For my non-microfinance readers, the number one debate in microfinance right now is whether or not organizations should be charging higher interest rates (or improving their operating efficiency) in order to access the capital markets, which opens the doors to huge amounts of money, but also an obligation to generate returns for your investors. Over at the Big Think, a very cool site full of interviews with thought leaders, Muhammad Yunus shares his thoughts on the commercialization of microfinance:
Commercialization is a kind of code word. In plain, simple English it means “make money” by doing that. My position has always been microcredit should be an area for social business where you want to help poor people get out of poverty by doing business. You don’t lose money. You get your money back, but you don’t make profit out of it. Because with that money you want to give to the poor people so that they get out of poverty faster. That’s where the interest is. So I look at microcredit in that direction. The other direction is this is an interesting, new, emerging area of business. If you put money . . . If you invest your money, you make a lot of money. I don’t see that is the right kind of approach, because loan sharks have been doing this for years and generations and for ages. They lend money to the poor people and make a lot of money by exploiting them. So microcredit is not a new tool for exploitation. Microcredit is a tool to help people get out of poverty. So if commercialization means you make money, I will say I’m not in support of that. I would rather discourage that thing to happen. But if you want to do in a business way . . . make some profit, I would still allow or admit up to a certain amount. And their interest rate issue comes in – how much you take back. Say my definition of reasonable interest rate is cost to fund at the market price, plus 10 percent maximum. So that should be the maximum of interest rate that you can charge, and you’ll be a proper microcredit program. If you go beyond that, I tell you you are going into a risky area where you are getting too high. And after a while if my cost to fund at market price plus 15 percent and above . . . If that is the interest rate, then I’ll say you are in the red area of lending to the poor because now you are moving into the loan shark zone. So this is the kind of ground rules that I try to promote.
I understand where Professor Yunus is coming from, but I still think the argument focuses too much on the profit motive itself, rather than what is being done with the profits generated. A microfinance institution could charge lower interest rates and make a smaller profit, which is, in turn, returned to investors in the form of dividends. Or, it could charge higher interest rates and make greater profits, but reinvest that money into the organization in order to expand operations and reach more clients. Which one is is more ethical? Which one is doing a better job of serving the poor? And which one is making a larger impact in terms of poverty alleviation? This is an idealized situation and an oversimplification that ignores the nuance, but it’s a valid question I think.
I talked more about this issue in a post from a few weeks ago.
Josh,
Yunus’ focus on the profit motive is well placed. When profit replaced poverty alleviation as the key indicator of success, it led MFIs down a path of changes that has left the “industry” with a real identity crisis and left the poorest of the poor again without reasonably-priced access to capital.
Microfinance now looks ever more like a niche in the for-profit banking industry and less like the pro-poor social innovation it began as. Perhaps the old adage of social enterprise “doing well by doing good” needs updating: “getting filthy rich by doing good…maybe” When microfinance practitioners bought into the hubris that every poor person needs a loan, they stepped onto a dangerous path. The only way to fund such a massive scale-up was to access to capital markets. So, microfinance, the miracle of social innovation that solved the incentives problems that made the poor unbankable, shifted its attention to the incentives of investors, and profit replaced poverty alleviation as the critical success indicator.
Once this happened, a cascade of changes followed, and MFIs shifted from serving the poorest of the poor to the moderately poor, from serving the rural poor with no access to financial services to serving the urban poor, from starting new businesses to growing established businesses, from peer lending to individual collateralized lending, away from providing auxiliary services like literacy, health, and even business training, and finally from making the poor the primary beneficiary to making the investor the primary beneficiary.
While more and more impact studies conclude without rejecting the null hypothesis on this new breed of MFIs, their investors and founders are raking in huge profits. Microfinance has lost its first love; its turned on them and devoured them. I just posted my own wordpress blog on this subject. I would be honored if you read it and shared your response.
http://stayingfortea.org/2010/08/03/profits-perverse-incentives-the-new-face-of-microfinance/
Aaron,
Thanks a lot for posting this thoughtful comment. It’s a difficult question and one with a lot of nuance. Your article clearly shows that you know what you’re talking about and that you been in this space and understand what it is all about. I wanted to post my response as a blog post, because I think it is a good debate to have. I agree with a lot of your points, but think that in some cases exaggerate just how much money is being made and how many MFIs are making it. That said, I think the points are still valid and I tried to address them in my post. It will be going up on the site tomorrow. I’ll be checking your blog frequently in the future.
I agree with the non-exploitation focus of Yunus, with the outreach argument supported by higher profit re-invested in the MFI, and I am familiar with this debate. What I do not understand, and perhaps viewers of this video and blog could explain this, is how one of Grameen Foundation’s main partners in Africa, LAPO, is charging 126% to the poor, according to the front-page New York Times article of April 14th, two MicroRate rating reports and a Planet Rating report? Yunus is a board member of Grameen Foundation, LAPO is extremely profitable (see the MixMarket or the ratings for details), Nigeria does not suffer very high inflation, and there is fierce competition amongst the microfinance funds to lend to LAPO, so I doubt the cost of capital is so high.
Yunus says above: “Say my definition of reasonable interest rate is cost to fund at the market price, plus 10 percent maximum.” How does this end up at a rate of 126%? Or are the rating agencies, the NYT, and the few investors who did pull out of LAPO when this story broke all wrong?