Among some in the microfinance community, there is almost a reflexive tendency to dismiss profit as a bad thing, a corrupting force that causes microfinance institutions (MFIs) to abandon the social mission that underlies their reason for being. I have thought a lot about the issue over the last few months and have seen a lot of upsides and downsides to the different arguments. But more and more I have come to the conclusion that the two are really inseparable. The idea that higher interest rates that produce extra income beyond what is needed to just continue doing business is exploitative to the poor belies the priorities of microfinance clients. Interest rates are important in their decision-making, but more paramount is receiving a good product with attentive service from the loan officers and the ability to continue taking loans. When higher interest rates give MFIs additional capital to pay their employees higher salaries, expand operations to new regions, and invest in technology that enhances their ability to offer their services on-time and on a larger scale, the end result is more capacity serving a larger market. I will address some of the points one-by-one.
Microfinance has a human resources bottleneck. Being a loan officer is a tough job. They travel long distances by motorbike on beat-up roads to rural areas far off the grid, twice a day, four or five days a week. They handle the accounts of 300 or more clients and are responsible for making sure those clients pay their loans every week. And, unfortunately, they aren’t paid very much. This is true for most microfinance employees, since MFIs, as NGOs, cannot offer the same level of compensation as a for-profit company. Some people choose to work in microfinance because of an idealistic commitment to serving the poor, but others work at MFIs because it is a paying job. If MFIs could offer higher salaries with greater benefits, they could attract more qualified candidates and raise the general morale of their staff.
This job satisfaction might manifest itself in the way employees deal with their clients, offering better and more attentive service. In a report from Women’s World Banking titled “Marketing for Microfinance,” the authors cite a customer study performed by Microfund for Jordan, the largest MFI in the country. The MFI wanted to know what criteria their clients used for selecting a service provider. For women, the top criterion is the relationship with the institution, followed by “Cooperation, smile” and “Answers questions, clear.” Qualified and happy employees are more likely to offer these women what they want. Similarly, the MFI could invest in hiring additional staff, reducing the workload of individual loan officers by lowering the borrower-to-staff ratio. This would allow the loan officers to focus more on cultivating strong relationships, as opposed to being stretched thin managing all of their clients.
Another benefit of higher interest rates is scale. Some of the interest rate debate seems like it is arguing about the color of the drapes when the house is burning. More money means more capital for expansion. If an MFI is making a decent amount from their existing clients in low-risk areas, they will be more likely to venture into financially riskier areas, serving the rural poor that have really been left behind. If an MFI has razor-thin margins, the prospect of entering a market where the clients are the poorest of the poor and are less likely to be able to repay their loans is less appealing. But if a buffer exists, an MFI can effectively subsidize the cost of expansion and hedge against risk by continuing to earn a profit off their more reliable customers.
Profitability also attracts other institutions to the game. More NGOs will be attracted to microfinance markets when they are shown to be profitable. If NGOs are turning a little bit of profit from their activities, formal financial institutions (banks, credit unions) might see the potential in the microfinance market and begin tailoring services to the poor. The original social goal of microfinance has been to bank the unbanked, to bring the billions of women operating in the informal sector into the light and give them access to financial services. If this is part of the social mission, then turning a profit supports the goal.
Lastly, MFIs can benefit hugely from investments in technology. Using database systems to track loans and monitor repayment rates means MFIs can more effectively manage their portfolio and take preventive measures when problems are identified. Having a strong MIS (management and information systems) department is critical to the success of an institution, because it can lower operating costs and improve the level of service an MFI can offer its customers. Ultimately, when these investments are beneficial and productive for the institution, costs fall, allowing the MFI to reduce interest rates to its clients.
In a guest post on the CGAP Microfinance blog, Casey Wilson of Wokai, a China-focused microfinance operation, discusses why interest rates in China are actually too low:
As Muhammad Yunus indicated, the focus of microfinance should be on providing opportunities to the poor, not to profit from them. However, microfinance was always intended to be a sustainable and scalable way to help the poor—one that compensates a lender for the opportunity cost of lending out money enough that the lender can provide more microloans to more people. Thus, it is a mistake to think that 1) interest rates on microloans should be judged by a universal standard and 2) that interest rates above a certain threshold (e.g. 20%) indicate that a MFI has lost focus on its mission. MFIs have a responsibility to sustain and scale their operations. This will mean raising interest rates. But, it’s a certainty that the hundreds of millions of potential borrowers in China who would gain access to credit would think the higher cost is worth it.
Capacity-building is a mantra in development. Skills-training and infrastructure investments are key to creating long-term solutions to poverty. But these things require money, usually from major donors and foreign governments. Microfinance prides itself on being a financially-sustainable poverty alleviation tool. To that end, I think it is important to embrace profitability as a means of enhancing this tool. In the end, the social mission will remain intact, and microfinance will become available on a much larger scale.