This is the second part of a three-post series on commercialization in microfinance. Read Part 1 and Part 3.

Commercialization can lessen competition in the industry

If one or two MFIs undergo an IPO while the rest remain non-profit, the differences in their balance sheet sizes can lead to a monopolistic situation. Milford Bateman expresses his concerns over the possible widening of the gap between large MFIs and medium and small sized MFIs as a result of IPOs:

The big MFIs also benefit from economies of scale, especially in marketing and IT, and so can push out the smaller MFIs from the savings market too. MFIs after an IPO also typically have more power, incentive and opportunity to lobby for changes to laws and regulations that best suit their own commercialization and profit-seeking goals, and rich shareholders. Milford Bateman to Microfinance Insights.

Has This Happened Previously?

Bank Compartamos drew plenty of attention and criticism because of its sky high interest rates (85% per annum) at the time of its IPO in 2007. However, the MFI has not become less customer-centric or more commercial since the IPO, and their interest rate actually fell by to 71% in the subsequent year (CGAP) and this rate is amongst the lowest in the market. No doubt, the long-term risk remains, but so far, skeptics have been proved wrong.

Socially Responsible Investing (SRI) and Microfinance

Proponents of commercialization also point out the participation of social investors who have a genuine interest in social and environmental causes (read about measuring social performance from and investor’s point of view). Surely, it must be okay for them to make some extra money? This argument is a little misleading; according to Larry Macdonald, SRI stock indexes do not compromise on financial returns simply because they avoid investing in ‘bad’ companies.

The willingness to forego profits for the sake of social returns may hold true for individual investors, but the reality is, a majority of shares in MFIs are purchased by commercial investors because microfinance has been established as a rewarding financial investment.

In other words, David Hunter’s observation signals a real threat.

Moral Implications of Commercialization of Microfinance

From the moral point of view, it is incorrect to make money off the poor, even if the organization’s mission remains intact. It’s a disturbing idea that while the poor are made to pay above-market rates (on the basis of high operating costs, and other factors), company executives walk away with millions of dollars.

The original investors of (Bank) Compartamos received about $450 million for selling 30 per cent stake, representing a rate of return on their original investment (about $6 million) of 100 per cent a year compounded over the eight-year investment period. Source: Business Standard

Similarly, the CEO of SKS (the largest MFI in India, which recently went public) sold a quarter of his stake in the organization for $11.9 million. (Source: Microfinance Focus News)

Risk Management and Commercialization of Microfinance

As an MFI grows, its risk management as well as other internal controls begin to strain under pressure. While each MFI has different coping mechanisms, a boost in equity can absorb default risk and safeguard public deposits (in the case of MFIs who offer micro-savings and take deposits from the general public).

The David Roodman blog explains the two requirements in the context of Professor Yunus’s criticism on the SKS IPO (Professor Yunus pointed out it that since Grameen Bank was funding its loans by taking deposits, it was also possible for other MFIs to function without going public):

• Savings deposits cannot substitute for risk-absorbing, profit-claiming equity capital of the sort SKS has just raised… In fact, the real substitute for savings at SKS and other fast-growing Indian microfinance institutions has been loans taken from commercial banks… And whether a microcredit portfolio is funded with deposits or bank loans, the lender still needs equity to absorb the losses on the bad loans it makes. If SKS took no equity, every rupee of loss on its microloans would have to come from its creditors or its depositors, which would not be tenable.

• Even if Grameen is handling its deposits with all appropriate care…its capital cushion is by all appearances now illegally thin compared to the size of its lending portfolio. Seemingly, it needs to either cut back lending, which it has not done, or…it needs to raise capital.

This concludes the second part of the three-post series on the debate of commercialization in microfinance. Read Part 1 and Part 3.