Opinion

Felix Salmon

Microfinance datapoints of the day

By Felix Salmon
September 2, 2010

Here’s three takes on microfinance, all from the past month:

  • Indian microfinance lender SKS goes public, raising $358 million and making its founder dynastically wealthy. The decision was controversial, and was largely responsible for an entire non-profit organization, Unitus, disappearing. When that kind of money is at stake, noble non-profit principles have a tendency to evaporate.
  • Steven Schwarcz of Duke University, has a bright idea: why not use the magic of securitization to provide funds for microfinance lenders? “Such disintermediation,” he writes, “would enable microfinance loans to be funded directly from low-cost, and virtually limitless, capital market sources”. What could possibly go wrong?
  • Hema Bansal reports from a roundtable in New Delhi, which found that many microfinance lenders don’t know their effective interest rate, and the ones who do know it tend not to reveal it.

The lesson I take from all of this is that microfinance is much, much messier than its advocates normally like to admit. I’m constantly astonished at the number of people I meet who are all excited about some microfinance fund or initiative, with some vague idea that the main problem is finding people to loan out dollars at low interest rates; after that, the magic of the market will help bring billions of people out of poverty.

But in reality it doesn’t work anything like that. Microfinance loans are often punitively expensive, with the main beneficiaries being the owners of the MFIs rather than the borrowers. MFIs which start off on a non-profit basis convert to being for-profits, following the well-trod path most famously trod by Compartamos, in Mexico. Insofar as default rates are low, that’s often because borrowers keep on rolling over their loans into ever-larger debts, without ever really exiting from poverty. The lenders compete viciously in densely-populated urban centers, being very opaque on pricing, and leaving many rural areas untouched. And all the while well-intentioned people in the US dream up new ways of throwing more dollars at the industry, in the absence of any evidence that more dollars is what the industry really needs, at this point.

My feeling is that good non-profit microfinance organizations do exist, and that they should be supported with grants first, with technical expertise on things like underwriting and growth strategies second, and with local-currency funding third. If someone tells you that you can help bring millions of people out of poverty while still making a profit on your investment, your first reaction should be that they’re selling something which is too good to be true. Start by asking about local interest rates and then work out from there: the facts on the ground are likely to be a lot more complicated, and a lot less compelling.

Update: Accion’s Andrew Sprung responds in the comments.

Comments
3 comments so far | RSS Comments RSS

There have in fact been several microfinance securitisations. None, that I know of, have actually securitised the micro-loans themselves. They’ve securitised loans (usually created for the securitisation) to microfinance insititutions. So they’re more like a club funding CLO than a consumer loan ABS. But there have only been a handful (maybe $500m total), and most of the investors have been development banks and the like, although more private sector investors have got involved in recent deals.

Posted by GingerYellow | Report as abusive
 

This is exactly why we support only nonprofit MFIs who moderate their interest rates to target sustainability and include business education in their programs. When MFI capital pools are burdened with the requirement of generating a return for investors, it’s the impoverished borrowers who pay the price.

Our approach generates interest-free capital for MFIs. I encourage social entrepreneurs to follow our model, known as Good Returns. In this model companies sell products in the developed world and then invest 100% of profits into sustainable non-profits at zero interest for successive one-year terms.

Aside from being socially beneficial, Good Returns creates drives many business advantages: customers reward this good corporate behavior with loyalty and word of mouth referrals; employee morale is boosted in a company with a deep social mission; and the company receives much needed local press for their mission.

Our company Soap Hope is an example of a successful Good Returns business. Soap Hope (http://soaphope.com) invests 100% of profits into three sustainable nonprofit MFIs at zero interest each year. Customers are passionate about our cause and spread the word to family and friends.

My vision is to teach 1,000 entrepreneurs the Good Returns model and thereby generate one billion dollars in interest-free capital for MFis and other sustainable nonprofits worldwide. You can read more about Good Returns on my blog at http://salahsblog.com.

Posted by soaphope | Report as abusive
 

Yes, “the facts on the ground are likely to be a lot more complicated.” But Felix, it’s you who are oversimplifying, and overgeneralizing from a few overheated microfinance markets. It’s true that in some regions in India, and in other countries including Nicaragua — and years ago, Bolivia — too many MFIs piled into a limited market and too many clients took out multiple loans. But some facts that you don’t consider:

1) Rates that seem high by western standards on an annual basis are generally far lower than rates the poor in those markets are accustomed to paying to lenders from a variety of informal sources (those sources are not always exploitative. A one-week $10 loan with $10.25 due at week’s end comes to 261% on a compound annual basis (Portfolios of the Poor, http://amzn.to/bORHOC). In many cases, too, saving is as expensive as borrowing, as people pay substantial fees to have their money kept safely and delivered predictably.

2) Microfinance rates are driven mainly by the high cost of servicing lots of small loans. Nonprofits do not generally charge lower rates than for-profits.

3) MFIs cannot sustain themselves over time by inducing clients to roll over debt. If that were the norm for Compartamos, why does its client base keep expanding, and why are its repayment rates among the best in the business? No one is putting a gun to Mexicans’ heads and forcing them to take out loans.

4) The largest MFIs in India have moved quite swiftly to address problems of client overindebtedness that have cropped up in some torrid markets (while large swaths of India remain underserved). They have formed a trade association, MFIN, with 42 members, which is creating a credit bureau, with which it will require members to register, and has promulgated a comprehensive code of conduct that it plans to enforce strictly http://bit.ly/aD6mN6. A global effort, The Smart Campaign for client protection in microfinance, http://www.smartcampaign.org, / aims to institutionalize client protection principles throughout the global microfinance community

5. It is true that some maturing microfinance markets are not the most productive targets for aid dollars. Grant funding should be directed at MFIs that reach marginal groups, or for R&D for development of new products like microsavings and insurance, or for development of industry infrastructure like credit bureaus. See Congressional testimony by Elisabeth Rhyne, director of the Center for Financial Inclusion at ACCION http://bit.ly/d4scrO (disclosure: I work for ACCION).

5) For-profit institutions have not only helped lift people out of poverty- they are the primary engines of human prosperity. Investing in the right for-profit ventures can indeed help to alleviate poverty.

Posted by adsprung | Report as abusive
 

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