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.
SKS CEO Vikram Akula disbursing money to a client at a center meeting
Given my post yesterday about the benefits of profitability, a new article in the Wall Street Journal about the IPO of the largest microfinance institution in India is serendipitous. This isn’t that new of a story, though whenever microfinance makes it into the Wall Street Journal or the New York Time, you can guarantee that everyone in this industry will be talking about it. Hopefully I will be one of the first to offer my opinion.
There are a lot of case studies that highlight the “capitalism vs. altruism” schism in the microfinance today. After all, Compartamos in Mexico went public three years ago i topic I discussed at length one of my first posts on this blog – and there are dozens of private equity and venture capital firms focusing on the microfinance segment. But this one is unique in that the two central players – Vikram Akula, the CEO of SKS, and Muhammad Yunus, founder of Grameen Bank and godfather of microfinance – are closely related and, on this debate, stand diametrically opposed. Akula is a former disciple of Yunus, copying the Grameen model in SKS’ initial phases. It is not dissimilar to Aristotle and Plato, or Luke Skywalker and Darth Vader. My opinion on the matter has become a bit more formed over the last few months. I tend to side with Akula and SKS in their decision. First, some background on the path of the organization once Akula left Grameen Foundation to start SKS:
Muhammad Yunus, the godfather of microfinance, contends that everyone is an entrepreneur. And microfinance is about individual economic empowerment, built on the premise that credit is both a human right and a path to economic freedom. This reading has been distorted by those who talk about the “entrepreneur myth,” which says that microfinance romanticizes the poor by pushing a false by-your-bootstraps narrative. This narrative, in turn, undermines development by giving the poor something they don’t want – credit for a business – instead of something they need, which is steady employment. This argument isn’t necessarily untrue, but it is irresponsibly oversimplified and demonstrates a lack of grounding in reality. I want to discuss two articles that address this issue and use them to explain why this reading of microfinance is not only flawed, but is counterproductive in serving the poor.
Rational actors in the U.S.
The first one, titled “Romanticizing the Poor” from the Stanford Social Innovation Review, is a bit more difficult to refute, in part because I agree with the premise but not the logic, and also because I am intimidated by the fact that the author, Aneel Karnani, is an economics professor of South Asian descent and, I would have to assume, intellectually superior to me. But I’ll try. The article is less a refutation of microfinance as a poverty alleviation strategy as it is a caution against the merits of market-based solutions in general. According to Mr. Karnani, the poor are not rational actors when it comes to economic decision-making. Therefore, the argument goes, it is misguided and potentially harmful to try to apply free-market strategies – like microfinance – when the spending behavior of the poor is irrational. He highlights the fact that the poor spend a disproportionate amount of money on booze and cigarettes at the expense of healthcare and education (Nicholas Kristof’s most recent article discusses the same issue). The poor are more prone to impulse buying, so introducing more money and more material product choices will just drive them deeper into debt:
Many advocates of market-based solutions to poverty view poor people as rational consumers who, if given more options, would make better choices—that is, choices that would increase their economic welfare. They see no problem with encouraging the poor to spend their already meager incomes on low-priority products and services. They further argue that the poor have the right to determine how to spend their limited income and are in fact the best judges of what is in their best interests.
I don’t dispute the truth of these statements, mostly because I haven’t read the research. I would say it’s not unreasonable to say that adults should be treated like adults when it comes to making decisions about how they spend their money. Either way, they are irrelevant to an argument against microfinance. Continue reading →
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 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.