Two Sides, Not So Black and White

Most controversial topics are controversial for a reason. They often engender in people two or more very different, but legitimate, points of few. And despite the zealotry of advocates arguing the two sides, the evidence surrounding the issue in question is rarely black and white.

This week's Newsweek article skewering microfinance suggests such a circumstance.

While the the microfinance industry's success in achieving the very diverse goals set for it over the last twenty-five years is anything but definitive, there have been many stories of unique organizations that have built successful microfinance models to serve either social, or commercial purposes, and, in a few cases, both.

But the Newsweek article I mentioned cherry-picks stories of microfinance organizations that don't fit into the author's pre-determined perspective on what a microfinance organization should be.

Like any organization, a microfinance organization cannot be all things to all people. Some microfinance institutions (MFIs) are social trusts which do not seek returns for shareholders but rather act like credit bureaus, lowering the cost of borrowing for locals, with little interest in rapid earnings growth (see Bangladesh's Grameen Bank).

Other MFIs are indeed for-profit companies (Non-Banking Finance Companies, or NBFCs, in India - "Non-Banking" because they cannot take deposits). These for-profit players tend to be sub-prime lenders downscaling into microfinance because they see a market opportunity. The rates they charge may seem high at 20% - 30%, but as I mentioned back in January, rates charged in the informal market by money-lenders can be two or three times that amount.

Occasionally you get a star like SKS (described in my post last Friday) which can achieve both social and commercial objectives. These organizations are the exception rather than the rule, but they are the model that many MFIs aspire to.

I believe there are more potential SKS's out there, and my job at Lok is to find them, invest, and add value.

Moreover, the Newsweek author's scientific method in assessing the industry is a tad disingenuous.
When asking 'Whether microfinance organizations are indeed serving the poor?' he quotes Thomas Dichter, an individual who spent a great of time in microfinance and development. But if you read more of what Dichter has written, you get a fuller picture. Dichter writes:

Since the mid 1990s research on microcredit use has found that it often goes to "help the poor smooth consumption over periods of cyclical or unexpected crises…"⁷   Again, there is no question that such a use of credit helps the poor, but this is not what the majority of microcredit enthusiasts claim it can do - function as capital aimed at increasing the returns to a business activity.

I will not get into claims about what microfinance can do - that is a subjective argument, and I agree that the recent hype is not a healthy thing from a long-term investor's standpoint. But whether there has been too much hype in the industry is irrelevant to a poor borrower who seeks to stabilize his cash flows or ease his standard of living. I am not a poor borrower and I do not have a small business activity that I finance through microcredit. However, for many of the MFIs whose internal numbers I have seen (and my experience is limited to the Indian market) their clients continue to take and repay loans, usually taking larger loans each time. This suggests a increasing trend in absorption capacity.

So whether the loans are making a serious dent in poverty or simply easing life's uncertainties for poor workers, we do not know for sure, but microfinance does seem to be a service which many poor people wish to avail and are able to afford.

On 'Whether micro credit is as effective as savings,' the author suggests that savings plays a more important role. It's true that credit without savings deprives clients of the second critical piece of any financial services offering. Unfortunately, in places like India, Microfinance organizations are either not allowed to take deposits, or face enormous regulatory and capital requirements to do so. The inability to take deposits increases their cost of funds and limits the effectiveness of the loans the MFIs do offer.

For example, many low income people have very cyclical or seasonal cash flows. A farmer may take a loan in the spring, have a successful harvest in the fall, but after selling it in the market, have no place to park his profits. His only choice then is to invest these monies in non-liquid or semi-liquid assets like livestock, life insurance, or gold. When the next planting season comes around, he may have to tap into loan funds again because his savings assets (the cow, the insurance policy, etc.) cannot be easily de-capitalized and used to stabilize cash flow. Deposit-taking can remove this problem, but if MFIs are not allowed to offer savings products it hampers the effectiveness of their lending activities. Most microfinance practitioners agree, savings should accompany credit.

On the last criteria, 'Whether microfinance is a real business model', I think it is particularly bizarre that the author cites state-owned credit programs in China and Brazil to make his point. It doesn't take a Harvard MBA to figure out that state-owned institutions are not the most effective managers of banking or financial service companies. These are not the industry leaders. Had the article cited repayment rates and earnings margins from the large rural MFIs in India (SKS, Spandana, Bandhan, ShareMicrofin) or established private Latin American MFIs (Compartamos, BancoSol), the default rates would be less than 4% and the earnings margins would have been positive.

Yes the microfinance industry is one that is still evolving to find its appropriate place in the world economy. Leading voices in the industry often engage in heated debates at industry conferences and across negotiating tables. Should credit be subsidized? Should the capital markets be involved? Does their involvement cause mission drift? Does microfinance actually pull people out of poverty?

I could cite conflicting evidence on these questions all night, but the real answer is, it depends.
Microfinance alone will not pull people out of poverty, but it may enable them to survive or at least ease their daily living in a way that is more sustainable, productive and dignifying than constant reliance on benefaction and begging. 

There are usually two sides to every tall story. The microfinance story, with one paw planted in development and another gingerly stepping into commerce, will likely have even more.

Comments

[Yuri Gadow]

Interesting points Mark; I hadn't thought through the difference in goals between a Grameen and an SKS.

I don't know enough about the field to take sides, so I found Margolis' vague citations irritating. I found some: Myths and Magic, Money is Not Enough, and Posner's quoted blog post. But, not the study from Dichter or anything exact from Milford Bateman; have you any idea what Margolis was referencing?

Here's what found:
http://www.insead.edu/indevor/Events/documents/0606_MF_magicMythl.pdf
http://org.elon.edu/ipe/Zephyr_Edited.pdf
http://www.becker-posner-blog.com/archives/2006/10/microfinance_an.html

[Shripriya]

Interesting post. I think like all things that get a ton of positive press, there is a backlash of sorts. As a journalist, are you going to make news with one more story about how great MF is or are you going to make news with the first negative story? That's also something to keep in mind while reading the Newsweek story.

Btw, loved the b&w pic at the beginning and the partially colored one at the end - nice! :)