Microfinance has lost its soul. Six fundamental shifts in the practice of microfinance have left it operating more like a for-profit bank and less like an innovative pro-poor movement.
I don't have much against banks; they mostly do good things for people who can access their services. But, if you happen to lack title to property, a credit history, or official identification, as many of the world's poor do, banks are little more than sets of closed doors. Until recently, the only options for accessing credit and savings services were informal networks and local moneylenders. That all changed with the invention of microfinance -- a pro-poor social innovation that has provided access to financial services to millions of people previously thought to be "unbankable."
Over the past three decades, a massive scale-up has taken place as NGOs, banks, foundations, and private investors launched MFIs in every corner of the globe. Even I got swept up in the excitement and led a 1999 launch of an MFI in Bolivia. At some point though, a good part of the movement got hooked on the hubristic notion that we had to provide credit to every person on earth, and in order to do this we'd have to access the formal capital markets, which it was assumed (falsely) are 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. Mission statements were revised to soothe investor apprehension. Healthy assets were prized over healthy borrowers. In short, microfinance lost its soul.
Here are six fundamental shifts in the practice of microfinance that accompanied us down this path.
1. Shift from targeting poorest of poor to the moderately poor.
There are two 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 don't have savings or other sources of credit to fall back on. 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 don't need or want large loans. To make any money, a lender either has to charge very high interest rates, or have very low per loan operating costs. Many lenders began sidestepping these issues by abandoning the very poor and lending instead to the moderately poor -- a safer and more profitable lot.
2. Shift from rural to urban.
Other lenders pushed down operating costs by focusing operations in cities. With a high population density, the time and cost required for a loan officer to service his caseload is reduced. Simultaneously, the nature of the loans shifts from agriculture to commerce, which keeps capital cycling quickly through the loan portfolio, generating more cash for the lender. But, the rural poor, who already had the least 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.
The relative anonymity and mobility of city dwellers made it difficult to form peer groups willing to co-sign each others' loans. MFIs also discovered that it was less time consuming to work with individual lenders than to manage the complexity of peer lending groups or community banks. This permitted a further increase in caseload, which is a critical driver of profitability.
I recently visited several nonprofit MFI's where loan officers' desks were wedged between refrigerators and stacks of radios and microwave ovens. The household appliances had been taken from the homes of the poor by these "pro-poor" nonprofits collecting their collateral on at-risk or defaulted loans. Made me want to smack somebody.
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 non-core expenses to investors 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 return on investment.) 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. 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 micro-insurance 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.
SKS Microfinance, one of the world's largest microfinance institutions (MFI) recently raised an estimated $350 million in a stock offering. The very successful IPO made its founder, Vikram Akula, an estimated $55 million. While he and other 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. After all, it is on the backs of the poor that these MFIs derive their profits. And more and more of them are being left out again, abandoned by the very social innovation that had brought them into the financial modern era. The aspects of microfinance that they most needed are being swapped for a model that best meets investor needs. MFIs market the poor as an opportunity for profit.
Perhaps its time for the old adage of social enterprise to be updated; "getting filthy rich by doing good" seems more fitting. But one has to wonder if the "doing good" part still holds.
For a longer version of this article, please see "Profits & Perverse Incentives: The New Face of Microfinance" posted at www.stayingfortea.org.
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