Microfinance services, financial literacy, and socio-economic wellbeing of smallholder farmers in southwestern Uganda: A mediation analysis

Abstract

This study examined the role of financial literacy in mediating the relationship between microfinance services and the socio-economic wellbeing of smallholder farmers in Southwestern Uganda. Specifically, it sought to determine the direct and indirect effects of microfinance services and non-financial interventions on household wellbeing, and to assess whether financial literacy serves as a critical pathway through which these effects are realized. Financial Capability Theory anchored this study. The study adopted a cross-sectional research design using a quantitative approach. Data were collected from a sample of 384 smallholder farmers using structured questionnaires. Descriptive statistics, correlation analysis, and regression techniques were employed, while Structural Equation Modeling (SEM) was used to test the hypothesized relationships and mediation effects. The SEM model demonstrated good fit indices (CMIN/DF = 2.753, GFI = 0.930, AGFI = 0.904, NFI = 0.938, TLI = 0.952, CFI = 0.960, RMSEA = 0.068), confirming the validity of the model. The findings revealed that microfinance services have a negative direct effect on socio-economic wellbeing (β = -0.22) but a positive effect on financial literacy (β = 0.25). Financial literacy, in turn, has a strong positive effect on socio-economic wellbeing (β = 1.26). The indirect effect of microfinance services on wellbeing through financial literacy (β ≈ 0.32) outweighs the negative direct effect, resulting in a small positive total effect (β ≈ 0.10). These results indicate that financial literacy fully mediates the relationship between microfinance services and socio-economic well-being. The study concludes that microfinance services alone are insufficient to improve household well being unless complemented by financial literacy. It recommends that policymakers, microfinance institutions, and development partners integrate structured financial education into microfinance programs, strengthen client protection mechanisms, and promote holistic interventions combining financial and non-financial services to achieve sustainable socio-economic development.