Making nothing into something

The success of microfinance has fuelled the need to finance growth into full-scale financial services for the poor, writes Rod Newing

Microfinance has been hugely successful in cutting poverty and promoting economic growth in developing countries. It started as philanthropy, with charities and non-governmental organisations (NGOs) using donations to give very small cash loans to poor people, predominantly women, to start businesses so that they could feed themselves and their families.

Offering training and support in financial and business matters along with the money resulted in successful businesses and repayment rates of up to 99 per cent. Repayments were lent to new borrowers, fuelling growth. Given the high number of dependents of each borrower, the economic benefit has been considerable and has attracted more donors.

The success of simple cash-based loans has also fuelled a demand for other financial services including savings, banking and insurance, creating a drive towards full financial inclusion. But what started as a charitable activity is now moving on to a more commercial footing and NGOs need to convert to, or set up, commercial entities to hold banking licences and accept deposits.

The main problem with the switch from charity to commercialism is the need to generate financial returns. This is at odds with the need to provide considerable support to lenders, which is funded by relatively high interest rates and leaves nothing for lenders. Some microfinance institutions have been accused of harassment of borrowers. The Indian State of Andhra Pradesh, which accounts for about 30-40 per cent of India’s $6.5 billion microloan portfolio, introduced new regulations after families and media blamed 30 suicides on aggressive debt-collection tactics.

“They were not spending any time assessing what the money was for, other borrowings and whether the loans would be repaid,” says Peter Ryan, founder and chief executive of MicroLoan Foundation, a London-based charity that works in sub-Saharan Africa. “Their loan managers were targeted only on getting money back, with no social performance objectives. They were saying that if the loans were not repaid, they would take assets.” This approach left financially illiterate borrowers feeling very exposed.

Financial access is very important but people also need financial capability, knowledge and the tools to make good financial decisions

Such examples highlight the natural tension between the need to reward already-wealthy investors and the social mission to alleviate poverty. Nobel laureate Muhammad Yunus, the founder of Bangladesh’s Grameen Bank, the first microfinance bank, takes an uncompromising view: “If you’re making money out of poor people, then you’re loansharking.”

But Vikram Akula, founder of SKS Microfinance, the first microfinance fund in India to be publicly listed, believes that in order to meet the huge unmet demand for more affordable credit from the poor, he needs to go to the commercial capital markets, which means being not just profitable, but very profitable. He has pointed out that it only had 120,000 members as a non-profit-making organisation, but now has 6.2 million and has maintained repayment rates of 99 per cent.

Citibank has had a presence in all the main countries where microfinance started and has also grappled with reconciling these two needs. “The vast majority of the population in so many countries we were operating in did not have access to financial services,” says Bob Annibale, Citi’s global director of microfinance and community development. “We originally saw microfinance as a tool for greater financial inclusion and livelihood generation in a whole segment otherwise not reached.”

Citi, which made its first donation 30 years ago through Citi Foundation, continues to support the sector through education, financial innovation, technology, building financial capability and capacity. “Financial access is very important,” adds Mr Annibale, “but people also need financial capability, knowledge and the tools to make good financial decisions.”

Six years ago Citi Microfinance was set up within the bank to go beyond philanthropy and provide commercial banking services to the sector. It has worked with more than 120 microfinance institutions, networks and investors in over 40 countries. It has assisted in areas like local securitisation of microloans to fund growth, bond issues, savings products and hedging foreign exchange risk on borrowings.

MicroLoan is currently having to restructure to support its growth. Its operations in Malawi are set to switch to being a limited company, with its funding coming from interest free loans rather than donations and lenders taking the exchange rate and any credit risk, possibly followed by a move to full interest bearing loans. It is also considering whether to become a deposit taker. “There is a need for poor people to save, particularly against illness, but they don’t understand the delays and cost ofdealing with a commercial bank,” says Mr Ryan.

The charity will also use Grameen Foundation’s Progress Out Of Poverty Index to measure the increased wealth of borrowers. “In its purest sense, microfinance helps people who have nothing to have something, which is a social mission,” he concludes. “A lot of investors have been lured into it because it ticks their social performance box and makes them feel good. However, they must have a very sound understanding of social performance and align it to their financial performance.”