Yunus v. Compartamos

The following is an article I wrote for The Inductive.

Within the international development community, a debate for the heart of the movement recently came to the fore with the IPO of Compartamos, the largest microfinance institution in Mexico.  Divisive and controversial, Compartamos’ decision to sell shares and publicly list on an exchange is perhaps the clearest manifestation of where the two sides diverge.  One side, led by Muhammad Yunus, founder of the Grameen Bank and winner of the Nobel Peace Prize in 2005, contends that, at its core, the sole fundamental mission of microfinance is poverty alleviation.  The other side argues that the goal must be maximizing profit and, more specifically, ROE (return on equity) – extending services to a previously unbanked population and expanding via revenue growth.  Just about everyone has an opinion on the decision and, at the very least, it allows for a great philosophical and economic debate about the most effective way to assist the billions of people who live below the poverty line.

It’s necessary to first give a little background on microfinance and its role in economic development.  Without going into too many specifics, microfinance describes the provision of financial services to individuals below the poverty line with no material collateral.  Microcredit, specifically, refers to the disbursal of small loans – generally between $50 and $1,000, depending on the sophistication of the institution and the industry in general (average loan with Compartamos is $623) – to individuals that cannot access credit via the traditional banking system.  Given their small size, the cost of servicing these loans, as a percentage of the total, is high.  Remember: it costs the same amount to service a $10,000 loan as it does a $100 loan (salaries, office materials, etc.), and these microfinance institutions often have to track down the borrowers on a weekly basis to collect the interest and principle.  In other words, interest on microfinance loans are higher than one might think appropriate.  In the United States, 50% for a loan may seem exorbitant.  But, when you look at it relative to the alternatives (up to 800% from loan sharks) and the fact that these loans are expensive to service, high interest rates are a necessity.  But at what level are interest rates exorbitant, even for an MFI?  This is the question at the heart of the Compartamos debate.

Interest rates have an inverse relationship with loan size

For an MFI to be financially sustainable (in other words, rely on profits, rather than donations or grants), it needs to generate sufficient revenue from its loan portfolio to pay for its overhead.  For it to grow, it must make substantially more than that.  Muhammad Yunus would argue that all profits be reinvested in organization and put toward subsidizing interest rates, focusing on the singular mission of poverty alleviation.  Yunus’ organization, Grameen Bank, is actually owned by the borrowers, so profits that are not reinvested are distributed as dividends.  Compartamos, which has institutional and private investors, takes a different approach. In 2005, Compartamos had an average interest rate of over 88% – an exorbitant rate, even within the world of microfinance.  Yet, at the end of the day, Compartamos has been a model of success in the microfinance world.  It generated annual returns on equity of 53% between 2000 and 2006, attracted investment capital from around the world, and, in the process, expanded access to credit and financial services for millions of people without previous access.  So why is it controversial?

At its core, microfinance embodies the idea of the double bottom line – a dual commitment to financial profit and social responsibility.  By nature, the management of a publicly-traded entity is responsible to its shareholders, above all else.  Unless there is an agreement among shareholders to sacrifice profit for social impact, the tenets of publicly-traded organization are at odds with the concept of the double bottom line.  Muhammad Yunus would argue that the answer is simple: a microfinance organization cannot be a publicly-traded entity, because its goals are inconsistent with the mission.  His opponents would argue that, without generating profits for investors, MFIs will never attract the capital necessary to achieve poverty alleviation on a scale large enough to make a lasting difference.  After all, in the eyes of potential investors, money that isn’t making more money is actually losing money.  But a profitable MFI will attract a lot of money, which, in turn, can be put to work by potential entrepreneurs in the developing world.  So, the other side would argue, Compartamos and profit-generating MFIs not only remain true to the fundamental mission of poverty alleviation, they actually serve to expand it well beyond the scale it could achieve in a non-profit framework.

A myriad of other factors are critical to an informed discussion of this debate.  For example, how can Compartamos serve the poorest individuals with a higher risk of default when it is responsible for generating returns for its shareholders?  Without that function, how then is it any different from the traditional banking system it was designed to circumvent?   These are questions for another post.  I’ll try my best to posit a solution, or at least a compromise that might satisfy both camps.

Microfinance can operate across the pyramid

It seems to me that these two models of microfinance – non-profit or borrower-owned vs. public for-profit – can coexist, serving different populations within the spectrum of poverty.  Currently, the microfinance industry serves ~10% of the estimated $250 billion of global demand.  Microfinance institutions, in theory, offer a broad suite of services to individuals with no access to the traditional banking system, yet the unbanked population (~4 billion people) is dramatically stratified.  At the very bottom are the destitute, those living in extreme poverty (less than $1 per day).  Here, microfinance is ineffective, and aid, in the form of food and healthcare, are necessary.  For the ~3 billion people that could benefit from these services, both the non-profit Yunus model and the public Compartamos model could each serve a valuable role.  For the near poor and individuals just below the poverty line, Compartamos could offer high interest rates and still generate a positive return on equity, attracting large investments from institutional investors, rather than donor capital.  In fact, Compartamos has perhaps been a victim of its own success, as new competition by others replicating its model has driven interest rates down from ~88% in 2005 to 71% in 2008.  The non-profits, on the other hand, can serve those below this level at lower rates of interest, with implicit subsidies justified by altruistic motivations.  To ensure Compartamos customers don’t move downstream and poach the loans meant for the poorer customers, the non-profits could mandate specific thresholds for potential customers that guarantee the social mission.  Investors can make decisions based on their own motivations.  Online P2P lending organizations like, MyC4, and Microplace have proven that people are willing to accept 0% rates of return, provided funds are directed to borrowers of a specific profile.

At the end of the day, the success of microfinance and microcredit depends on scalability and adherence to mission.  The Compartamos IPO highlights the divide among the development community.  I reject the premise that the two models are mutually exclusive.  I’d go so far as to argue that they are complementary.  Pursuit of profit is a good thing – it is what drives the capitalist engine, and microfinance is fundamentally a capitalist approach to development.  Let Compartamos target a lower risk, less impoverished clientele, and focus the non-profit segment on the still-unbanked poorer individuals.  True, this is a drastic oversimplification of a complex and nuanced topic, but at the end of the day, 90% of this market remains untapped.  It is premature to be arguing about which of these two proven models are best going forward.  It seems to me like there is more than enough for everyone.

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