Microfinance has to strike a balance between helping the poor and being a business that aims to make sky-high returns
The microfinance industry has been under siege recently. Earlier this year, Muhammad Yunus, founder of Grameen Bank in Bangladesh and recipient of the Noble Peace Prize in 2006, was ejected from the bank’s leadership as part of what has been portrayed as a long-standing feud with the country’s prime minister Sheikh Hasina Wajed.
A Norwegian documentary accused Grameen, the prototype for other micro lenders, of alleged business irregularities during the 1990s, specifically of shifting funds provided by a Norwegian aid agency from one legal entity to another for tax purposes.
More generally the industry has been criticised for usurious lending, encouraging over-indebtedness through multi-loans and driving farmers in the Indian state of Andhra Pradesh to suicide.
So it is not surprising that politicians in India and Bangladesh, where microfinance institutions (MFIs) have around 60 million clients, have made moves towards tighter regulation.
In Bangladesh, the government has already capped the annual interest rate MFIs can charge at 27%, while similar moves are planned in India where “for-profit” MFIs have proliferated.
Against this uncertain background, three leading microfinance professionals discussed the outlook for the industry at the 14th annual Credit Suisse Asian Investment Conference in Hong Kong last week. There was some soul-searching and reflection about the current state of the industry, but also optimism about its prospects.
“MFIs can maintain their business models of generating both social and financial returns without sacrificing either,” said Roy Jacobowitz, managing director for external affairs at Accion International.
They are hybrids, earning a complex mix of both. And in practice, they include a wide range of lenders – specialist MFIs, niche banks, development banks, regional and international banks and non-profit organisations.
“Microfinance is a big tent,” agreed Jennifer Meehan, Asia chief executive officer of Grameen Foundation (which is also a charity that FinanceAsia supports). Models with disparate emphases between social and financial objectives have mushroomed since about 2005, and there is room for most of them. "Microfinance is a tool that enables people to transform their lives," she added. ,",
And when it’s done properly, microfinance works. “Clients repay, household business income increases, and small businesses grow."
But, one size or shape doesn’t fit all. There are vast country and regional differences. The most mature MFI market is in Latin America where many countries have well-developed capital markets which means that MFIs, with assets now amounting to around $9 billion, can attract equity investment through IPOs, pointed out Jacobowitz.
“Cultural context is very important,” said Aaron White, chief executive officer of Opportunity International (OI), China – a Christian organisation.
In China, it’s not just about lending money; training and improving skills is essential.
OI, a Christian organisation, customises lending, for example by deferring capital repayments to farmers’ planting and harvesting cycles. Also, consistent with its social role, it will allow payment holidays and provide new loans during natural disasters such as floods.
And it is effective. OI claims to have helped create nearly 21,000 new jobs in local communities since it opened for business in China in 2003.
The Chinese authorities are supportive. OI currently has a catchment of 700,000 people within its licensed area, but that could increase to a staggering 34 million people.
“We’re scaling up very quickly,” said White.
But, Accion International's Jacobowitz argued that microfinance must look beyond simply providing small amounts of working capital, and offer a broad range of financial services, such as savings, insurance, annuities and a payments system.
New players are entering the business too. Wal-mart offers microfinance services in Mexico, for instance, and Vodafone provides rudimentary banking services via mobile phones in Africa.
“These new entrants represent the future,” Jacobowitz said.
Meehan agreed that the industry needs to expand in scale and adapt to technological changes, for instance how services are delivered.
However, although there is potential to increase the variety of financial products and for innovation, it is important not to lose sight of the main objective of spinning a safety net for the poor and helping them get businesses going in the first place.
“Poverty reduction is the main purpose of microfinance,” she said.
On the issue of regulation, all three panellists agreed that external controls and supervision was necessary, but shouldn’t be so intrusive as to inhibit lending.
A rigorous, but “appropriate”, regulatory regime is essential not least to attract investors. Interest rate caps or loan size restrictions are unhelpful, and limit growth. On the other hand, “self-regulation is insufficient”, said Jacobowitz.
Meehan insisted that any regulatory regime must put the interests of customers first.
There’s been a focus on over-indebtedness, but that shouldn’t obscure the fact that most people in poor countries lack access to finance.
OI manages to prevent over-indebtedness by restricting people to one loan at a time, according to White. It also relies on loyal customers who act as “knowledge-partners” in addition to its Rural Service Centres to assess credit risk.
The challenge is to manage credit risk without the aid of credit bureaus. Information sharing among MFIs is prioritised over competition between them, in Latin America, noted Jacobowitz.
But, the biggest risk is politics. It is necessary to broaden the mitigation strategy to cope with indebtedness and political interference, said Meehan.
According to Jacobowitz, lessons can be learned from the experience in Latin America in the 1990s. Here, politicians and regulators worked closely with MFIs, militating against political or populist backlashes. Strong governance structures were installed from the beginning, with active investors on MFI boards, and transparent operations.
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