Chapter 5: Microfinance as Business

I've just posted the long-threatened draft of chapter 5 (.doc .pdf). To write it, I started with the text of Microfinance as Business which I wrote with Uzma Qureshi three years ago in response to a request (and grant) from the ABN AMRO bank in the person of Suellen Lazarus. My last act before posting the chapter just now was to go over annoyingly astute comments on the text form Suellen's son Eben, who served me this summer as a superlative intern.The chapter argues that much of what characterizes modern microfinance, notably the emphases on credit, groups, and women, can be explained with recourse to rather crass commercial considerations. In other words, doing microfinance in the ways it is usually done helps microfinance institutions (MFIs) solve this problem: how do you mass-produce financial services without losing your shirt? By fully covering their costs, MFIs scale up and serve millions of people. Group lending to women, for example, turns out to be cheaper than group lending to men because women in many societies repay more reliably in the group setting. They may be more sensitive to the peer pressure, and may value access to opportunities to do business in public forums of the sort where men usually dominate.This thesis comes at the question of the impacts of microfinance through a back door. "If the common emphasis on credit over savings, for example, can be explained as a matter of business practicality, that should seed judicious doubt that credit is what the poor most need."My chief influences in writing this chapter were Jared Diamond, famous for bringing an evolutionary perspective to human history in Guns, Germs, and Steel, and Pankaj Jain and Mick Moore, who wrote What makes microcredit programmes effective? Fashionable fallacies and workable realities.I welcome your comments. Here's the intro:

A system of finance which might prove a commercial success would not necessarily prove an economic success, but the system which promises to be an economic success must be based on commercial principles. —William R. Gourlay on cooperative credit in Bengal, 1906

To properly appreciate the great achievements of the microcredit movement, one has to be more skeptical of its self-image than is normally considered polite or respectful. —Pankaj Jain and Mick Moore, 2003

Most microfinance is supplied by macro-organizations. In 2007, six microfinance institutions (MFIs) had more than one million current borrowers: the big three of Bangladesh; fast-rising SKS and Spandana in India; and BRI in Indonesia. These six accounted for 45 percent of all microcredit borrowers worldwide in 2007, according to data from the Washington, DC–based Microfinance Information Exchange (MIX), and the 74 MFIs above 100,000 accounted for fully 79 percent. (MFIs voluntarily supply their data to the MIX. See Table 1.) To cut the data another way, the “average microcredit client” in the 2007 sample was served by an MFI with 2.5 million borrowers, a national market share of 26 percent, 11,200 employees, $800 million in assets, and operating profits at 15 percent of revenue. And torrid growth has made 2007 a long time ago statistically speaking: at least two MFIs each in India and Mexico have since joined the million-borrower club. [update]The operations that dominate microfinance today did not exist 30-odd years ago, and so must have arrived at their current position through rapid growth. Though many today take charitable grants or capital at lower prices than are available to conventional organizations of similar risk, the MFIs are large enough that subsidies are a modest fraction of overall costs. In other words, the providers of most microfinance are successful businesses. They have found ways to control costs, build volume, keep repayment rates high, and prevent internal fraud, all while operating in countries with weak infrastructure and low education levels.Table 1. Characteristics of microfinance institutions (MFIs) by size, 2007The main task of this book is to impose an outsider’s question on microfinance: What is its social bottom line? How much does it help poor people? But before tackling the question directly, it is useful to take microfinance organizations more on their own terms, to observe them the way Darwin did finches, looking for links between how they operate and whether they survive. Most MFI leaders, staffers, and investors no doubt care deeply about the ultimate impact on borrowers and communities. But viewing MFIs more crassly—as practical solutions to challenging business problems—turns out to give an interesting, back-door entry into the question of impact. If the common emphasis on credit over savings, for example, can be explained as a matter of business practicality, that should seed judicious doubt that credit is what the poor most need.The business problem for MFIs can be described as finding ways to keeps costs near or below revenues—but that generalization is vacuous and needs unpacking. The real challenges include building a large customer base to exploit economies of scale, retaining those customers, keeping loan repayment rates high, and complying with regulations. This chapter highlights some ways that MFIs meet such challenges, emphasizing credit, the service the movement itself has emphasized. The big picture that emerges is of an interaction between human ingenuity, chance, and evolutionary dynamics. Microfinance leaders have found a suite of techniques in product design and management that meet the business challenges they face. Most of these were consciously designed. Others were stumbled upon. And in any particular case, most were copied from another MFI. Regardless, because the techniques work, organizations using them have moved to the forefront of the microfinance movement through a process of “natural” selection. Thus business imperatives strongly shape the microfinance that most clients experience.