Microfinance has been featured extensively in the media recently – even making it on to an episode of The Simpsons, where a cartoon version of Muhammad Yunus, founder of Grameen Bank, provides financial advice to Lisa. The real live version of Mr. Yunus also made headlines in an exchange at the Clinton Global Initiative with Vikram Akula, CEO of SKS, an Indian microfinance bank that raised over $350 million through an initial public offering (IPO) this past July. The IPO fueled a debate within the microfinance community on governance structures, and whether microfinance organizations should pursue profit and/or be publicly traded.
Despite the ideological debate over the profit motive, it is my view that success will be determined by who borrowers choose to do business with, and how an organization chooses to balance their social mission with the profit motive.
In order to examine the profit motive in microfinance, let’s take a closer look at two of the key participants in our potential microfinance transaction: Borrowers and Microfinance Institutions (MFIs).
The borrowers I have met here in Tajikistan each made a conscious choice to enter into a loan agreement with their Microfinance Institution. Given available options, they determined that their best economic opportunity was to take out a loan for their business; agreeing to pay the principal and interest as defined in the contract. In deciding which MFI to borrow from, my impression was they were less concerned with the governance structure of the organization or its stated social mission, and more concerned with finding a loan with a low interest rate, from an MFI who provided good customer service and convenient banking options. The transactions illustrated the economist Milton Friedman’s central principle of free markets that “no exchange takes place unless both parties benefit.”
From the lending perspective, let’s take a look at the MFI I’ve been working at for the last 3 months, Humo and Partners. Humo was started through funds from an international aid organization in 2004. The grant allowed them to focus on lending to very poor clients in war torn areas of the country, at rates that were below the commercial cost of funds. However, without the guarantee of future donations, it became clear that in order for Humo to survive and continue serving their target market, they would need to become financially self-sufficient, requiring a raise in interest rates. Since they are an organization legally prevented from taking deposits, their primary source of funding is international creditors such as Oikocredit, Blue Orchard, and Kiva. Right now Humo prefers this debt financing because it is comparatively cheaper than what they would expect to pay on dividends from equity, and they are free to control the strategic direction of the organization without having to answer to shareholders who could demand profits. However, they conceded that in order to continue expanding, they would eventually need to attract equity investors.
So as a for-profit organization, what is to prevent Humo from excessively profiting off of the poor? In my time at the MFI, I have observed two compelling reasons: 1) a well-defined social mission, and 2) (socially responsible) self interest.
First, Humo has a social mission that drives them to target rural areas, serving a population that often would not otherwise have access to financial services, and meeting the seasonal borrowing needs of farmers who are often excluded from conventional loans. A crucial element to ensuring loans are mutually beneficial is that both sides are fully aware of the terms of the agreement. To help encourage informed decisions, Humo has client protection principles and a code of ethics that ensure cost transparency to clients and incentivize staff to avoid irresponsible lending. This year Kiva began an initiative to understand and encourage the social performance of its Field Partners (two informative blogs on the topic were written by Kiva Fellows, Betsy McCormick and James Allman-Gulino).
Second, as the MFI goes about its operations, market forces have also driven them to socially responsible outcomes. Acting in the interest of the organization resulted in benefits to clients. For example, during the recent economic crisis, Humo was struggling with client over-indebtedness, as many clients had taken out loans from multiple organizations. The delinquency on repayments was jeopardizing the financial health of the organization. As a result of this challenge, Humo initiated a credit exchange with other MFIs and banks to compare client lists. If a client has an open loan at one organization, other organizations will refuse to issue additional loans. A second example is the lowering of interest rates based on competition. As the economy is emerging from the financial crisis, some MFIs have begun to decrease their interest rates. The competition among MFIs provides a constant pressure to improve efficiencies, and lower rates.
Enabling the choice
Based on my observation there is no one operating model that will fit each unique local situation and regulatory environment. I believe actors within the industry should be free to evolve, selecting the governance structures and operating models that best meet their needs; including the option to tap into greater investment capital as a publicly traded company. Fueled by competition, organizations that provide high-quality financial services to clients, at an attractive price will be rewarded with sustainable business – and in doing so will contribute to people’s access to financial services and economic development. For my own personal investments, I would like to support organizations that find ways to share profits with the poor – I believe Kiva’s initiative to analyze the social performance of its Field Partners will help identify and promote these organizations. But I also believe that the increased potential for capital and transparency resulting from MFIs being publicly-traded can expand the reach of the industry. As the economist Adam Smith said, “it is not by augmenting the capital of the country, but by rendering a greater part of that capital active and productive than would otherwise be so, that the most judicious operations of banking can increase the industry of the country.”
Having shared my thoughts on the profit motive in microfinance, I’d be very interested to hear yours. What do you think?
Donald Hart is a Kiva Fellow in Tajikistan