In last week’s column, we questioned whether Microfinance has shifted away from its initial mission of targeting the poorest of the poor as it becomes more and more institutionalized and commercialized over time. I pointed out how Microfinance in developing countries has followed three key trends: 1.) a shift in lending methods: from group to individual lending; 2.) a change in the purpose of loans, broadening of product offerings, and the use of new technologies; and, 3.) the diversification of funding sources and changes in organization type. Today, we delve further into what exactly these three trends imply.
These three trends are indications of the dominance of what academics call the institutionalist perspective, or when social structures and norms start to dominate behavior, often to the point wherein the original objective is lost. In this case, market-driven forces shift the Microfinance model into a commercialized institution. The change from group to individual lending is easiest to explain from a financial sustainability viewpoint: group lending is simply more costly and cumbersome than individual lending which may not be compensated by the financial profit. Group lending entails higher frequency of repayment periods, longer loan approval times, and smaller loan sizes than individual lending. Additionally, group formation costs, training, and supervision of clients all result in high operating expenses.
Taking the amount of each loan granted (that is: higher for individual lending compared to group lending) as a proxy for the poverty level of customers, this shift indicates that Microfinance Institutions (MFIs) increasingly target less poor households. Similarly, some research suggests that younger MFIs begin with group-lending and move toward individual-lending when they grow, illustrating that moving towards individual lending may have less impact on outreach and evidences a change in the MFIs’ philosophical orientation towards a prioritization of financial sustainability over a social mission.
Nevertheless, the change in purpose of the loan, the broadening of product offerings, and the use of new technologies all signal key positive developments, from both a financial and social point of view. MFIs realized that in order to become entrepreneurs, the poor must first use their financial access to fulfil basic needs while learning financial discipline. Over the years, MFIs have developed several types of products extending to micro-insurance and micro-savings and improved them by removing upper ceilings and setting reasonable interest rates. Some studies on micro-savings have shown that doing this allows for client loyalty, facilitates the credit screening process, and increases the capital of the MFI. MFIs are also able to address the issues of health, a key concern which was absent from the original objective of the Microloan. In this way, Microfinance has become not only a micro-entrepreneurship tool but rather a means for reducing vulnerability.
What is most problematic, however, is the third trend: the diversification of funding sources and the consequent change in strategies and policies. While doing so may make the firm more efficient, distributing dividends to shareholders and being controlled by capital markets is where heavy debates come in. It is no longer a question of changing business models to address firm survival but rather a change in identity and mission. The Mexican Compartamos story is the notorious case study about mission drift. Founded as an NGO in 1990, it became a regulated financial institution in 1998 before issuing public debt in 2002 and going public in 2007, transforming itself into a commercial bank. The IPO was a success, with the issue being over-subscribed 13 times. However, this IPO was highly controversial. The backlash held accusations that poor people were paying for rich investor returns. Apart from the exorbitant interest rates, both public and private funds initially received by the NGO Compartamos were reinvested in the for-profit entity, raising the question of the acceptable level of profit for MFIs.
According to some scholars, the use of subsidies is associated with better social performance and a deeper outreach. Further, other research evidence that subsidized MFIs do not always charge lower interest rates, but rather enjoy higher gross margins and that most performance indicators such as portfolio quality are unchanged between subsidized and non-subsidized institutions. This implies that there is no real reason for MFI institutions who have access to cheap credit, subsidies, and donations to have to go to the stock market for expansion as their performance indicators show that they can grow organically.
The recent evolution of microfinance in the developing world indicates a host of possible problems that need to be addressed with a shift in client focus towards the less poor (but more profitable) clients and correspondingly the exclusion of those who need it the most. Further, because regulation remains weak in many places, the borderline between setting interest rates to appropriately reflect high risk and taking advantage of the vulnerability of the poor is increasingly blurred.
Microfinance faces an identity crisis. It appears that the social mission approach in the developing world has lost in favor of commercialization, yet it seems to have become a successful industry in terms of financial stability and business sustainability. Is it possible, then, to truly have Microfinance in a win-win situation?
Notes: This article is based on a co-authored working paper originating from the Master Thesis of Hélène Laherre under the supervision of the author at the IÉSEG School of Management (Catholic University of Lille) in Paris, France. References are available upon request.
Daniela “Danie” Luz Laurel is a business journalist and anchor-producer of BusinessWorld Live on One News, formerly Bloomberg TV Philippines. Prior to this, she was a permanent professor of Finance at IESEG School of Management in Paris and maintains teaching affiliations at IESEG and the Ateneo School of Government. She has also worked as an investment banker in The Netherlands. Ms. Laurel holds a Ph.D. in Management Engineering with concentrations in Finance and Accounting from the Politecnico di Milano in Italy and an MBA from the Universidad Carlos III de Madrid.