Hyderabadass

Microfinance Under a Microscope

Almost two years ago I wrote a post about microfinance – “Microfinance 2.0”.  I had just heard about Kiva.org and was fascinated with the power of online communities and social media, and on a personal level, I was looking for ways that my driver, Satyam, could finance his business idea.  While living in Hyderabad I became friends with a few people that worked for SKS Microfinance, and was involved in a few discussions about moral concerns people had with the popularity of microfinance in the commercial world.  There were rumors that part of the reason that default rates were so low was because ‘collection agencies’ hired by banks practiced mafia-like tactics for obtaining repayment of the loans.  I have no idea if this is true or not, but it was part of my early perceptions of this system, and thus I have always had a concern for the social benefits through this form of lending to the poor.

While microfinance lending was envisioned to help the poor gain access to capital to start their own enterprises, it has become evident that it is far more complex in today’s world.  With several strong examples of social ventures that give micro-finance loans, it is easy to generalize this practice as being social entrepreneurship.  However, loans can be given out in several ways through socially responsible investment funds, non-profits, and commercial institutions that operate strictly for profit.  Just like I had doubts two years ago, today I am even more concerned about the future of this model with non-profits becoming more commercial.  I support social ventures that make a profit because using innovation and business strategies help the ventures stay self-sufficient.  However with micro-finance, I am concerned that the entire system might be damaged if the industry becomes too capitalistic.  Profit incentives may consequently punish the people microfinance was originally designed to help: the poor.

There are two ‘pure’ microfinance lenders that have made public offerings to raise capital, Compartamos and SKS Microfinance.  Several Indian companies involved with microfinance are expected to follow soon based on the success of SKS’s IPO last month (generating $358 million)   In a study done on Compartamos’ IPO in Mexico in 2007, no significant negative consequences to the poor were found from the IPO:

• The grants supporting Compartamos operations went to not-for-profit non-government organizations (NGOs) and not into private pockets.
• Compartamos “overcharged” existing clients for the sake of outreach to potential future clients.
• Profits made by the NGO remained at the service of poor Mexicans.
• The tension between commercial and social objectives did not begin with the IPO, but with commercialization in 2000.

However I’m still skeptical.  With new incentives that are introduced for the business to maximize profits, how long can they afford to keep serving the poor as a priority?  The founders of Compartamos became instant millionaires and were accused of profiting off the poor.  This surely has given existing and future competitors a window of opportunity to follow and try to claim their piece of the pie. When the microfinance lender suddenly becomes an attractive stock to put in your investment portfolio, regardless of your desire to help the poor, where do the profits of that that transaction go?  Essentially, people will be making a profit of the poor even if Compartamos keeps their profits within the poor communities.   Competition in this industry will make lending even more competitive, changing the incentives for the firms.  It is yet to be determined if this level of competition will raise or lower interest rates for the poor.  More lenders might lead to lower interest rates, however lenders with new objectives tied to stock performance may actually raise interest rates.

It appears that in India, banks are regulated to give 40% of their funds to priority sectors.  This allows micro-finance lenders to borrow at around 10% interest, while they charge 30% interest to the poor.  This is still about 10% cheaper than other forms of lending available to people in these areas.  SKS has  given loans of $3.2 billion to to almost 7 million people (as of March 2010).  They have less than a 1% default rate.  Some analysts suspect that this will go up, and may create a “subprime crisis”.  While SKS started as a non-profit organization, it became a for-profit venture  when founder Vikram Akula came back to run it in 2003 raised $75 million in private equity before the $358 million IPO this summer.  The non-profit organization (Unitus) that helped start SKS has recently shut down, which one writer suggests is an live example of ‘seeing what the endgame for social entrepreneurship can look like.’

Today the nobel-prize winning Muhammad Yunus is criticizing SKS Micro-finance from profiting off the poor.  He initially trained Vikram Akula at the Grameen Bank, but Vikram  wanted to tweak the model, introducing strategies borrowed from Mcdonald’s and Starbucks to drive growth.  Vikram’s vision to have the venture free from government grants and charitable donations is a shared goal of at least 20 social entrepreneurs that I have spoken with at length.  Social entrepreneurship walks a fine line sometimes between capitalism and altruism, and the debate whether they can coexist is ongoing.  With early indications that we might soon be seeing micro-finance lending becoming popular at home in the US, I think this is an area worth thinking about more.  NPR did a great story on the Latin Economic Development Corporation giving micro-loans to a small business owner unable to get financing after the economic crisis.

While there are several forms of microfinance loans, and very successful organizations that operate from commercial capital, social networking, or generous grants, this field is about to change significantly in the next few years.  My hope is that with change come progress, and the people within the industry can find ways to self regulate the forms of corruption that may emerge.