organization This
paper is based on a talk delivered by the author at the conference, “New Development
Finance,” held at the Goethe University in Frankfurt, September 1999. The conference
was sponsored by IPC, Ohio State University, and the Goethe University.

Volume 1 Number 1 9
Journal of Microfinance

Reaching the Poor

The first point of connection is microfinance’s objective to alleviate
poverty, that is, at the client level. Indisputably, microfinance, at its
core, combats poverty. Clients of microfinance institutions are
poor city dwellers housed in slums or squatter settlements, often
living in appalling overcrowded settings, lacking access to basic ser-
vices such as health. Their survival tool kit lacks education or skills
that are essential to enter the mainstream economy. Many of them
are women, poorly trained and playing dual roles of provider and
caregiver. These poor people are more exposed to the threats of con-
tamination, bad sanitation, and disease than the rest of the popula-
tion. When disaster strikes, in the form of inflation, earthquakes, or
other outside forces, they are the most exposed.
Rural clients are landless or land poor; Their land is often unpro-
ductive or lies outside irrigated areas. Many farm in arid zones or on
steep-hill slopes land, that are ecologically vulnerable. Oppor-
tunities for off-farm employment are few and must be self-generated,
with many rural poor mixing, many earning activities to generate
the cash they need to survive. They live in large households, their
children are especially susceptible to disease, and many suffer from
malnutrition. Many poor depend on their children for work and
must weigh the opportunity cost of sending children to school
today against present and future benefits.
Conceptually, microfinance addresses one constraint faced by the
poor: their shortage of material capital (i.e., the input necessary to
generate income). Capital investment, from savings or borrowed
money, takes a critical place in the economy of all human actors,
regardless of their level of income. Microfinance creates access to
productive capital, which together with two other forms of

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 Bringing Development Back into Microfinance

capital--human capital, addressed through education and vocational

training, and social capital, built through creating representative,
local organization building, promoting democratic systems, and
strengthening human rights--enables people to move out of
poverty.1 Microfinance enables poor self-employed people to create
productive capital, to protect the capital they have, to deal with
risk, and to avoid the destruction of capital. It attempts to build
assets and create wealth among people who lack them. For the very
poor, microfinance becomes a liquidity tool that helps smooth their
consumption patterns and to reduce their level of vulnerability.2
At a more subtle but no less important level, which is much
harder to measure, increasing material capital strengthens the sense
of dignity a poor person possesses, and contributes to empowering
him or her to participate in the economy and society. With a source
of income, a person can provide for the family, improve the house-
hold’s access to basic needs, and plan for the future. When these
conditions are present, a person who was part of the marginalized
sector of the society becomes better equipped to be an active citizen.

Building Institutions
The second point of intersection between microfinance and devel-
opment occurs at the institutional level. Microfinance seeks to cre-
ate private institutions that deliver financial services to the poor.
These institutions become part of the infrastructure of the country;
that is, they are distribution channels for deploying services that
respond to the material capital needs of poor. Creation of such dis-
tribution channels that provide access to services to the poorer sec-
tors is one of the greatest challenges that governments face. Even
governments that want to allocate increased resources to address the
needs of the poor encounter a daunting challenge: the lack of effective

Volume 1 Number 1 11
 Journal of Microfinance

distribution channels or the infrastructure necessary to convert eco-

nomic growth into improved well-being among the poorer sectors.
In this setting, microfinance proposes to create private, sustain-
able institutions that specialize in delivering financial services to the
poor. Against a broader development backdrop, these institutions
become a means to an end, not an end in and of themselves. They
constitute part of the not-yet-attained and long-sought-after instru-
mentalities needed to incorporate the poorer sectors into the econ-
omy. They put capital in the hands of those who otherwise would
not have it, and they enable people with few assets to save.
It is for this reason that institutional sustainability becomes so
crucial to microfinance. If microfinance institutions are not finan-
cially solid, unable to cover their costs, and incapable of delivering
financial services over the long term, they become a transitory
means of reaching the poor and lose their punch as a component of
a broader development strategy in any setting. This major link
between microfinance and development begins to unravel, unless
microfinance institutions attain self-sufficiency in their operations.

Deepening The Financial System’s Reach

The final intersection between microfinance and development
occurs at the intersection between microfinance and the financial
systems in a country, accomplished when a microfinance institution
becomes a regulated institution that is part of the financial system.
This connection is made possible by the recognition in the last
decade that healthy financial systems are an important piece of the
development puzzle, and that financial sector improvement and
reform should be a priority in all developing countries.3
When microfinance institutions become part of the financial sys-
tem, they can access capital markets to fund their lending portfolios

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 Bringing Development Back into Microfinance

which allow them to increase dramatically the number of poor peo-

ple they reach. They can also capture savings, providing another
important financial service to the poor, and access deposits as
another source of capital.4
By inserting themselves into the financial systems of their coun-
try, microfinance institutions deepen dramatically the reach of
financial systems to populations previously excluded from banks
and other financial institutions. One essential means of alleviating
poverty becomes the creation of a broader and deeper financial sys-
tem which does not restrict the allocation of capital to a tiny group
of elites, but instead integrates the poor as a market segment and
reallocates resources from other sectors.
This last intersection with development is, in relative terms, a
recent one for microfinance, made possible only after attaining the
creation of financially viable institutions. Once it was demonstrated
that microfinance institutions could manage risk effectively and
that they would not become a systemic risk to the system, their
incorporation into financial systems became possible.
When microfinance intersects with development at the three
points suggested above, it has the capacity to create structural
changes in the way in which capital is made available to a popula-
tion. It is addressing the seemingly intractable problem of creating
the infrastructure to reallocate resources and to create wealth
among poorer sectors. More than that, it is changing the dimension
of a system within an economy--the system that moves and reallo-
cates capital in the economy. Microfinance operates at its best when
it intersects with development in these three points. Many microfi-
nance institutions, either because they have not become sustainable,
or because they operate in an unfriendly regulatory environment,
are not able to complete these three points of intersection.

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Journal of Microfinance

Within the field of microfinance, observers, donors, and practi-

tioners often tend to forget that the three above dimensions of
microfinance are the essential points of intersection with develop-
ment, and that all three must be present to make microfinance a
powerful development tool. There are several reasons why this rela-
tionship between microfinance and development is often forgotten.
First, some of the key debates within the microfinance field are
focused on the wrong issues. Perhaps the best example is the ongo-
ing controversy between reaching the poor and the sustainability of
microfinance institutions, a debate that has polarized the field along
these two dividing lines. Elisabeth Rhyne calls this the ying-yang of
microfinance, and rightly points out that “only by achieving a high
degree of sustainability has microfinance gained access to the fund-
ing they need over time to serve significant numbers of their
poverty-level clients. This image reveals that there is in fact only
one objective--outreach. Sustainability is but the means to achieve
it.”5 By focusing our debate in this way, one is pitting one point of
intersection of microfinance to development (reaching the poor)
against another (creating sustainable institutions). The basic flaw to
this debate is that it ignores that microfinance needs both points of
intersection to development--reaching the poor and achieving sus-
tainability. Otherwise, it begins to disintegrate as a compelling
development approach.
The second reason microfinance forgets its relationship to devel-
opment is that many of the biggest challenges in microfinance
remains at the institutional level. Building permanent, sustainable
institutions that deploy financial services to the poor and the very
poor, and are directly linked to or are part of the financial systems
remains an enormous undertaking which has not been achieved by
many microfinance institutions. For this reason, the focus in the

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 Bringing Development Back into Microfinance

last few years has been on developing the managerial, technical, and
systems capacity within institutions to move them towards sustain-
ability. The focus has been on the means, not the end. The level of
urgency regarding institutional viability is visible in the priorities
set by donors, the focus on tools, the establishment of performance
standards, and other interventions designed to advance the field in
this area. Whether these institutions come out of the NGO experi-
ence, involve traditional banks, or introduce new approaches such
as joint ventures, is not the important issue. What is important is
that the focus remain on creating microfinance institutions that
reach the poor sectors of society and at the same time achieve finan-
cial permanence.
One of the reasons attaining institutional viability has been diffi-
cult is because many microfinance practitioners have become
entrenched in the methodology or approach they have developed to
reach the poor. As such, many have focused on defending their
approaches and have diverted their attention from the essential
component of advancement: innovation. Breakthroughs in any
human activity have been achieved when new ideas have been intro-
duced and have been accepted by society. However, in microfi-
nance, the current receptivity to innovation has been severely
constrained because of the widespread efforts to defend existing
approaches, or because replication is occurring using models that
have not evolved. Yet for the field to advance, continued innovation
is a necessity.
The microfinance field’s lack of focus on innovation is reminis-
cent of the example of how typewriter keyboards were designed.
The QWERTY keyboard that we use today is named after the six let-
ters in the upper row of the keyboard. These were laid out in 1873,
employing a whole series of tricks that would force typists to type

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Journal of Microfinance

as slowly as possible, such as scattering the most common letters

over all keyboard rows and concentrating them on the left side.
These counterproductive features were purposely designed by man-
ufacturers because typewriters in 1873 jammed if adjacent keys were
struck in quick succession.
When improvements in typewriters eliminated the problem of
jamming, experiments with an efficiently laid out keyboard in 1932
showed it could increase the typing speed by 95%. But by then the
QWERTY keyboards were securely established, as typists, teachers,
and manufacturers crushed all moves toward keyboard efficiency.
These lessons of efficiency and innovation should not be forgotten
in the field of microfinance.6
The final reason behind the disconnect between development and
microfinance occurs because the best practice in microfinance has
fused two separate fields into one: development and finance. These
two disciplines operate from separate paradigms, communicate
using different terminology and concepts, and have previously not
been asked to exist together in an approach that attempts to deliver
services to the poor.
Merging these two ways of thinking and creating a level of com-
patibility between them that arrives at a good marriage and that
unites them to form a new way of thinking is the challenge micro-
finance is facing today. Those who come from a finance discipline
pull hard in their direction; those working from a development
framework pull hard in theirs. The first point of intersection
between, development and microfinance--reaching the poor--is
familiar and comfortable to the development camp, while the last
point of intersection--integrating into the financial system--is logi-
cal thinking for those from finance.

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 Bringing Development Back into Microfinance

Using a literary analogy helps illustrate the difficulty microfi-

nance faces in addressing this issue. In his novel Anna Karenina, Leo
Tolstoy says that happy families are all- alike, but every unhappy
family is unhappy in its own way. In order to be a happy family, it
must succeed in many different respects. The marriage must work,
there must be agreement about money, there must be agreement
about raising the children, religion, in-laws, and other vital issues.
Failure in any one of those essential respects can doom a family to
unhappiness, even if it has all other ingredients needed for happiness.
This Anna Karenina principle can be extended to understanding
why the linkage between finance and development will be possible
only if it avoids many separate possible causes for failure.7 In other
words, if these two are not combined in a way that effectively inte-
grates the major principles of each, microfinance efforts will fail,
each in their own way. One will fail because it will gradually forget
its target market as it seeks quick profits; another will fail because
it ignores the basic principles of finance; still others will insist on
only one model to achieve these intersections. Microfinance will be
strengthened if it recognizes that the answer to the capital needs of
marginal populations is developing cumulatively, based on innova-
tive efforts centered in the three intersections between microfinance
and development, rather than on isolated, heroic acts that engage
one or two experiences. If microfinance professionals lose sight of
these intersections and neglect to focus microfinance on all three,
the field will drift toward the landfill of failed development efforts.
Microfinance professionals know more about how to make capital
available to poor people than they did fifteen years ago. They have
taken the bold step in the last five years of adding one crucial inter-
section point between microfinance and development: integration
into the financial system. While one can never avoid all crises

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Journal of Microfinance

microfinance institutions will confront in delivering credit and sav-

ings services, one can make these less frequent and less severe.
Additionally, one can use the knowledge being acquired to meet and
address new situations that will continue to arise.
For microfinance to continue its path toward becoming a success-
ful development strategy, it must display these three dimensions: a
relationship to the poor, a reliance on permanent institutions, and a
connection with the financial system of a country. These three
dimensions of microfinance are not a discussion about the trade-offs
of one over the other; without all three, the strong points of inter-
section between microfinance and development will fade into obliv-
ion and microfinance will become either a set of highly profitable
financial institutions that have abandoned their market, or a set of
insignificant donor-dependent and localized credit programs.
Keeping the collective eyes of microfinance professionals on these
intersection points is the huge challenge of this field today.

Notes
1. See Vernhagen, K. (1999). Towards a Misereor Sector Policy: Financial
Systems Development. Draft. Vernhagen distinguishes these three types of
capital and their shortage for the poor. Combating poverty is a battle
against these three shortages of capital. Microfinance directly addresses
one of these, the shortage of material capital.
2. These findings are emerging from work conducted by Jennefer Sebstad and
Monique Cohen, “Microfinance, Risk Management and Poverty,” pre-
pared for the World Bank’s World Development Report 2000 on Poverty,
1999. Data from four countries demonstrate that finance for the poor
serves to reduce their risk, especially when they face personal emergencies.
3. It was not until 1989 that the World Bank dedicated its World Development
Report to financial systems in developing countries.
4. There are countries where the regulatory system is not conducive to the
regulation of microfinance institutions. Issues related to the supervision
and regulation of microfinance have become a leading topic of research
and analysis in the microfinance field. See especially Valenzuela, L. &

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 Bringing Development Back into Microfinance

Young, R. (1999, September). Consultation on Regulation and Supervision

in Microfnance: A Workshop Report. DAI. Microenterprise Best Practices
Project. Draft.
5. See Rhyne, E. (1998, July). “The Yin and Yang Microfinance: Reaching
the Poor and Sustainability.” The Microbanking Bulletin, Calmeadow.
pp. 6-8.
6. The QWERTY example is widely as’ an example of what kind of circum-
stances crush innovation in business. See Diamond, J. (1999). Guns, Germs
and Steel: The Fates of Human Societies. Norton and Co, pp. 248-249. See
also Liebowitz, S.J. & Margolis, S. (1999). Winners. Losers and Microsoft:
Competition and Antitrust High Technologies. The authors argue that the
QWERTY keyboard is efficiently laid out.
7 See Diamond, J. Guns, Germs and Steel, pp 131-156. The author develops
the Anna Karenina principle to explain why some animals were domesti-
cated and why some remained wild.

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