“Has the microfinance market come of age?” The question, posed last October by the Washington-based Consultative Group to Assist the Poor (CGAP), was seemingly designed to elicit only one answer: a resounding “Yes”.
And for good reason: an industry that barely existed before the 1990s was coming off a banner year, culminating in the $350 million Mumbai initial public offering (IPO) of India’s SKS Microfinance. All of a sudden, microfinance institutions (MFIs) were in vogue.
Capital was flooding in from private lenders, state institutions and donor agencies, including the Bill & Melinda Gates Foundation. Moreover, microfinance was no longer a peripheral industry. Its success in the Indian subcontinent was replicated across Africa, Latin America, Asia and even the wealthier global bastions of North America and developed Europe.
Microfinance, it seemed, had grown up.
Yet coming of age is never simple. All too often, it’s a process in which lessons are either noted and absorbed, or missed and let slip, much to the individual’s – or the institution’s – lasting regret.
So it is proving with microfinance: this most worthy of financial services has followed a remarkable year with 12 of its worst months to date.
In India, a spate of suicides in one of the nation’s poorest states, Andhra Pradesh, has been blamed on allegedly aggressive methods of loan repatriation by MFIs. Publicity-seeking local politicians castigated micro lenders, many of which have pulled out of the state altogether.
Corruption has dogged many MFIs across the subcontinent, as well as in Africa and Latin America. In Bangladesh, the industry’s de facto founder Muhammad Yunus has been hounded out of the MFI he founded in the 1980s, Grameen Bank.
Some have even started to ask whether microfinance has a future. Perhaps no statistics better sum up the industry’s alarming malaise than SKS Microfinance’s stock price, trading in Mumbai on August 19 at Rs272 ($6.04), a fall of more than 80% in just 11 months.
NO SILVER BULLET
So what can be done to halt the apparent if not actual decline of a recently high-flying industry? Perhaps one should start by focusing on what microfinance can and cannot do. First, key figures within and outside the industry need to recognize that microfinance is far from being a panacea for all the world’s ills, a structure capable of bridging the yawning gap between the rich and the poor.
“It is not the silver bullet to fight poverty that we thought it was,” says Naomi Chakwin, a microfinance specialist and a director in the East Asia department of the Asian Development Bank (ADB). “It is a tool. It can be a very effective and important tool, but it is just a tool.”
Arguably the biggest failing is an inability to communicate to donors, governments, lenders and borrowers, what it is that microfinance does – or what Chakwin calls the “expectations gap”.
Another glaring problem is a general inability to provide the right products to the right people at the right price. In some cases, whole markets have become saturated in a few short years, flooded with lenders (more than a thousand MFIs operate in India alone, according to the World Bank) desperately seeking a dwindling number of willing borrowers.
Micro credit, a single-product service (small loans handed to small businesses at relatively high rates of interest) is often erroneously confused with the wider microfinance sector, which takes in everything from loans to banking to insurance.
Micro credit, in particular, has grown exponentially, in large part because it is easy to provide: small loans handed usually to entrepreneurs at high rates of interest. Yet this has led to saturation, notably across the Indian subcontinent: there are only a finite number of flower and fruit sellers in any country, and not all need, or should be encouraged to borrow, small chunks of capital on credit.
Other markets have the opposite problem.
In China, the microfinance industry is almost non-existent. MFIs do exist – Beijing-based CreditEase, founded in 2006 by Ning Tang, a graduate of Grameen Bank’s training programme – is a trailblazer.
But they are the exception rather than the rule in a country whose autocratic government is reticent about permitting any manner of service that is not fully controlled by the state or could lead to the sort of negative media seen in recent months in India and Bangladesh. Yet MFIs are sorely needed, particularly when it comes to micro insurance, a vital service in a country where farmers have little or no recourse to state aid if their crops fail.
Other, more specific problems also weigh down microfinance. Tilman Ehrbeck, CGAP’s chief executive, highlights two further conspicuous problems.
First is the industry’s lack of infrastructure. So, for example, precious few MFIs share information about clients with each other or with a central national database, making it easier for borrowers with poor credit records to take out multiple loans at the same time.
Second, the industry is struggling to adapt to the demands of a market that is simultaneously growing and maturing fast.
COMMERCIAL LOGIC NEEDED
In other words, it’s not just about flinging credit at a small business. There has to be solid business and financial logic behind the transaction, an understanding of why the product is needed, and why it’s being delivered. “Some of the negative characteristics that resulted from the industry’s rapid growth in some contexts included a loss of credit discipline, imperfect functioning of risk controls, and too much competition for the same segments, and often the same geographies,” says Ehrbeck.
Clarification and direction is also needed in two final areas: who should be allowed to provide finance to borrowers and who should regulate an increasingly global industry (and whether regulation is needed).
There is a perception within the industry, fair or not, that many of the current problems were initiated by SKS Microfinance’s IPO. Not that the company is at fault – SKS is widely respected, as is its founder and chairman Vikram Akula.
But the entrance of profit-seeking private lenders into a market with a social conscience appears to have thrown together two apparently clashing ideologies. SKS and other listed MFIs, like Mexico’s Compartamos Banco, in many ways cannot win: if profits rise and they announce strong financials, critics decry their avarice; if net income falls, as it did at SKS in the quarter following last year’s events in Andhra Pradesh, the doom mongers predict the demise of the industry.
No one appears to have a good answer to this intractable problem. Private institutions are in every way – efficiency, management, an ability to attract investment capital – better placed to drive forward microfinance. Yet they need to get better at balancing the needs of shareholders with the needs of borrowers – and then communicating this message.
Chakwin, one of the world’s foremost microfinance specialists, embodies this uncertainty. She describes her hesitancy about private-sector MFI providers, based on a belief that they have a higher threshold to prove themselves to a doubting public.
But she notes with approval the fact that the private sector “does bring a lot more credit skills into the market, which is a good thing, and needed for the evolution of the industry”. And there is a broadly-held belief that the industry does need to become financially sustainable across the board – it cannot continue to rely heavily on donor money forever.
Private-sector MFIs are also vulnerable to orchestrated attacks from the public sector. In India, Bangladesh’s government has vilified Muhammad Yunus, awarded the Nobel Peace Prize in 2006 for his role in cutting global poverty, perceiving his popularity as a political threat.
In India, politicians have lined up to disparage the way privately run MFIs have operated in Andhra Pradesh. To be sure, some microfinance firms have acted with negligence in the state – there will always be a few bad apples in every barrel – but this is also one of India’s poorest states, with a long record of high suicide rates, particularly during poor harvests. Critics contend that it’s easier for Indian politicians to blame MFIs than to point their fingers at their own inability to cut poverty.
This has a second positive result for bureaucrats – it denigrates private-sector MFIs at the expense of those run and favoured by regions and provinces. The latter almost always perform poorly compared to their private peers, much to the embarrassment of local officials.
Vidar Jorgensen, president of Grameen America, the US division of a pioneering trust set up by Grameen in an attempt to spread its model beyond Bangladesh, disparages these politicians, warning that by protecting state-run MFIs at the expense of the private sector, they are “enacting legislation that will significantly slow, reduce or even eliminate most microfinance activity”.
REGULATION
Regulation is perhaps the knottiest problem of all: how to regulate an industry with high costs – due to the price of funding tiny bundles of loans made to millions of low-income households with no credit record – where client information is rarely shared and rates of interest rarely start below 25%, despite a credibly low default rate.
The banking industry as a whole has fought – successfully – against a single global regulator for centuries. Microfinance is unlikely to gain a global or even regional regulator. Grameen America’s Jorgensen says country-by-country regulation is more practical, and allows for more innovation and competition.
The ADB’s Chakwin believes that in most cases regulation is simply not necessary, as MFIs, tiny and peripheral as they remain, are unlikely to put a nation’s financial sector in peril. “Central banks or banking sector regulators usually don’t want to set up specific rules,” she says. “They are not resourced for it, and they see it as a minor activity as the issue at hand is not overall financial stability.”
But rules, naturally, do exist – impressive ones, in some cases. India is working on tighter legislation that will make MFIs more strictly supervised, as non-bank financial companies, by the Reserve Bank of India. South Africa is a groundbreaker when it comes to setting in place strict rules governing how MFIs are supervised, who can borrow from whom, and how many existing loans can be guaranteed, at one time, to a single person or household.
The microfinance industry has had its fair share of pain over the past 12 months, but the industry continues to grow apace.
Grameen America, for example, made its first loans in the US in New York in 2008 yet it already has 6,500 members with a repayment rate of 99%, and is expanding this year into Indianapolis, Indiana and Omaha, Nebraska.
It offers micro loans, but only on the proviso that a customer opens up a bank account with a major US lender – Citi, Capital One or Wells Fargo, depending on the district. So when the first loan is paid off, the customer has a credit history and a bank account, allowing them access to a range of more straightforward, main-market financial services.
This is an industry that is unlikely to wane in significance. According to CGAP, 2.7 billion people, or more than half the world’s working-age adults, do not have access to formal financial services, and that is before one adds insurance into the mix.
Ehrbeck believes that poorer households need financial services more than their wealthier counterparts, largely due to erratic income streams and higher relative basic living costs (rent, food). Yet most are denied access to formal financial services or are presented with unpalatable substitutes that are unreliable (such as loan sharks) or more expensive (many MFIs).
This Ehrbeck describes as a “double injustice”.