Archive for: commercialization

People who favor a commercial approach to microfinance and people who oppose interest rate caps have argued for years that competition would bring meaningful reductions in microcredit interest rates. Others have been skeptical about this prediction. A new study by Guillermo Baquero, Malika Hamadi, and Andreas Heinen seems to shed considerable light on this question. The study uses a comprehensive data set including not only MIX Market information but also data on 329 microlenders provided by three rating agencies, for a total of 1335 institutions.

The headline finding is that increased competition in a country is associated with substantial declines in interest rates. Interestingly, this effect is driven by for-profit lenders; the study found a much smaller correlation between competition and changes in non-profit rates.

In for-profit institutions, the size of the effect is surprising. The opposite of competition is market concentration, typically measured by the Herfindahl Hirschman Index (HHI). If a given country moves from the 90th percentile on the distribution of HHIs down to the 50th percentile (i.e., the industry is becoming less concentrated, more competitive) the associated drop in the interest rate is almost eight percentage points. This is about triple the rate decrease reported in studies of the regular commercial banking sector. Competition seems to work better in microfinance than in conventional finance. Of course, these are average results. They di not mean that interest rates will decline in every microcredit market that becomes more competitive.

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I have been working in the microfinance sector for about 15 years, with MFIs in institutional development and on the investor side, raising and placing a series of funds to invest equity in MFIs. I have also served on the boards and investment committees of MFIs and investment funds in various countries.  From these vantage points, I have been able to observe and participate in the struggles managers and funders face over the questions of maximizing impact, mission drift, balancing financial and social objectives, and appropriate rates of financial return:  in short, the promise and the risk of commercialization. Read the rest of this page »

I read Chuck Waterfield’s CGAP blog post and have been participating in many discussions lately about the plight of microfinance. As people talk about the way forward, I cannot help but notice what seems to me an obsessive focus on issues that really seem rather secondary – issues such as standard setting, defining responsible microfinance, transparency, certifications, and so on.  We need to focus on the real underlying issue and I am coming to think that it is commercialization that is the problem. Read the rest of this page »

Time for the hard questions
Microfinance is at a critical juncture, and as we reflect on how we got here, I suggest that we challenge ourselves to ask:  What makes us different from what was previously done through the ages, since coins were first established as a medium of exchange? And how do we maintain what’s different and avoid slipping into the well-worn paths that emerge when we examine the history of usury?

Making loans to the poor has always been a commercial activity, but one that was generally shunned by the broader society. It was an activity of usurers, and one did not fraternize with usurers. Today, it is an activity of pawnshops and payday lenders, and they don’t get awarded Nobel Prizes.

Should we as a field transition into more commercial approaches to lending?  If so, how do we avoid becoming indistinguishable from modern day usurers? Read the rest of this page »

The issue of individual over-indebtedness has been around for a long time in microfinance, but the depth and extent of over-indebtedness that has recently emerged in Andhra Pradesh is quite unprecedented. Something is clearly rotten in the state of microfinance.

It is vital that we recognise right away – however painful this will be for some – that over-indebtedness is the almost inevitable outgrowth of the international development community’s preferred model of microfinance; the commercialised model. Even before the sub-prime-driven global financial crisis, financial history showed the potential for huge damage if opportunistic individuals are allowed (thanks to extensive deregulation) and encouraged (thanks to free market ideology) to effectively take control of the financial institution that employs them. Senior managers begin to act like private entrepreneurs and impose upon their institution a new operative goal — their own private enrichment. The long-term benefits that might accrue to the shareholders/owners and/or to other important stakeholders (clients, employees, suppliers, and the community) are effectively abandoned as the primary strategic goals.

This negative ‘institutional capture’ phenomenon is exactly – and quite predictably – what is behind the over-indebtedness crisis that has befallen microfinance.  As microfinance was increasingly commercialised from the mid-1990s onwards, ‘best practice’ for an MFI was simply to pump out as much microcredit as possible, in order to grow fast, grab market share, hike up profits, and so grow even faster.

It was simply assumed that what a country, region, or locality needed and wanted was always ‘more microfinance.’ Carefully hidden behind this focus upon extending outreach, however, was the awkward fact that a MFI’s senior managers were quietly turning these institutional gains into private gains taken out in the form of spectacular salaries, bonuses, dividends and, eventually, the windfall profits arising from an IPO.

Under such circumstances, raising the possibility of client over-indebtedness and the damage it might cause to the poor, was deemed completely off-message. Such loose talk would undermine the central justification for the rapid growth of an MFI, which was in turn the central pillar upon which private enrichment was made possible.

But as many observers began to appreciate from the Bolivian microfinance crisis of 1999-2000 onwards, and now fully accept as a result of events in Andhra Pradesh, ‘more microfinance’ and over-indebtedness are actually fundamental problems in poor communities and have been deeply damaging to the poor.

By the same token, over-indebtedness is not generally related to insufficient information about clients, which is why support for the public or private credit bureau model is often so wide of the mark. Consider the situation in Bosnia. The main MFIs, as well as most members of the public, knew as early as 2005-2006 that the microfinance sector was heading in the direction of massive client over-indebtedness. But the MFIs individually and collectively appeared to be able to do nothing to halt their own expansion plans. Present in Bosnia since at least the early 2000s, private credit bureaux were completely ignored, as was a public credit bureau established quite recently.

From first hand experience, I learnt that the desire to grow fast and build market share was paramount. No matter how deep potential clients were already in debt, the pressure was on to obtain as many new clients as possible, and also to get existing clients to top-up their microloan.

It greatly helped here that the risk of default was initially seen as minimal (the Bosnian economy was growing and remittance income flows were massive) and anyway default costs were pretty much factored into the high interest rates charged. There was also the hugely important ‘two guarantor’ system, which meant that friends and family of the client could be chastised to get a potential defaulter to repay, and then – as happened from late 2009 onwards to around 100, 000 of them- chased up themselves to repay a microloan they had guaranteed and which had gone all the way through to default. So, as I heard on many occasions as both an academic researcher and consultant, why pay for data on indebted clients if in general you had no problem whatsoever in working with them?

Moreover, if one MFI refused to work with these indebted individuals, it was unlikely that its competitors were all going to be equally as cautious (or ethical). And those MFIs that willingly accepted clients already in possession of one or more microloans, no matter the risk, would quickly outgrow the competitors: that what was counted. Crucially, that MFIs senior managers would be in a better position to individually profit when their now larger MFI was sold off to a western European bank or investment fund, as was every Bosnian MFI’s plan pretty much right from the start.

The inevitable result of this unrestrained competition, however, was the ‘microcredit meltdown’ that exploded in late 2009. Some of Bosnia’s MFIs will no doubt recover, and most financial analysts expect that the senior managers’ private enrichment goals will eventually be turned into reality once the law is changed. But with no evidence whatsoever to confirm that Bosnia’s poor actually benefitted from expensive microfinance in the run up to 2009’s meltdown, it’s pretty much been all pain and no gain for them.

One of the most worrying aspects of the over-indebtedness problem today is the way that even non-profit MFIs have tried to ensure their own financial sustainability by wilfully assisting poor individuals into over-indebtedness. Haiti is the obvious example here. Far too many poor individuals were all too easily convinced into believing that if they keep on trying they will eventually hit upon a microbusiness idea that can be a success, an outcome that would then clear all their accumulated debts and allow them to return to something like a normal life.

But hope is all too often an unsatisfactory substitute for the lack of basic business opportunities in post-earthquake Haiti. Most of the poor accessing a microcredit have used it to buy simple household goods to sell to others equally poor. This is not a real solution to poverty anywhere.

Those in Haiti simply tapping into a microcredit to purchase desperately needed consumption goods have done so in the hope that some other business opportunity, or cash windfall, would come along in the meantime that would help them repay their steadily mounting debts. This way of engaging with microfinance in Haiti is culturally not that different to playing the ‘Borlette’, the traditional numbers game that very many poor Haitians hope and dream will one day help them escape their poverty, but which in reality actually soaks up much of their already tiny incomes. Sadly in Haiti, as even the main MFIs working in Haiti now concede, notably Fonkoze, as have development organisations like Oxfam, that most of the hopes and dreams built up around microfinance have amounted to nothing more than a destructive wave of individual over-indebtedness.

The over-indebtedness crisis that is bringing down the microfinance industry is not some plague that arrived from space. Nor is it a result of government intervention, as some market fundamentalists contend. It is a phenomenon that is quite intrinsic to the preferred commercialised microfinance model. Until we first accept this unpalatable fact, most of the solutions proffered so far are simply papering over ever-widening cracks.

–Milford Bateman

The views reflected in this post are those of the author, and not of CGAP.

Milford Bateman is currently a Research Fellow in the Private Sector and Markets (PSM) Group at the Overseas Development Institute (ODI) and also Visiting Professor of Economics at the University of Juraj Dobrila Pula, Croatia.

This post is the next in the blog series on over-indebtedness. In the coming weeks we’ll be featuring a variety of voices from across the globe on this topic. We welcome your participation in this discussion through comments.

In the month of October, this blog ran a series of posts on the SKS IPO. It was meant to spur discussion and present a variety of voices on the issue. It did, thanks to the authors (Rasmussen, Harper, Sen Sarma, Waterfield, Crawford, and Danel) as well as the lively comments by readers.

From the rich conversation that was generated, here are the main issues that emerged and some of the many highlights from authors as well as readers.

There has been an explosive growth in microfinance institutions in the last decade, with many of them transforming themselves from nonprofit to for-profit financial institutions. While this trend is viewed by many as facilitating a sustainable business model that can provide financial services to more poor at lower costs, it has also invited criticism from pioneers of this field such as Mohammed Yunus who argues that the term “microfinance” should not be used for commercial MFIs.

In the series’ kick-off piece, Stephen Rasmussen asked six questions to SKS about how this IPO would benefit the poor:

“Will clients be better served by an expanding the range of services, higher quality services, and more affordable services? Will the clients retain a strong voice in the affairs of the company to help it sustain a direction that serves their interests first and best? Will shareholders understand that doing what is best for the customer is fundamental to sustaining long term shareholder value?”

Malcolm Harper’s provocative piece argued that SKS should be treated like any other commercial enterprise that is part of a global capital market, like Wal-Mart:

“Is SKS any different from Wal-Mart? And does it matter if it isn’t? Because when the promoters of SKS make millions out of a business whose original objective was to serve the poor, that’s capitalism. Cooperative banks, which don’t make a lot of money for any one individual but do provide safe and accessible savings products to poor people. In spite of some notable exceptions, however, that’s not the dominant paradigm. It’s more profitable to keep people in debt than it is to help them save.”

In his view, an MFI should be judged on the basis of whether it can keep a customer, “MFIs certainly do that, and if we don’t like it we should maybe go back to Marx rather than nit-picking over the details,” he concluded.

Since the SKS IPO was floated, there has been much speculation in the media and by experts around the globe about whether this trend of commercialization and tapping capital markets will lead to a drift away from the original promise of microfinance – helping the poor.

Moumita Sen Sarma’s post pointed out that the current policy context in India makes it even more imperative that microfinance’s impact rather than profit is the priority:

“With an already nervous RBI (Reserve Bank of India) and Ministry of Finance wary of the path being charted out by the Indian MFIs and now SEBI (Securities and Exchange Board of India), the market regulator asking SKS unpleasant questions, it’s perhaps a time to pause and introspect. In the end, shouldn’t the true measure of an MFI’s success be when people on the street instead of asking in surprise ‘So is microfinance really that profitable?’ as they did in the wake of SKS IPO, ask rather ‘Is microfinance really that impactful?’ We need to shift our focus away from the means and on to the end.”

Among the many comments concerning mission drift, here is one:

“Will SKS diversify their portfolio suited to the clients’ needs in a manner to generate an equally balanced income from both interest based source ( micro credit ) and non interest based source like fees & commission (micro insurance) for sustaining financial impact and social impact as well?” –V.Rengarajan

The only other “pure” MFI to go public in the world was Compartamos in 2007. Carlos Danel’s piece argued that Compartamos had not drifted and that “if you do an IPO, you’re not inevitably doomed to drift.” As evidence, he provided some data on the MFI’s growth and productivity post-IPO:

“In the past 42 months, Compartamos has grown from serving 614,000 clients to serving 1.75 million, a 191% increase in outreach. Of those, 98% are (still) women and loan size has increased marginally 0.002% (in pesos), currently at 391 USD per borrower.  Our internal culture has been sustained, if not improved, from being named the fifth best company to work for in Mexico in 2007, to number 1 in 2010. Transparency is now not only a voluntary trait, it’s a regulatory requirement.  Efficiency is 17% better with a cost per client of 125 USD, still well below the average of  176 USD for Latin-American MFIs, and pricing has continued to drop steadily, as it did before the IPO, to 68% average APR (plus VAT).”

Chuck Waterfield’s post analyzed whether the IPOs signal the coming of age of microfinance markets. Asking an essential question, “How much profit is too much profit?”  He compared the two IPOs by SKS and Compartamos, asking:

“Why should we make significantly higher profits loaning to the very poor than commercial banks make from the middle-class and wealthy?  The Compartamos IPO resulted in a 300-to-1 return on initial investment to the original investors.  The SKS IPO resulted in what looks like a 12-to-1 return to the original equity investors.  IPO returns were much lower for SKS, but the SKS returns are still higher than the commercial business world, and the public still wonders if we have any limits.”

On the other hand, Gil Crawford argued that “good business is good development” and that commercial microfinance leads to better governed institutions. In his view, the most sustainable way to attract capital is through commercial markets. He cautioned against capping interest rates as that might be counterproductive:

“It has been suggested that limiting the profits of MFIs is a way to prevent exploitative profiting off the poor.  The only realistic way that we can see to limiting profits is to cap interest rates.  This has been counterproductive, most recently in Nicaragua and Venezuela. I believe that any implementation of interest rate caps will perversely and significantly hurt the working poor.  MFIs will be forced to focus on a very specific, targeted market that is cheap to serve and reliable in repayments.  Incentives for innovation will be destroyed, as will the desire to offer small loans to the poorest of the poor or to expand to rural areas that are more expensive to service. At the end of the day I fear that we would see MFIs begin to mirror the worst attributes of large utilities: minimal competition, low levels of efficiency and a lack of product innovation.”

The issue of governance was a concern for many readers. For example:

“How appropriate is it for a financial services institution like SKSML – especially, one that is meant to service poor clients – that had significant public money (SIDBI’s investments) and client money (MBTs), to lend (interest free) to its own founder director to buy shares in the same company? Is this a good practice of Corporate Governance? Should this be allowed in MFIs?” –Ramesh Arunachalam

In the recent weeks, as the events in Andhra Pradesh have rapidly unfolded, the questions and issues raised in this series resonate loudly. We thank you for your participation and invite you to our next series on the Andhra Pradesh crisis starting today.

The series will feature many experts deeply familiar with the Indian context, starting with Justin Oliver’s post with fresh data from a new study by IFMR on rural households and their access to finance in Andhra Pradesh.

You can access the whole series on SKS here and continue to leave your comments.

This is the first time that I have knowingly contributed to a ‘blog’; hence I am not familiar with medium’s etiquette.  Am I to oppose, to concur, or to add? I’ll try to do all three.

Steve Rasmussen poses a number of important questions; they are mostly about the future, and about clients, which is surely where our focus should be.

I shall not comment on the rights or wrongs, legal or ethical, of the ways in which the shareholdings of the SKS clients’ Mutual Benefit Trusts were handled; Professor Sriram has already covered that issue, very well.

I shall start by making some general assertions which I believe to be true, or perhaps at least to be provoking, which may be more useful than being true.

First, the impact of microfinance, for good or for ill, is exaggerated.  It is no more than second-rate retail banking for people who cannot afford the relatively decent services which all the readers of this ‘blog’ enjoy. Our banks serve us, more or less effectively, but they are much less important to us than our schools, our health care, our employment, our security, our communications… Let’s not fall into the trap of believing that microfinance, or the institutions which provide it, or still less the parasites which surround it, academics, commentators, consultants, researchers and so on, are so very important.

Second, the number of people who are still un-served by microfinance is also exaggerated. The figure of 150 million people omits the sixty odd million members of self-help groups in India, whose groups are served by commercial banks, the millions who have individual accounts with banks of all kinds, particularly cooperatives and credit unions, and the many more who are rather well-served by informal but often very sophisticated traditional institutions.

And every human being does not need financial services. Most households do, and there are not three billion un-banked households.

Third, the commercialisation of microfinance is a ‘done deal.’  To misuse a sentence from Abraham Lincoln, “the world will little note nor long remember what we say here.” When BASIX was started in Hyderabad our mission said we hoped to “access mainstream capital.” Now microfinance is a mainstream business, it’s been “Wal-Martised,” whether we like it or not, Compartamos and now SKS have shown the way, and soon many more will follow. The clock cannot be put back.

So, let’s look at microfinance, and SKS, through the same lens as we look at any other business. We don’t expect Wal-Mart or their peers not to rip off the poor because they want to help them. We hope that antitrust laws, other regulations, public opinion, and above all competition will stop them. Generally, albeit imperfectly, it works.

Mr. Sam Walton and his family have made vast sums of money by successfully satisfying the needs of millions of people, particularly not-so-wealthy people, and we don’t seem to grudge them their riches. If a donor had subsidised Wal-Mart’s entry into some apparently unattractive market; rather as DFID so cleverly subsidised Vodaphone’s MPESA in East Africa, and Wal-Mart had done very well out of it, as MPESA apparently has, would we complain? I think we would congratulate the donor for effective promotion of ‘market access for the poor.’

So although many people (and I include myself), find it distasteful, or may even think it stinks (are we perhaps secretly a little jealous?), when the promoters of SKS make millions out of a business whose original objective was to serve the poor, that’s capitalism.

We may prefer co-operative banks, which don’t make a lot of money for any one individual but do provide safe and accessible savings products to poor people. In spite of some notable exceptions, however, that’s not the dominant paradigm.

It’s more profitable to keep people in debt than it is to help them save.

As Peter Drucker wrote, “the purpose of business is to create and keep a customer,” MFIs certainly do that, and if we don’t like it we should maybe go back to Marx rather than nit-picking over the details.

— Malcolm Harper

Watch this space for a new post every week on the SKS IPO. Next week we feature Moumita Sen Sarma.

This post is the second in a special blog series on the SKS IPO. Over the coming weeks we’ll be featuring a variety of voices on the issues raised by the IPO. We welcome your participation in this discussion through comments.

The World Microfinance Forum in Geneva just put on a conference, and I might say, a quite successful one: over 300 investors and others paid their money to attend, and the presentations were well received. I was asked to moderate a debate between Prof. Yunus and Michael Chu. Michael, for those who don’t know him, was a big-wig investment banker who then spent a few years on microfinance as President of ACCION. He’s now teaching at Harvard Business School, and has stayed close to our field since he stepped down from running ACCION. The debaters argued about whether commercialization (let’s define it as the entry of investors whose primary motive is financial rather than social) is good for microfinance. Yunus thinks that it’s immoral to make money off the poor, and that the only kinds of investors needed in microfinance are ones who are willing to accept very limited profits for the sake of keeping as much money as possible in the pockets of the borrowers. Michael thinks that we can’t meet the worldwide demand for poor people’s financial services unless we can draw in private, profit-oriented capital, and that eventual competition can be counted on to bring interest rates and profits down to consumer-friendly levels in most markets.

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We’re launching this blog as a way for CGAP’s microfinance specialists to talk about research they are working on and to share interesting observations about issues around access to finance that they come across from their study, mission and advisory work. We hope that you’ll enjoy the opportunity to engage in the conversation, and share your own observations by providing your comments and responses to relevant posts.

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