If the term Microfinance brings images of charity, of handouts; then think again. Could it be possible that a business be created around microfinance. After all, if banks and financial houses can make big money by lending and investing money, then why can’t these big numbers be scaled down to the micro-entrepreneur? Can a business be build around that?
These are some of the aspects that the authors of this paper deal with. The first question to ask is – is there a market for microfinance. And the answer from the paper seems to be – yes, there is. Paradoxically, it is the poor who need to save more and borrow more than someone who is well-off. And the authors also provide evidence that for most part (geographical factors also play a part in this), the poor are willing to save money and borrow it when required. Then the challenge for the MFI (microfinance institution) becomes not just serving its clientele but to do it in a sustainable manner. Can the MFI recover its costs; what are the average margins that a MFI can realistically expect to achieve?
To be able to be sustainable, a MFI needs to be able to create products that can help it sustained returns; returns that can be reinvested into more communities. The various kinds of products that MFIs offer are discussed in the paper. The core product types are
- Group lending – money is lent to a group of individuals who are part of a community. The social pressure between the people ensures that the % of loans that are defaulted is minimum
- Individual lending – here the emphasis is on the individual, like any other loan product.
- Village banking – instead of the MFI deciding on where the money goes, the money is lent to a group of villagers and they decide where they would like the money should go to. This consortium (more a cohort actually) ensure that the repayments of the loans are not missed
Each of the products has its advantages and disadvantages. Grameen bank, for example concentrates a lot on group lending. The type of product is largely determined by the geographical location of the clients. In a rural environment, it might be easier to allow for group lending, than in an urban one where individual lending might be a preferred approach.
Another important part of a MFI’s success apart from the product design considerations is the MFIs view of itself – how does it structure its management. How does the MFI train its employees, should there be a strong command-control structure, or should the retail offices be allowed to have more freedom with only a general direction given by the parent office. What about compensation and incentives to its employees. That is a very important consideration if the MFIs have to keep its people motivated. Even though, the average person who is going to work for a MFI is not there just for the salary, that doesn’t mean that the incentives don’t factor in heavily. The authors talk about two metrics for incentives. One, the accounts per (field) officer and the second, outstanding portfolio (money to be repaid) per officer in currency terms (i.e. in INR / $ / some currency).
The final factor that affects MFIs is the environment in which they are operating. Regulatory hassles are not trivial for a MFI. Given that the interests that MFIs charge is not very far from what the evil moneylender charges, there might not be too many people who espouse the opposition of the MFIs by the governments. The authors narrate an incident, wherein the Chief Minister of Andhra Pradesh, India accused the MFIs of charging ‘moneylender’ interest rates and using ‘unethical recovery measures’. The minister went on to launch a plan to regulate MFI interest rates. These regulations have a huge impact on the commercial viability of the MFIs. Given the thin line that MFIs have to walk, between their no.1 priority of social empowerment and then commercial success, regulations of this sort can tarnish the image of the MFIs. And in the defence of the government regulation, allowing the mushrooming of MFIs can create an unhealthy appetite for commercial success ignoring the primary purpose.
Given these challenges, one does question the commercial viability of MFIs. At this point, there seems to be not enough proof that MFIs are commercially successful. But given the social impact, the numbers seem to indicate that they do have a considerable, if not silver-bulletish impact on empowering those people for whom credit is hard to come by. And it is not always very easy to measure social success that were caused by microfinance and only by microfinance. Various factors along with microfinance could have had a positive impact. AFAIK, there is no study that shows that microfinance as an area of Economics has always resulted in positive change. But while waiting for such studies to happen and the numbers to be churned, you could do your little bit by investing in a micro-entrepreneur. Head to RangDe and make an investment, as little as INR 100. And once you are done with that, you can read this paper; it will give you a 1000ft. view of microfinance.