Microfinance Monday: Full steam ahead…for what?

March 26, 2012

Amid a damning report from one of the industry’s heavyweights, financial activity in the microfinance world is picking up, clearing the way for more opportunity – but at what cost?

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David Roodman, one of the world’s foremost thinkers on microfinance, presented his newest book in a column last week that might appear to strike a spear through the heart of microfinance champions everywhere.

On current evidence, the best estimate of the average impact of microcredit on poverty is zero. So microcredit as a whole appears neither to live up to the hype nor justify the harshest attacks against it as modern usury. Microcredit does not appear to be the financial equivalent of cigarettes.

Well that’s good to hear! At least we’re not addicted to cancerous activity. Yet, the heart of what Roodman is getting at is something secretly feared by microfinance champions for years. Does it live up to the hype? Is this truly impactful?

Financial Health

This may not seem to concern the movers and shakers behind the dollars, as the past few weeks have been quite impressive for an industry facing its toughest struggles to date. In an industry struggling for capital, the past few weeks have been kind and optimistic:

  • SKS securitizes $72M of microfinance loans
  • USAID authorized 1% of its development assistance budget to be put in a fund with potential for direction to microfinance
  • Internantional Finance Corporation is setting up a $100M debt fund called Microfinance Initiative for Asia
  • Muhammad Yunus set up £1m in a charity aimed to bring the microlending model to Scotland

The money is flowing and microlending is getting back on the right track from the business side. Yet this is only one side of the industry equation.

Political Play

As much as the free market plays a role in the development, success, and direction of microfinance, when dealing with developing nations, there is a fair amount of governmental assistance required to stabilize the industry.

Karachi’s government has allowed microlenders to lend to microenterprises at more than 3x the current loan size of individuals.  By opening up the flow of capital to entrepreneurs, the hope is that measurable economic development is not far behind.

Back in India, SKS continues to realize tangible benefit (in their stock price) over the passage hopes of the newest bill in Parliament.  The Reserve Bank of India (RBI) is weighing the suggestions of an expert panel that would aim to provide:

  • Half of all agricultural credit should go to small and marginal farmers
  • Key changes in the definition of the so-called priority sector that will encourage banks to direct more credit through MFIs
  • Raising the credit limit for foreign banks investing in the priority sector from 32% to 40%
While these are all positive changes for the industry, it is worth noting that the bill’s biggest champion is Mr. Dili Raj, CFO of SKS Microfinance.  Mr. Raj went on CNBC to talk about his confidence of the bill’s passage.  It is worth noting this, of course, because this regulation that is being proposed would override the AP (Andhra Pradesh) Act which choked off almost all microfinance loans in that state.

This bill would provide central regulation via the RBI and standardize India’s microfinance sector – something highly necessarily and quite overdue.

Industry Innovation

While removing obstacles to lending is critical to the success of the industry, what is happening on the innovation side of microfinance?

Grameen Foundation recently spun off Mifos Microfinance Institution Software to the Community for Open Source Microfinance (COSM), a nonprofit open source organization.

“Mifos is a software package used to manage the data of microfinance institutions. The software is ‘open-source’ meaning that it is free of charge and can be edited to meet local needs. The microbanks that use Mifos reportedly serve about 850,000 clients as of June 2011.”

Technological advances within microfinance are going to be critical to ensure that this still rather junior industry remains at the forefront of development.

The Huffington Post recently featured a blog post by Tom Murphy, Founding editor of ‘A View From the Cave’ and ‘DAWNS Digest’, describing the Integrated Village Development Project (IVDP), which is “using interest-free microfinance loans to increase access to products people could not afford on their own.”

This ability to leverage a now mainstay of financial services (microloans) as a way to finance other products that the BoP cannot afford is innovative, but risky. As Roodman pointed out, “Microcredit, like all credit, is susceptible to bubbles. Overindebtedness is a real possibility.”

While the prospect of those at the BoP being able to finance medical procedures and afford things previously they could not is appealing, it must be met with stringent caution so that this is not just another pitfall waiting for borrowers.

The Push For Metrics

Roodman finishes off his undressing of the state of the microfinance industry with a line that we here at Rising Pyramid could not be more in favor of:

The microfinance movement got into trouble by allowing its rhetoric to get ahead of the evidence. Only by critically confronting the evidence and the theories used to interpret it can the movement realize its full potential for helping the poor manage their wealth.

It is obvious that the metrics we have judged microfinance on are simply outputs, and do not accurately measure the true impact of the loans. Is it even possible?

We must first dive into the reasons for our analysis and the reasons for even supporting microfinance. What is it supposed to do? What, at the very core, is the measure of success?

Total dollars lent; total lenders served; repayment rates; interest rates…these are all important metrics to help get a pulse of the industry, but they are not success metrics. Success metrics are rooted in the measurable future state. I look forward to what organizations and individuals like The Acumen Fund, Next Billion, and David Roodman are cooking up.

Yet at the end of the day, Roodman summarizes the next steps accurately by saying, “The practical question is not whether microfinance should continue, but how it can play to its strengths…”

- Chris



2 Responses to Microfinance Monday: Full steam ahead…for what?

  1. Tom Murphy on March 28, 2012 at 1:16 pm

    Nice post, Chris. I agree with your concerns. I am working on how to exactly put this into something more substaintial, but in the conversations in India, one of the women discussed the amount of her debt. The number was rather high, but she was meeting the payments ahead of time. What struck me was that her income was based on sugarcane harvests and her milking of cows. It is not hard to imagine how a dry season could affect both the crops and the cows’ milk.

    I too will be writing my review of Roodman’s book and agree with your overall assessment of caution towards microfinance. I appreciate the comments and the inclusion. – Tom

    • Christopher Cuellar
      Christopher Cuellar on March 28, 2012 at 3:39 pm

      Hi Tom,

      Thanks for the response! When you live on day by day income, if you take out a loan more than the money you have in your pocket, you’re going to over-lever yourself. I think the question is really how badly that should be occurring. When are loans becoming more of a burden than a path to a better life? I applaud your writing, and look forward to your post!

      - Chris

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