Re-Evaluating the Commercialization of the Microfinance Industry

More than 3 billion people (almost half the world) live using less than $2 a day... and have no access to financial services due to a lack of collateral, bad credit history, high interest rates, doubt from the bank of repayment capacity, and lack of financial infrastructure/ services in remote areas. The founder of Grameen "Village" Bank Project, Dr. Muhammed Yunus was the major impetus for the successful establishment of microcredit arrangements in many developing, in transition countries. Microfinance is an institutional innovation designed to address issues of poverty, under development and marginalization by providing poor individuals access to small amounts of loan capital. Recipients of micro-loan can start their own micro-business, generate income, accumulate assets, and can even extend their own education/ skills and maintain their personal health. Microcredit lenders like the Grameen Bank rely on trust and community peer pressure to maintain high repayment rates rather than the more traditional banking methods of meeting collateral requirements and legal enforcement of contracts.

Though the short-term poverty impact of microfinance is positive, the same cannot be said about its longer run aggregate impact. In countries like Bangladesh (where Grameen Bank started) as well as other developing countries in Sub-Saharan Africa, South East Asia, and Latin America, it is hard to point to any localized sustainable development that has risen from the provision of microfinance over the last thirty years. Microfinance has absorbed a significant amount of international donor community resources, yet marginalization continues.  In an article in the Economist, Elizabeth Littlefield (currently OPIC's President, previously Director of Private and Finance Sector at the World Bank & Chief Executive Officer of the Consultative Group to Assist the Poor (CGAP)), is worried that "foreign money, public and private, is not necessarily catalyzing the creation of sustainable, savings-based financial system in poor countries."

But with the founder Muhammad Yunus told to step down from Grameen Bank and the lack of regulation in the microcredit industry has lead people to question the sustainability of microfinance. Many development economists argue that economically and socially inefficient institutions often prevail simply because it is in the interests of the powerful for this to happen. The series of civilian suicides (mainly women) from the state Andhra Pradesh in India sparked calls to create laws that will regulate the industry. Developing countries are potential critical markets that lead to the question whether it is possible to incorporate profit-making into a business that is historically in the realm of non-profit organizations and cooperatives.  For instance, the initial success of the microlending industry in India (i.e. one company SKS Micro Finance raised $350 million in an initial public stock offering) lead to a “shift away from helping the poor start new enterprises.” Rather than encouraging investments in education and promoting entrepreneurship, microfinance companies like SKS Micro Finance pushed loans with no questions asked of its purpose or whether borrowers had loans outstanding from other companies.  

The microfinance instituations' goal seemed to be to increase the number of borrowers; thus attracting the attention of big investors and banks. Consequently, people began taking out new loans simply to stay current on new ones and once they couldn’t pay them back, banks stopped lending to microfinance companies (unlike Grameen, India’s commercial lenders relied primarily on private banks) and the industry was on the verge of collapse. It was simply unsustainable and had little accountability. Just like the .com bubble crashed in the 90s and the housing market came to a tumble--- so did the microfinance industry in India. Too many Indian microfinance institutions opted for growth strategies that put their missions at risk and didn’t do much to manage such risks. With the trust system shattered, the MFI industry in India is entangled in a crisis where too many borrowers no longer feel obliged to repay their debts.  As a result, India’s government is currently working on national regulation that would include interest rate caps and closer scrutiny of credit limits as well as borrower’s incomes. These would help establish a regulatory environment conducive to the viability of microfinance.

But as microfinance gets bigger and becomes universally available, the industry is at a crossroads between its social business mission and commercial, profit making business approach.  How can microfinance institutions (MFIs) ensure that people who live on the bottom of the pyramid with meager, erratic incomes pay them back? This is a challenge. Although there is a higher rate of success with women, in a socially oppressive, gender-biased society (a common trait in developing countries), wives often take out loans for their husbands and spend their money on immediate needs for their families, rather than investments in businesses. These are important questions that international institutions and national politicians and law makers must figure out to define microfinance (profit v. non-profit), to monitor and audit microfinance institutions (make them accountable for their actions), and to find the right balance between government regulations and the free market.