This is the first part of a three-post series on this topic. Read Part 2 and Part 3.
Microfinance was born to reduce poverty, but now it is notorious for providing exceptionally high returns to shareholders. The fierce debate over the commercialization of microfinance has many sides to it, and this series of blog posts looks at the different arguments for and against the practice of profiting off the poor, and ends with a practical (read, compromised) solution.
Commercialization will help raise funds
MFIs generally bemoan a lack of low-cost funds to support the growth and sustainability of their operations. Commercial banks lend to MFIs at market rates and there is only so much development aid to go around, which may push MFIs to access equity markets for funds.
The success of two MFIs in the capital markets (Bank Compartamos of Mexico and SKS of India) will improve the ‘credibility of microfinance in capital markets’ (CGAP) and help attract the much needed funds from social and commercial investors. These funds can be re-invested to grow the microfinance program.
“The only place you can get the amount of money that is needed to help the poor is in the capital markets… That’s why we are doing this IPO.” Vikram Akula, founder and chairman of SKS, to WSJ (IPO Pits Profit vs. Altruism – Wall Street Journal).
Is that a valid argument?
Grameen Bank, one of the largest MFIs in the world, grew purely based on its social performance – grants, donations, voluntary savings from borrowers and deposits from the general public are major sources of funds (as evident from their Balance Sheet). World of Vision, another giant NGO, falls in the same category because its ideas of sustainability are far from commercial.
It is worth mentioning here that central banks in many countries (including India) forbid non-bank MFIs (such as NGOs and cooperatives) from offering micro-savings to the poor. Grants, loans and IPOs are the only other alternatives.
Commercialization Will Ultimately Help the Poor
The additional funds (profits and other equity generated through an IPO) can be invested in the microfinance institution (MFI) to expand market outreach and achieve operational efficiencies (economies of scale) which will, in the long run, lower interest rates while increase the range of customer centric products. The natural result of this will be a stronger social and economic impact on the poor, which stands true to the original mission of microfinance.
Commercialization can Also Harm the Poor
It stands to reason that commercialization (especially to the extent of tapping into capital markets) is against the mission of microfinance, which called for the protection and empowerment of the poor.
“When you put an IPO, you are promising your investors that there is a lot of money to be made and this is a wrong message. Poor people should not be shown as an opportunity to make money out of…this pushes microfinance in the loansharking direction” (Professor Yunus, in an Interview about the SKS IPO to Microfinance Focus).
Critics feel the pressure to deliver high returns to investors may drive MFI managers to rely on exploitative practices, such as increasing interest rates, lending to high-risk clients or following aggressive credit collection methods. This may go on to serve as a dangerous precedent for non-profit MFIs in the market. This control exerted by investors/funders holds true for non-profits, as pointed out by David Hunter in his article, The End of Charity: How to Fix the Nonprofit Sector Through Effective Social Investing:
In general, nonprofits do what their funders tell them to do. When funders make demands, more often than not the vision, mission, goals and objectives of nonprofit organizations give way. As the saying goes, ‘We are what we eat’. And most nonprofits are what their funders make them.
The same logic applies to for-profit companies as well if they heavily depend on funders.
This concludes the first part of the three-post series on the debate of commercialization in microfinance, which looks at arguments both for and against the idea. Read Part 2 and Part 3.
Request permission to repost your article on our blog with credit.
Regards
Abhay
Hello Abhay,
I’ll be honored if my article is cross-posted on India Microfinance. I have a small request regarding the referencing though – could you please credit me, as well as my site, at the beginning of the post? My full name is Fehmeen Khan.
Thank you, and good day!
Commercialization is the spirit of any business. Poor also must do their businesses with a confidence of commercialization. However, it does not mean that the microfinance providers charged them unjustified rates of interest or profit. We could do charity and microfinance side by side, but when we do microfinance we would have to be commercial. Otherwise one cannot sustain the business. Neither could the poor attain sustainability nor the investor. The prestige and self respect of a poor also demands commercialization. According to my point of view, if we develop any different strategy for microfinance clients with a social approach, it is not beyond commercialization. MFIs earned a lot from the poor with high interest rates. Most of the time MFIs even did not tell the rates they charge. MFIs sold the products, which were not providing the solution of poverty alleviation. MFIs earned a lot of money by selling unproductive products to the poor in full rates. So if we adopt true commercialization, there is no harm in it.
Mr. Shah,
Thank for the comment. I agree the pivotal point is the differences in the levels of commercialization, the main issue being sustainability versus profitability versus greed, and there’s a fine line between the second and third objectives. Research indicates that around 60% of an MFI’s cost is attributed to operational expenses, but there are some MFIs that minimize their operational costs (especially transport and administration costs) by tweaking their business model to reduce the number of trips to the fields and process payments in bulk. I also fear some MFIs may be charging excessive rates on the pretext of offering services to a large geographical area, but as Milford Bateman said, in simple words, the logic is that you charge higher rates to one group of poor people so you can serve another group of poor clients in some other area…
There is no black and white solution to this issue, and hence, I thought I would cover the topic as a debate. Again, I appreciate the comment!
But we should be mindful of the fact that the desire to commercialize is likely to jeopardize the focus on poverty reduction and serving the economically active poor.No wonder ,micro finance currently still goes to the haves in society. We therefore need to keep an eye on both sides ie both sustainability and poverty reduction.
Femeen,
I appreciate the work you doing with this informative blog. Thanks for the link to my post “Profits and Perverse Incentives: The New Face of Microfinance.” (http://wp.me/pYIwQ-2u) in the hyperlinked text “World of Vision, another giant NGO, falls in the same category because its ideas of sustainability are far from commercial.”
I feel I should clarify, however. Although I currently work with World Vision International, my views do not necessarily represent theirs. My experience designing, founding and leading an MFI in Bolivia from 1998-2001 was with another organization, World Concern. This experience and my own observations about how the “industry” has changed over the past decade or so have shaped my personal views on microfinance. But again, my views don’t necessarily represent theirs.
A better source for World Vision’s approach to microfinance is the home page of Vision Fund: the microfinance subsidiary of World Vision. –> http://www.visionfundinternational.org/VisionFund/VisionFundweb.nsf
Your welcome, and thanks for the compliments and clarification. I’m sure readers will understand the independence of your views now and will follow the link to develop their own opinions of World of Vision.
Thanks Fehmeen to facilitate this important debate.
I believe that the sector (I hate the word ‘industry’ … is now ripe enough to make out when microfinance actually adds value to poverty alleviation and when this is a system for civilised sharks (including investors).
YES the issue of the conditions (especially interest rates) is a serious one, why can credit be cheap in the North and expensive in the South?
Yes the issue of return on investment is a serious one. How can we expect establish a sustainable MFI providing relevant services when the investors regard the sector as a financial jackpot?
Yes the issue or ownership is a serious one one. How can one be sure the microfinance sector besomes a component for development if the owners of the MFI are not the beneficiaries, as well?
There can’t be any effective outreach in microfinance without sustainability. MFIs need to be financially sustainable before they can impact the poor effectively. Donor funds are no longer available. But by the way, who says that the poor cannot do a sustainable business?
In my opinion commercial approach, aiming profits, is ok. These approach brings the needed capital (more people served with credits), efficiency (lower rates) etc.
But beside this there must be a strong accepted supervision which controls that the profits are moderate and ensures that there is transparency and so on. Donations or government money should be used in the organisations that supervise. The supervision should ensure that microfinance indeed helps people to come out of poverty.
Hello Felix,
I agree commercialization is acceptable if the pursuit for profit remains within appropriate limits, but the question then arises, who will enforce these limits? Governments are hardly in a position to work effectively here since they face monitoring issue themselves, and if voluntary bodies take up the task, how many MFIs will listen? It’s just like the Smart Campaign enforced by the Centre of Financial Inclusion – they propagate excellent ideas but MFIs adopt them on a voluntary basis. No doubt, some efforts are better than none, but for the sake of discussion, this question remains intriguing.
I will love to hear your views about this.
Microfinance is an impartant tool to eradicate poverty from the socity. Financial base is created from members by thrift / savings, donations, bank loans. In India, member savings are not allowed. Donations also playing a very small role. Only bank loans are playing big role due to RBI’s priority sector notification. Now a days banks also not intersted to grant more loans to MFIs due to RBI’s advises on risk area.
Due to need of finance now a days many MFIs are concentrating on foreign equity, NCDs. This also advisable on low cost of funds and return on investments by way of divedent and share prices. Due to the BPL catagory people’s honesty the MFIs recovery rate is always more than 98%. Hence the ROI is good and it leads to good share price increase.
MFIs are working with BPL catagory people against loan disbursement and loan collection where banks are not able to enter. Actualy financial inclusion is taken care of by MFIs now a days without government support.
Hence commercialisation of MFIs leads to viability of services and erradication of poverty from the socity without any subsidy or loan waiver.
Hello Seetharaman,
Thanks for commenting! I agree with you to the extent that commercialization may be an acceptable option if regulations do not allow NBFCs to access low cost funds in the form of deposits, as in India. However, the favourable option is to go for debt instead of equity as a source of financing, and hence I wonder why SKS did not take up that option. I do agree an MFI’s IPO can deliver good returns to investors (there is plenty of evidence to support this), and there is nothing wrong with this as long as the poor benefit more. However, the long term threat mentioned in the last paragraph of this post, still remains. True, it hasn’t happened so far with SKS and Bank Compartamos, but only time will tell who was right.
The other threats of commercialization have been discussed in the second part of this post-series, which you may be interested in.
I look forward to hearing your views.