For the past several weeks, the microfinance movement has been buffeted in the media by events unfolding in India. The stories are shocking: poor people in India allegedly driven to suicide by thuggish collection agents working on behalf of profit-maximizing Microfinance Institutions (MFIs). In reaction, local politicians are urging borrowers not to repay their loans. Others are calling out for excessive, punitive regulation. This has thrown the Indian microfinance industry into crisis. The media is asking: will the conflagration spread to other countries and bring the entire industry to its knees?
First, as a movement, let’s look in the mirror. Aggressive, imprudent lending practices on the part of rapidly-scaling, profit-maximizing MFIs contributed to the India crisis. This same failure to understand the limited capacity of the poor to repay loans, even small ones, played a large part in the high default rates many MFIs in other parts of the world experienced during the recent global financial crisis.
Why has this occurred? It is an unwanted byproduct of the microfinance industry’s enormous success in making credit easily accessible to poor people. When I made my first micro loans to small farmers in the highlands of Guatemala back in 1972, access to capital was unheard of for poor people. The few who obtained our 50 dollar loans realized dramatic returns, just with a small investment in fertilizer and pesticide. A decade later, when FINCA, the microfinance network I lead, began to lend to market women in other developing countries, they were able to move away from loan shark loans offered at 10% interest, per day, and access FINCA loans at 3% interest, per month, realizing windfall profits.
The advent of abundant credit for poor people has changed the landscape in two ways. First, millions more micro entrepreneurs have entered the sector, causing the margins on their microenterprises to fall dramatically, reducing their capacity to repay. Second, poor people with no businesses at all have entered the sector, using their loans for consumption.
Does this mean that microfinance as a tool to fight poverty has exhausted its potential? As one who has labored in this vineyard for almost 40 years, I doubt that. But it does mean that, going forward, we need to work in a different way.
First, in the short run, MFIs need to conduct more rigorous analysis of their client’s repayment capacity, which includes information on their existing level of indebtedness. Second, we should do more research into the impact of our loans on our clients’ wellbeing to address, what our detractors claim, is a reversal of the Hippocratic Oath – rather than doing good, we are actually doing harm. Third, we need to offer more than just loans, and include savings accounts, remittances and micro insurance in the product mix. Fourth, we need to more actively promote Client Protection and Financial Education, and censure those engaging in abusive or irresponsible lending practices. Many of the major MFI networks are involved in the SMART campaign, an initiative organized and funded by Deutsche Bank and the Center for Financial Inclusion which strives to enlist more MFIs to that effort.
Finally, because microfinance in highly saturated markets can be susceptible to diminishing returns for clients and MFIs alike, we need a plan to make microfinance more effective by marrying it to other interventions that help the poor diversify into more value added microenterprises.
Increasingly, entrepreneurs and even large corporations working in other sectors of the economy are looking for ways to export their ideas, technical innovations and expertise to developing countries in an effort both to open new markets, and lift up the poor. George Economy, food sector entrepreneur who serves as mentor to the Global Social Benefit Incubator (GSBI™) Enterprise-Building Program at Santa Clara University told me: “Young, up-and-coming entrepreneurs see the next wave of opportunity and excitement in developing countries, where their innovations will have a social impact.”
There could be a second entrepreneurial wave in the making that will not only involve giving small producers access to financial services, but opening the door to small-scale, affordable technology that will make them more productive and bring improvements in their welfare. The timing couldn’t be better. Linking the poor in developing countries to global markets in a more profitable, sustainable way will combat a host of social ills, from malaria, to AIDS to terrorism.
Let’s not do something stupid and kill the movement that could make it all possible.
Rupert