Table of Contents

Handbook on the Economics of Foreign Aid

Handbook on the Economics of Foreign Aid

Edited by B. Mak Arvin and Byron Lew

It would be fair to say that foreign aid today is one of the most important factors in international relations and in the national economy of many countries – as well as one of the most researched fields in economics. Although much has been written on the subject of foreign aid, this book contributes by taking stock of knowledge in the field, with chapters summarizing long-standing debates as well as the latest advances. Several contributions provide new analytical insights or empirical evidence on different aspects of aid. As a whole, the book demonstrate how researchers have dealt with increasingly complex issues over time – both theoretical and empirical – on the allocation, impact, and efficacy of aid, with aid policies placed at the center of the discussion.

Chapter 32: Aid and microfinance

Niels Hermes and Robert Lensink

Subjects: development studies, development economics, economics and finance, development economics, politics and public policy, international relations


Microfinance institutions (MFIs) focus on providing financial services to poor households who are excluded from the formal financial system. Having access to finance is crucial for the poor as this helps them to smooth their consumption, generate business opportunities, and improve their inclusion in the formal economy in the long run (Collins et al., 2009). Since the late 1970s, the poor in developing economies have increasingly gained access to financial services offered by MFIs. The market for microfinance has been booming, especially since the early 2000s. During 2000–2005, average annual growth rates in terms of the number of clients served by MFIs amounted to 50 per cent; during 2006–08 growth rates rose further to 70–100 per cent per year (Sinah, 2010). Although the global financial crisis led to a reduction of the growth of microfinance activities (Wagner and Winkler, 2013), microfinance has remained high on the agenda of policy makers as a potentially important instrument to reduce poverty. An important source for the high growth rates of microfinance has been the financial support MFIs have received from governments, development agencies and nongovernmental organizations (NGOs). In many cases, MFIs can only survive because they receive subsidies to cover their costs. Although an increasing number of institutions have been able to attract commercial funding and have become financially sustainable, the majority of these institutions is still dependent on subsidized funding from donor organizations.

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