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.

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