Why Yunus is right about for-profit microfinance

By Felix Salmon
January 16, 2011
Muhammad Yunus has a heartfelt NYT op-ed railing against for-profit financiers.

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Muhammad Yunus has a heartfelt NYT op-ed railing against for-profit financiers. When he founded Grameen Bank in Bangladesh, he writes, “I never imagined that one day microcredit would give rise to its own breed of loan sharks. But it has.”

Yunus names the obvious names, such as Compartamos in Mexico and SKS in India, which have gone public, providing windfall profits for their founders with little if any benefit for their borrowers.

Yunus calls for stricter government regulation of microfinance entities, saying that their interest rate should be capped at 15 percentage points over their cost of funds. (Grameen manages on a spread of 10 percentage points.)

But Matthew Bishop, on his Philanthrocapitalism blog, pushes back hard against Yunus’s essay, with some rather peculiar arguments. (I’m assuming this is Bishop writing, and not his co-author Michael Green; the posts on the Philanthrocapitalism blog annoyingly don’t have bylines.)

It’s worth taking Bishop’s arguments in order:

For some microfinance providers, like Grameen, the way to keep down the interest rate is to take deposits from clients to fund loans. That is all well and good for Grameen but financial regulations in many countries stop microfinance providers taking deposits and the capital has to come from somewhere else. And, given the limited supply of the sort of philanthropic donations that helped Grameen get started, the only plentiful supply of capital is for-profit investors.

It’s true that it’s much easier to become a lender than to become a fully-fledged deposit-taking bank. If a lender goes bust, only its owners are hurt; if a bank goes bust, either its depositors stand to lose all their money, or else some kind of government insurance scheme takes the hit.

But that’s kinda Yunus’s point: microlenders should be more regulated, and the world of microcredit should not be open to any old loan shark wanting to hide behind a flimsy veil of ostensible social responsibility.

As for those for-profit investors, they come in many forms, and there’s no reason why they need to invest equity. There are lots of people out there willing and able to make relatively low-interest loans to microfinance institutions; those people don’t require an ownership stake or the chance to make millions of dollars when the bank goes public. Microfinance institutions should be owned and run for the benefit of their borrowers and depositors, not by foreign (or even domestic) millionaires.

Banks do need capital as well as loans, but equity isn’t the only form of capital, and philanthrocapitalists looking to support microfinance institutions should be perfectly happy to provide a combination of grants and subordinated debt.

More generally, I’m not at all convinced that for-profit microfinance shops are a consequence of a lack of philanthropic donations: in fact I suspect that it might be the other way around. Given the millions to be made in the microfinance space, entrepreneurs wanting to lend money to the poor are more likely to want investments from the for-profit sector than they are to want grants from philanthropists who will insist that the bank be owned not by its founders but rather by its borrowers. If the world of for-profit microfinance institutions dried up, then maybe all those philanthrocapitalists might be more inclined to simply donate startup capital to non-profit institutions instead.

Bishop continues:

Of the billion people living in poverty about 150 million currently have access to microfinance, so there is still plenty of unmet pent-up demand. Providers like Compartamos and SKS have grown quickly and therefore helped more people because they have engaged the for-profit capital markets (and as they have grown, they have passed some of the savings from scale efficiencies back to borrowers in lower interest rates). If Mr Yunus has his way, this supply of growth capital will be choked off and hundreds of millions of people will be left waiting for financial inclusion.

This is highly disingenuous, partly for the reasons explained above: we simply don’t know how many people would have access to microfinance in an alternative world where non-profit organizations were the norm.

On top of that, for-profit lenders tend to congregate in dense cities where most of the population already has access to some kind of microfinance institution. In order to provide small loans to the billion people living in poverty, new lenders are going to have to venture out into much more rural areas, where banks can’t easily scale and where the limiting factor is finding qualified loan officers rather than finding sufficient capital. Yes, there’s pent-up demand for small loans. But most of that pent-up demand will not be met by for-profit lenders who can grow much more quickly in banked urban areas.

I’d also like to see some evidence that Compartamos and SKS “have passed some of the savings from scale efficiencies back to borrowers in lower interest rates”. Indeed, according to the CGAP report on Compartamos, the bank grew to its present size partly because of a deliberate decision not to lower interest rates:

When Mexico was hit by heavy devaluation and inflation in 1995, Compartamos, still in a pilot phase of operations, responded by raising its effective annual interest rate above 100 percent, in order to provide real (inflation-adjusted) yields that were sufficient to cover its lending costs. When inflation dropped back to normal levels, the founders and managers deliberated about whether to lower the rates. They had a choice about the matter because they faced little direct competition and were in a near-monopoly position with respect to their clients.

They decided to leave the high charges in place…

Looking at the facts available to us, it is hard to avoid serious questions about whether Compartamos’ interest rate policy and funding decisions gave appropriate weight to its clients’ interests when they conflicted with the financial and other interests of the shareholders.

CGAP’s report makes it clear that Compartamos never reduced its interest rates as a result of scale efficiencies; the only thing which would ever prompt it to lower its rates seems to be competition. Similarly, when SKS reduced its interest rates in October, it was clearly in response to political pressures, rather than a result of any scale efficiencies.

And this, from Bishop’s post, is just plain weird:

Mr Yunus supports the idea that governments should impose caps on the interest rate charged by microlenders. He says this should be no more than 15 percentage points above the cost of raising the funds to lend. In the case of Grameen, he says, that would be an interest rate of 25% – a number that, it would be easy to conclude, is not far off what he thinks would be the right cap on interest rates elsewhere. Yet in countries such as India and Mexico, where interest rates are significantly higher, the consequence of a rate cap of anything close to 25% would be a dramatic decline in the number of poor people able to get access to credit.

The proposal that banks’ lending rate be limited to 15 percentage points over their cost of funds is surely simple enough for the US business editor of the Economist to understand. At no point does Yunus ever say or imply that the lending rate be limited to 15 percentage points over Grameen’s cost of funds. Yet somehow that’s what Bishop contrives to understand him to mean.

And in what bizarro world are interest rates in India and Mexico “significantly higher” than they are in Bangladesh? The benchmark central bank interest rate in India is 6.25%; in Mexico it’s 4.5%. In Bangladesh, by contrast, the interbank rate is 15%. Poor borrowers in India and Mexico pay much more in interest than their counterparts in Bangladesh not because interest rates are higher in those countries, but because microlenders in those countries charge much higher spreads over their cost of funds.

There are good reasons to believe that Yunus’s 15% rule of thumb is overly simplistic: Richard Rosenberg points out that many of Grameen’s own favored microfinance institutions lend at much higher spreads than that. But once an institution becomes huge, like Compartamos or SKS, it’s pretty hard to make a case that it needs to charge vastly higher spreads than Grameen.

Grameen bank showed that the poor could be very good credits, and would repay loans even when they carried an enormous interest rate. Bishop himself concedes that Compartamos has a non-performing loan rate below 2%, which means that it clearly doesn’t need to charge enormous interest rates to cover the credit risk on its loans. And there’s no reason to believe that Grameen is vastly more efficient than Compartamos in the way that it does business, or that its all-in cost of funds is significantly lower. Which means that the excess lending rates charged by Compartamos over Grameen are entirely a function of profiteering, and that Yunus is right to criticize them.

Going forwards, I’m hopeful that a lot of the unbanked in poor countries will be reached by m-banking using mobile phones rather than through traditional microfinance institutions. Which is all the more reason to try to ensure that people lending to the poor do so at reasonable interest rates, rather than dividending monster profits back to international financiers who don’t need the money. I’m definitely on Yunus’s side of this debate: it’s pretty hard to be an apologist for millionaires and billionaires seeking to delude themselves that the best way to help the poor is to extract lots of money from them.

Update: David Roodman has a sophisticated, nuanced, and highly-informed view, which — like all his stuff — is well worth reading.


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Ouch. Brilliant, insightful.

Posted by intermediary | Report as abusive

I would add only that where I slightly disagree is in the framing of things in terms of for-profit vs. non-profit. There are many microfinance in around the world that are for-profits with a social mission, and committed to that objective by the fact that the primary equity investors are social investors. Social equity plays a role in maintaining their orientation and often transfers know how and other value.
In short there are lots of ownership/governance structures that can be put in place to make sure that the clients interests are paramount. In the transformation of many NGOs to NBFIs one ends up with structures where the primary shareholder is the former NGO (or a trust acting on behalf of its clients) and social equity investors. It seems useful to have heterogeneity and hybridness of this sort in ownership/governance forms for the development of new markets..

What I think is really the concern is when some of these closely held shareholder-corporations go public, because (a) it enriches insiders and (b) it establishes a new market for control in which profit-focused investors may attempt to wrest control at the expense of clients.

If we are going to see new microfinance institutions for those unbanked segments you mention we are going to need someone to provide the startup equity capital. In some/many circumstances it might be outright donated philanthropic capital (which is the story of a lot of microfinance startups) but in other circumstances I can see the value of trying to attract social investors who are willing to accept a lower (but positive) rate of return on equity in return for a role (possibly via a microfinance investment fund or institution like Oikocredit) in keeping that institution focused on its social mission. If you limit governance forms to non-profits (who by definition can’t distribute returns to outside investors, and therefore don’t give them control rights either) you might be missing out on the opportunity for useful innovation.

Posted by intermediary | Report as abusive

“it’s pretty hard to be an apologist for millionaires and billionaires seeking to delude themselves that the best way to help the poor is to extract lots of money from them.” That is too true and although some people really are trying to help, others could care less the borrower might be beaten for a late payment. I want a more ethical and regulated investment.

I would have liked to help others this way. A friend’s church you would think trustworthy, but, they didn’t do their homework and a few greedy people got paid a bonus to be the spokesperson and get backing.

Thanks but until I know my money is put to good use, I’ll build wells and schools and sponsor kids with straight donations. In my view, the ends don’t always justify the means, even though there are many who have benefited in the past.

Yunus is right. The loan sharks and scammers are back, but with frontmen that look like Nemo. The typical business model for these times.

Posted by hsvkitty | Report as abusive

If your non-performing rate is “below 2%,” you’re not taking chances with your capital. Which is fine, but then your supporters shouldn’t be stupid enough to argue that millions (or even billions) of people are your potential customers.

A 2% default rate in what are supposed to be high-risk loans? I can find you plenty of High Investment Grade (AA or better) portfolios with that much expected risk, even ex-PIIGS and US.

Posted by klhoughton | Report as abusive

I agree with many insights raised in this article.

“Intermediary” – I 100% agree with your view about the importance of getting social investors to be the primary investors in for-profit MFIs, because otherwise, there is no way to ensure that client interests are upheld and that they are not taken advantage of.

I recently wrote a blog on this exact topic for Avana Microinsurance. Would love to get your thoughts on my post as well.

Posted by nnehru | Report as abusive

This post makes a number of verifiable assertions about microfinance. It would be nice if more of them were correct.
• You state that Grameen “doesn’t need to charge enormous interest rates to cover the credit risk on its loans”: microcredit interest rates generally aren’t high due to credit risk, they are high due to the high operating costs associated with small balance transactions. Operating costs are the main drivers of interest rates for MFIs. Removing all profits from all MFIs would still leave almost 2/3rd in Yunus’ ‘red zone’ of high spreads: http://www.themix.org/sites/default/file s/MIX%20Data%20Brief%204%20-%20Analyzing %20Microcredit%20Interest%20Rates.pdf
• You state that “there’s no reason to believe that Grameen is vastly more efficient than Compartamos”. While you may not believe it, it happens to be true: Operating expense ratios are close to 30% at Compartamos (http://www.mixmarket.org/node/3083/data  /100299/calculation_usd.operating_expen se_ratio) and below 10% at Grameen (http://www.mixmarket.org/node/3110/data  /100636/calculation_usd.operating_expen se_ratio). This is not uncommon – institutions in South Asia, especially large ones, are much more efficient than MFIs in the rest of the world. David Roodman notes some of the reasons for this in his post (population density, labor markets).
• Costs of funds are also typically lower in Bangladesh than Mexico, although Grameen’s are higher than Compartamos’ (http://www.mixmarket.org/mfi/benchmarks  ?mix_region__c=All&country__c=Mexico&cu rrent_legal_status__c=All). Central bank rates are not generally the best indicator for MFI costs of funds in any case.
• You state that ‘once an institution becomes huge’ it should be able to lower spreads: It may be the case that economies of scale should apply to huge institutions, but there are only a handful of institutions of this size worldwide: (http://www.mixmarket.org/mfi/indicators  /products_and_clients.total_borrowers/2 009?order=products_and_clients_total_bor rowers&sort=desc), which doesn’t span many of the dozens of countries in the developing world (and I’m not sure how this point jibes anyway with the notion that donors should provide ‘startup capital’ stated earlier).
• Yields at Compartamos have dropped by about 10 percent since their IPO: http://www.mixmarket.org/node/3083/data/ 100299/calculation_usd.yield_on_gross_po rtfolio_nominal. This isn’t the same as interest rates, but they collect less revenue from their clients than before the IPO.

Posted by sgaul | Report as abusive

Rather than lamenting the lack of philanthropic capital the hundreds of millions of poor need from Western investors, here are three steps those of us in the microfinance field concerned with poverty should consider focusing on instead:

1. Advocate for country legal frameworks around the world that enable institutions to mobilize poor people’s savings. This would: ensure only those institutions that are up to the task of safeguarding poor people’s money can; put poor people’s money in a safer place than under a mattress, as jewelry around a women’s neck, or in the form of cattle or other illiquid assets; put poor people’s money to work for them in ways that we take for granted; and, most importantly to the current debate, mobilize serious local money at lower cost than international borrowing to meet the serious unmet demand among the millions of entrepreneurially-inclined.

2. Support institutional forms like credit unions and cooperatives that make poor people themselves owners; reduce the cost of funds and, hence, the cost to borrow; and yield financial returns to the poor first and foremost rather than wealthy investors in Seattle, San Francisco or New York. An alternative might be to hardwire existing MFIs’ statutes in ways that ensure reduction in interest rates come before dividend payouts to investors when an institution produces a surplus. The weakness in this approach is that trustees/owners find ways to change the rules to meet their needs (I watched this happen first-hand at an MFI I founded, which now manages a $60 million portfolio and aspires to go public like Compartamos).

3. Support simple, low-cost informal microfinance models that equip the poor to intermediate their money on their terms in places banks and microfinance institutions have proven they cannot and will not go: very rural areas. Here I’m talking about savings groups—also known as village savings and loan groups, self-help groups, etc.—that quietly serve the basic needs of hundreds of millions of very poor people in very rural areas across Asia, Africa and (to a lesser extent) Latin America.

Even a cursory look at the evolution of microfinance over the past 35 years points to the inevitable weaknesses of microfinance institutions as tools for anything other than market development. Any serious look at microfinance as a facilitating mechanism for poverty-reduction has to account for the fact that the most visible manifestations of microfinance—non- and for-profit institutions that focus primarily on lending (liabilities) rather than savings (assets) to low-income and non-poor clients in peri-urban and urban areas—fails to address the priority needs of very poor people: a safe place to save, health care, clean water, knowledge and skills, etc. Microfinance may not meet all of these needs, but certainly we can aspire to more than money lending with a mission.

Posted by Seankline | Report as abusive

Professor Muhammad Yunus has recently come under criticism following a Norwegian documentary. He has tirelessly worked for the poor of Bangladesh and his micro-finance model has been replicated around the world.
A petition is being circulated that is asking the Government of Bangladesh to stop the politically motivated smear campaign against him. If you agree with the petition, please consider signing it and share with others. Thanks.

http://www.petitiononline.com/a110115z/p etition.html

Posted by justaman99 | Report as abusive

The huge profits made by MFI institutes in India and lead to crisis in India. And further has broken credit discipline.

http://devinder-sharma.blogspot.com/2010  /11/mfis-profiteering-from-poverty.html

Posted by yayaver | Report as abusive

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Posted by traduceri daneza romana | Report as abusive