Tag Archives: Microfinance

What Do I Think of Microfinance? Pt. 1

This is part one of a two-part post on microfinance.

Through Kiva and Negros Women for Tomorrow Foundation, microfinance became my entrée into this world. I knew very little about microfinance prior to finding Kiva, other than what I had seen on an episode of Frontline highlighting the company’s early days. Over the subsequent nine months on the ground in the Philippines, I learned as much as I could, and became a bit of a microfinance apologist, believing it could do no wrong. I will do my best to step back with the benefit of hindsight and look at it objectively.

Microfinance is an umbrella term describing the provision of financial services to the unbanked. That includes, but is not limited to, credit, insurance, and savings products. The first one – micro-credit – is the most widely known, popularized by Muhammad Yunus and his Grameen Bank, founded in Bangladesh. According to the apocryphal tale, Yunus lent money to a group of furniture makers whose margins were tiny due to high upfront cost of buying materials. With a loan of only $40, Yunus was able to increase their profits by orders of magnitude and still get a return on his investment. The poor, it seemed, could be worth of credit after all.

Yunus formed the Grameen Bank, which, while not the first, became one of the largest microfinance institutions (herein referred to as MFIs). The group-lending methodology utilized by Grameen and other large microfinance organizations, like Accion and FINCA, came to be replicated by other MFIs around the world. A while back, I wrote about the replication of the Grameen model, specifically.

The group-lending model was created to guarantee payment in lieu of collateral. Typically, women self-organize into groups of four or five, and, in the case of the MFI I worked with, Negros Women for Tomorrow Foundation (NWTF) in the Philippines, up to eight of these groups come together and work with a single loan officer. The money is distributed to each woman at the same time and none can receive another loan until each has paid back their own. The threat of hurting the entire group, which implicitly agrees to guarantee the loans of each member, creates pressure on individuals to pay back. Clients are predominantly women, since women are more likely to invest the money into the business or, at the very least, spend the money on the family rather than leisure activities. As keepers of the house, women are also less mobile and, therefore, less likely to run off with the money. Using this system, Grameen Bank and others consistently have repayment rates of 95-98% .

The wealth management Hawley Advisors says that because of the small loan sizes (generally less than $500 per loan), the cost of servicing the loan is high, necessitating what some might consider exorbitant rates. NWTF, for example, charges ~30% interest on a 6-month loan based on a non-declining balance, which adds up to more than70% annually. This seems high, except when compared with the alternative, which is commonly referred to as a “6-5” – receive $5 in the morning and pay $6 in the evening. This equates to a 20% daily interest rate. Annualized, it is several hundred percent.

This is just the cost of doing business in microfinance. Back in 2008 and 2009, a schism developed between two camps in microfinance. Some, led by Muhammad Yunus, saw microfinance as a mechanism for bringing financial services to the poorest members of society, and felt that making significant profit ran counter to the underlying philosophy. Others, led by Compartamos, a publicly-traded MFI in Mexico, and SKS, the largest MFI in India which also IPOed, saw a huge untapped market that could only be served if MFIs had the capital to invest in expansion. These MFIs charged even higher interest rates and expanded rapidly to reach the 90% of the poor that still lacked access to finance.

This schism reached a breaking point last year, when the Indian government placed new regulations on MFIs in response to a spate of suicides among microfinance clients who had become over-indebted to multiple MFIs. Aggressive tactics on the part of loan officers was blamed, and the entire microfinance industry in Andra Pradesh – a state in India – and the rest of country suffered significantly. Muhammad Yunus was then forced out as the head of Grameen Bank in what some people saw as punishment for his starting a political party in Bangladesh. All in all, 2011 was not a good year for microfinance in South Asia.

In my next post, I will talk about other criticisms and sum up my thoughts on microfinance.

The Battle for the Soul of Microfinance

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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 and Bridging Loans 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.

Continue reading →

Microbusinesses as Start-Ups and the Problem of Flexibility

The Economics of a Cookstove

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The other day I went to the NWTF branch office in Hinigaran to interview clients that recently purchased an Envirofit cookstove. Cookstoves have received a lot of positive publicity recently as a cheap and effective solution to the problem of indoor air pollution – a problem that claims 1.4 million lives every year. The predominant stove in use by the poor – a basic design with a fire lit beneath a pot resting on three stones (a “three-stone stove”) – burns inefficiently. Much of the heat from the stove is lost due to lack of insulation and the fuel – sticks or charcoal – does not burn completely, requiring more to produce the same amount of heat. What’s more, partially-burnt fuel produces smoke containing particulate matter that is particularly harmful to the lungs when inhaled. The Envirofit cookstove, designed in conjunction with researchers at the University of Colorado, is the product of air-flow modeling and rigorous testing. It is designed for efficiency.

Continue reading →

Competition, Saturation, Interest Rates, and Microfinance

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CGAP, the World Bank’s microfinance arm, turns 15 this year, having been formed ten years prior to Muhammad Yunus winning the Nobel Peace Prize. In commemoration, Alexis LaTortue, the CEO of CGAP, wrote a summary of the state of the industry and the key transformations that have occurred over the last decade and a half. There is a lot of to unpack for a 500-word article, but I want address one point in particular that I found interesting:

More institutions are sustainable. Very few institutions were at the beginning, and there was even disagreement about whether they could be or should be. Yet, today, once you take away clients served by state banks, about three-quarters of total clients are served by sustainable institutions. In a few markets, we are even approaching saturation or real competition.

When I think about this statement, it leads to ask more questions about the implications of market saturation and sustainability for the microfinance community – the providers, the clients, the funders, everyone. I had always assumed that saturated markets already existed, but the fact that, by CGAP’s own estimate, there are only 100-150 million microfinance clients globally and a potential market of billions. It makes sense that, while some countries have relatively mature microfinance markets – Bolivia, Kenya, Bangladesh – most are far from being saturated in the way that, say, Boston is saturated with pizza shops. But in the same way that Boston has damn good pizza, when microfinance markets mature and become saturated with sustainable institutions, they begin to offer damn good financial services to the poor. Continue reading →

The Movers vs. The Shakers: The Microfinance Debate

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In the noisy echo chamber of the development community, there are a lot of arguments for (emphatically) and for (tentatively) microfinance as a tool of poverty. The debate surrounds a series of experimental studies questioning the impact of microfinance in achieving its stated goals – specifically, empowerment of women and poverty alleviation. The participants are the critics and the practitioners. The practitioners tend to dismiss the critics as having blind faith in statistics and either ignoring or being ignorant to the realities on the ground, while the critics contend that the practitioners drank the Kool-Aid long ago and refuse to admit that, while microfinance is impactful, it is perhaps not to the extent they believed. Those are both exaggerated overstatements and many people bridge the divide, but it is close enough. The debate reached a fever pitch recently, with some of the biggest practitioners – Accion, Grameen Foundation, Finca, Opportunity International, Unitus, and Women’s World Banking – jointly issuing a statement defending the impact of their trade. It is a short statement and worth a read, offering a distilled version of the practitioner argument. The authors describe what they consider to be the major flaw in the critics’ argument:

Unfortunately, it is extremely difficult for studies to quantitatively demonstrate the impact of microfinance. Such studies face two fundamental challenges: their ability to capture and analyze all the benefits of microfinance, and the duration of the study itself. To obtain quantifiable data, researchers have to ask narrow questions over relatively short periods of time–-14 to 18 months in one case–-which does not always allow the time necessary for impact to manifest itself. And because of the growing penetration of microfinance, researchers are finding it increasingly difficult to find homogenous geographical regions that contain both clients who have access to financial services and those who have none.

This is all true. Statistics give an incomplete picture and do not pick up the nuanced effectiveness of microfinance, which is manifested in individual success stories rather than a large group of people moving out of poverty. Negros Women for Tomorrow Foundation is a good example of this principle at work. It periodically measures the poverty level of its clientele using the Progress out of Poverty Index (PPI). Over the last five years, 22% have moved upward, 19% have moved downward, and the remaining 59% have remained pretty much the same. On balance, there is a net upward poverty movement, but not by much. Also, the number of clients that moved downward might have been much higher had they not been receiving microfinance services. Continue reading →

The Right Conditions for Microfinance

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Across the world, there are a lot of poor people. In the developing world, 1.4 billion people live on less than $1.25 USD per day. While this catch-all gives an idea of who is struggling to get by, the impoverished are stratified in terms of desperation. Some live in extreme poverty, racked by hunger and disease with little hope of “pulling themselves up by their bootstraps.” Combating this type of poverty requires humanitarian and development aid. But those higher on the ladder can be served by microfinance institutions. But according to the latest statistics from the Microfinance Exchange (MIX), about 100 million people worldwide receive microfinance loans (these figures are self-reported, and the actual number is much higher). There is still a large underserved population, and microfinance institutions (MFIs) are working to close the gap. Continue reading →

Microfinance and Job Creation

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The staff of the NWTF branch in Puerto Princesa

“So health care reform and reducing taxes and reining in spending has got to accompany tax reductions, and tax relief for Americans, and trade — we have got to see trade as opportunity, not as, uh, competitive, um, scary thing, but one in five jobs created in the trade sector today. We’ve got to look at that as more opportunity. All of those things under the umbrella of job creation.” – Sarah Palin

The international economic development community is constantly holding its own feet to the fire. I sometimes describe the push for transparency and demonstrated as a circular firing squad. It s probably an unfair characterization, since a lack of oversight leads to billions of dollars in squandered aid and international investment. Microfinance, in particular, is a frequent target of scrutiny from economists. It is the darling of the development world, and often mischaracterized as the long-awaited solution to poverty alleviation. But the impacts of microfinance are nuanced and cannot be reduced to a simple formula (i.e. poor woman starts business, business earns money, woman no longer poor). In reality, microfinance smoothes consumption, offers money for non-livelihood expenses, like tuition and home repairs, and, in a few cases, propels women above the poverty line. The impact on poverty alleviation is real, but perhaps more muted than the literature would have you believe. Continue reading →

Microenterprise to SME: A Thought Exercise Pt. II

Microenterprise to SME: A Thought Exercise pt. I

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This is the third post of a three–part series on small- and medium enterprises. It is a two-part post.

[youtube=http://www.youtube.com/watch?v=6Z66wVo7uNw]

A month ago, I attended a conference in Manila sponsored by the Microfinance Council of the Philippine Islands. I wrote briefly about the level of cooperation among the participants, but have yet to share what I learned. The conference – titled “Operationalizing Social Performance Monitoring (SPM)” – brought together a dozen microfinance institutions (MFIs) and lenders from across the country to discuss best practices for focusing on the social mission. In the microfinance world, theoretical solutions to problems, like how to focus on the poor and remain financially sustainable, are often incompatible with the nuanced realities on the ground. This gathering offered a chance for MFIs to share what has worked and what has not, so that the microfinance community at large can be more effective at addressing poverty alleviation in the Philippines.

The keynote speaker, Prof. Ron Chua, functioned more as a facilitator and moderator than a lecturer. He asked the MFIs to present a specific social goal and discuss the measures each would take to achieve it. One nameless participant set an organizational goal of transitioning 30% of existing clients from micro-enterprises to SME (small- to medium enterprise) within five years. They presented a laundry list of programs designed to aid in this process. The underlying assumption behind each of these measures is that financial services (microcredit) must be complemented by the provision of non-financial services, including business development and support services and integrated community development. Provision of financial services alone is not enough to bring people out of poverty. This exhaustive list addresses all of the key issues in moving a client out of poverty. I will present the first six here, and the remained six in the next post. Continue reading →