Microfinance has lost its first love and lost its way. A focus on investor incentives over borrower incentives led to 6 shifts in in the practice of microfinance that changed its face and left it looking more like a for-profit bank and less like a pro-poor innovation.
SKS Microfinance, one of the world’s largest microfinance institutions (MFI) just raised an estimated $350 million in a stock offering which closed yesterday. The very successful IPO was oversubscribed by nearly 14 times. The founder, Vikram Akula, who has already sold shares worth $13 million, holds shares that after today will be worth an estimated $55 million. Perhaps its time for the old adage of social enterprise “doing well by doing good” to be updated. With these numbers, “getting filthy rich by doing good” seems more fitting. But one has to wonder if the “doing good” part still fits.
In 1999, I designed and led a microfinance program with World Concern in rural Bolivia. I had written my undergraduate IPE thesis at UPS on microlending in 1996 and used that research as the basis for the design. The key at the time was understanding the incentives of the borrowers – how do you get very poor borrowers who have neither a credit history nor collateral to offer to borrow and repay in good faith so that you can recover your capital and re-lend to other poor? (And how do you cover your lending costs on interest from tiny loans ranging from $20-100?) The answer was a relatively new banking model, developed originally in Bangladesh by Muhammad Yunus, an economics professor who received the Nobel Peace price in 2006 for his work. Dr. Yunus had solved the incentives problems that kept the banking industry from being able to lend to the poor. The new model worked very well and the poor demonstrated an ability to repay loans at rates that often beat highly-collateralized commercial borrowers in the formal sector. Long story short, the previosly unbankable poor were finally granted access to reasonably priced credit and the flow of capital to poor entrepreneurs helped launch and grow millions of small businesses.
The early success of microfinance led to a massive scale-up and everybody from NGOs to banks to foundations to private investors began launching MFIs in every corner of the globe. The problem then became how to finance this scale-up and so the key shifted from understanding the incentives of the borrowers to understanding the incentives of investors. At some point, a good part of the microfinance movement got hooked on the hubristic notion that we had to provide credit access to every poor person on earth and in order to do this we’d have to access the formal capital markets, which were driven solely by financial incentives. And so, without hardly a look ahead at what it would mean, profitability became the leading indicator of success. Instead of talking about how many people had been helped to move out of poverty, MFIs began bragging about low rates of portfolio at risk and high rates of ROI. Healthy assets were prized over healthy borrowers.
The new focus on investor incentives over borrower incentives has led to a number of dramatic changes in the industry. Here are six shifts in the face of microfinance that make it almost unrecognizable to someone like me.
1. shift from poorest of poor to the moderately poor
There are two fundamental problems with lending to the poorest of the poor when you are concerned more about profit than poverty alleviation. One is that they are very vulnerable to external shocks. A late rain, a death in the family, a run-over pig – these are economic catastrophes for the poorest of the poor. They have a very limited ability to rely on savings (stored grain, fattened pig) or other sources of credit (equally poor relatives and neighbors) to smooth out these frequent bumps. When faced with a choice of surviving or repaying their loan, these will survive. Second is they don’t have a huge appetite for credit. They generally want really small loans. They are incredibly risk-averse (see point one) and don’t want to become highly indebted. Even if you charge 3% a month on a loan, when that loan is $40, you need both really low operating costs and lots and lots of borrowers to make any money. The solution was to abandon the very poor and begin lending the moderately poor – a safer and more profitable lot. We lost our first love.
2. shift from rural to urban
To lower the operating costs many MFIs began operating exclusively in places with a higher population density – i.e. cities. This limited the time and cost required for a loan officer to service his caseload. It also changed the nature of the loans from agriculture to commerce. Agriculture loans are slow to turn-around as the capital is tied up for some fixed amount of time in something like corn stalks or goat kids. And these investments don’t generate any cash until the very end (i.e. harvest or slaughter). Most agriculture borrowers only pay interest until the very end when all the principle can be returned. Commerce loans on the other hand have a fast turn-around and generate principle payments throughout the cycle since the new business asset or inventory begins generating new income immediately. This keeps capital cycling quickly through the loan portfolio which generates more cash for the lender. But it also means that the rural poor, who already had the least amount of access to financial services, were further abandoned.
3. shift from starting businesses to growing businesses
To decrease risk and increase repayment rates, MFIs began shifting away from start-ups and toward business growth. When they worked with the poorest of the poor, they were providing seed capital that gave the poor entrance to income generating activities. But, most new businesses fail, especially when led by inexperienced entrepreneurs, whereas established businesses have a better shot at profiting from an influx of additional capital. So, those who already had some capital and income generation were given access to more, while those who had none lost the opportunity.
4. shift from peer lending to individual collateralized lending
A few months ago I was in Nicaragua visiting a branch office of a local non-profit MFI. The offices were stuffed with a crazy assortment of household appliances. Loan officers’ desks were wedged between refrigerators and stacks of radios and microwave ovens. It turned out this was all the stuff the “pro-poor non-profit” organization had taken from the homes of the poor. They had collected their collateral on at-risk or defaulted loans. I thought, “What business is this NGO in?How in the world do they measure success as they sit in the middle of all this capital they’ve collected from the poor?”
The anonymity and mobility of city dwellers coupled with the difficulty of getting established business owners to risk their capital by co-signing on loans with mobile strangers made this shift almost necessary. It turns out that it is also a lot less time consuming to work with a bunch of individual lenders than it is to manage the complexity of peer lending groups or community banks. So this had the additional benefits of permitting an increase in the caseload of each loan officer. This has been the saddest shift for me. Peer-lending was the key to solving the incentives puzzle in the first place. It was a practical way to value the relationships people had in their own communities as an asset you could bank on. In many ways, this was the final capitulation to becoming a niche in the banking market rather than an anti-poverty social movement.
5. shift away from auxiliary services
As the focus shifted toward making profitable loans and away from alleviated poverty, the ability to justify expenses to investors that were unrelated diminished. Quasi-related services like literacy and health training were the first to go. These may empower someone and increase their well-being, but they don’t directly help them repay a loan. And as loans became increasingly collateralized and borrowers increasingly business experienced, the cost of providing even the most related auxiliary services like small business and financial management training soon outweighed the benefits (in terms of loan repayment rates.) It was cheaper to threaten to seize collateral than provide business training. This helped further drive down operating costs and increased the caseload capacity of loan officers, which is a critical driver of profitability. It also discontinued some really good anti-poverty activities, many of which had nice synergy with the peer lending model.
6. shift from the poor as the primary beneficiary to the investor
And now we see the end game. Microfinance is becoming at once more complex as MFIs develop new products like microinsurance and remittance mechanisms, and more simple as many have become more comfortable and unabashed about their profit motives. While more and more impact studies conclude without rejecting the null hypothesis on the new breed of microfinance programs, their investors and founders are raking in huge profits.
While investors pat themselves on the back, stuff their pockets with cash, and cynically declare that they’re just “doing well by doing good”, I wonder how their clients feel. Afterall, it is the interest charged to the poor that generate profits in the first place. It would be one thing if this new kind of MFI could prove they are helping the poor, but there are almost no studies these days that provide such evidence. So it is on the backs of the poor that these MFIs derive their profit. The industry has done more than lose its first love, it has turned on them and devoured them.
Perhaps this is why Dr. Yunus had this to say about the recent spate of MFI IPOs:
“This is pushing microfinance in the loansharking direction. It’s not mission drift. It’s endangering the whole mission.”
“By offering an IPO, you are sending a message to the people buying the IPO there is an exciting chance of making money out of poor people. This is an idea that is repulsive to me. Microfinance is in the direction of helping the poor retain their money rather than redirecting it in the direction of rich people.”
I couldn’t have said it better.
Here’s some links to other views on all this: