Microfinance is going through some major growing pains right now, hitting its first major challenge since it hit the mainstream in 2005 after Muhammad Yunus won the Nobel Peace Prize. The “silver bullet” of poverty alleviation that brought credit to those previously thought unworthy of a loan has seen an onslaught of criticism for failing to deliver on the lofty goals that its evangelists believed it could achieve (lesson: don’t overpromise).
Studies have shown that the impact of providing credit to poor women does not have a dramatic effect on poverty alleviation, and the success stories, at least in recent months, have been trumped by tales of aggressive loan-recovery tactics and suicides among poor borrowers in India. Portfolios of the Poor, a book written by four development economists with a healthy skepticism about the transformative effects of microfinance but optimism about its marginal impacts, showed that access to credit is actually less important than savings – access to a safe place to keep your money.
The big schism in microfinance since 2008 has been about where to get the money for operations. On one side, there is a group that believes microfinance must always focus on serving the needs of the poor and resist temptation to exploit borrowers with overly-exorbitant interest rates (I say “overly” because interest rates are, well, exorbitant). This camp, led by Muhammad Yunus, the spiritual and, until recently, actual leader of the Grameen Bank, condemns a profit motive. Instead, microfinance institutions (MFIs) should charge interest rates that will cover expenses and will finance expansion efforts. In other words, MFIs should be financially and operationally sustainable, but nothing more.
Proponents of the other side believe that, for microfinance to achieve its true potential and reach the billions of poor people without access to credit, it must tap into the vast financial coffers of the capital markets. To do so, microfinance needs to become attract investors with, at the least, a hybrid model focused on financial returns and social impact. There are still only a handful of MFIs of adequate scale to access the same type of capital that a normal company might access, at commercial rates.
In 2008, Compartamos, an MFI in Mexico, became the first MFI to go public and issue shares on the stock exchange. It was initially a huge success, with an ROE of 50%. The Compartamos IPO sparked a debate in the microfinance community about whether this was the beginning of slippery slope toward mission drift. Once stockholders owned a piece of the company, Compartamos would no longer be an independent decision-maker. Investors expect financial returns, and management must be focused on the bottom line more than anything else. In an oil refinery or an electric utility or a manufacturer, there is no conflict of interest, since competitiveness is always the end game. But for an MFI that is serving poor clients that have limited resources to pay the already-high interest rates, raising those interest rates to increase profit presents an ethical dilemma.
In 2010, SKS Microfinance, an Indian MFI founded by a protégé of Muhammad Yunus, became the second institution to go public. It is the second-biggest MFI in India and its IPO led critics to revisit the capital markets debate. Muhammad Yunus criticized his disciple’s decision, saying it would compromise the mission of the organization and could tarnish the reputation of microfinance. As it turns out, he was right.
Just a few weeks ago, Muhammad Yunus was ousted as chairman of the Grameen Bank. From the Wall Street Journal:
On March 2, Bangladesh’s central bank ruled that he must step down as managing director of Grameen Bank, the institution he founded in the 1970s to get small loans to poor farmers without collateral. The success of Grameen won Mr. Yunus international acclaim and helped spawn the global microfinance industry. The bank and Mr. Yunus shared the 2006 Nobel Peace Prize.
But Mr. Yunus is facing pressure at home. Some analysts say Bangladesh Prime Minister Sheikh Hasina is angered by Mr. Yunus’s short-lived move into politics in 2007, citing an attempt to clean up corruption. Mr. Yunus floated a political party for a while but it never got off the ground.
Others say Grameen, with 8.3 million borrowers and scores of other businesses from telecoms to dairy products, has become too powerful in the eyes of Bangladesh’s politicians.
The move from NGO to profit-driven and publicly-traded opened the flood gates for politicians to take advantage of the plight of borrowers and champion the poor against the big, bad microfinance institutions. The same thing happened in Nicaragua a few years ago when Daniel Ortega launched the “No Pago” – “no payment” – movement, encouraging MFI borrowers to stop paying back their loans. When the government becomes involved with the industry like that, it can be catastrophic. MFIs collapse, investors flee, and, at the end of the day, the losers are unbanked poor.
Some people believe that the reason for Yunus’ ouster is due to his setting up a political party in 2007, which subsequently fizzled out. By entering the political realm, Yunus may have begun to make enemies, or at least be perceived as one, with the Bangladeshi Prime Minister, Sheikh Hasina. The government then used information from a recent Norwegian documentary on microfinance that many view as a hit job on the industry. It claimed that Grameen Bank had diverted funds from the Norwegian aid organization for alternative use, though this claim is shaky.
Using this information as a starting point and building on the fervor around alleged abuses from MFIs in India and Bangladesh, the government, which has a 25% stake in the Grameen Bank, tries to oust Muhammad Yunus, who some people believe the government sees as a threat. What is the basis for the firing? Yunus, who is 70, is past the accepted age to be running a state-owned bank.
This is a bad precendent, and, as I have discussed on this blog, governments and microfinance do not mix. From the New York Times:
Here’s an example of what could happen: The Prime Minister has made it clear that she believes the interest rates are too high. Her concerns for the poor may be well-intentioned. But historically, subsidized loans have been seen as goodies — and have gone to the most powerful, not to those they were intended for: the poor. Grameen’s rates are, in fact, considered low among microlenders, whose administrative costs are far higher than that of traditional banks. However, if a politically-minded managing director decided to cut the interest rate, it could jeopardize the bank’s solvency.
Similarly, if the government installed a bureaucratic manager who failed to appreciate the bank’s entrepreneurial culture, it could suck the life out of the bank. Managing a bank that actually works with poor women in villages means, above all, recruiting people who care about the poor and training them in creative ways. Before Grameen Bank workers get hired, for example, they spend close to a year demonstrating their interest in serving the poor. They have to do things like write detailed case studies about the lives of village women to show that they genuinely care about, and understand, their clients. Managing this workforce is nothing like managing a run-of-the-mill bank.
In an institution like this, the management needs to be perceived as honest, responsive and open. If corruption, politicization or bureaucratic torpor began to infect it, the disease would be irreversible.
So true. It is unfortunate, but this is a topic I want to dive into more. After all, this is, first and foremost, a blog about microfinance and development. I have strayed from where I began, but, just as David Simon followed the street dealers in season one of The Wire, then focused on the ports in season two, only to return to the drug trade and the streets again in season three, I am writing about microfinance again. More to come.