The myth of commercial microfinance

Commercial microfinance has seen tremendous public support in recent years. It has been considered a victory for capitalism, in the justification that when everyone works in their own material self-interest, society benefits as a whole, that 'doing good' is congruent with 'doing well for oneself'.

This position is untenable though. A few of the popular arguments for commercial microfinance are provided below, with a discussion on their flaws.

1. The first argument is that a commercial approach brings in professionalism, efficiencies, and innovation that are not there in the NGO sector. It is true that many NGOs are inefficient and unprofessional. But so are many corporations, as those in the corporate sector can attest to. Innovation occurs for reasons far removed from the desire for money. Just look, for example, at the phenomenal contributions of the global Free and Open Source Software communities in recent years. The microfinance sector, like any other sector, needs to apply skills and common sense in learning from every worthwhile source, whatever their origins.

2. A second argument is that commercial equity capital is needed to reach out to large numbers of unserved poor, so as to bring them into the financial mainstream. This argument has a seductive appeal. Implicit in this argument are two flawed assumptions - (a) that commercial equity capital is beneficial for financial inclusion and (b) that commercial equity capital is necessary for financial inclusion.

First, commercial equity capital is not beneficial for microfinance for the poor. Commercial capital has the goal of high financial returns, typically in the short to medium term. It does not have the goal of bringing poor people into the financial mainstream. As we have seen in recent years, there is too much of a conflict of interest between these two aims. There are simply too many ways of achieving quick financial returns without appropriately meeting the goal of financial inclusion for those who need it. This is why we see the current havoc in the microfinance sector - growth at any cost, urban crowding, multiple lending, staff poaching, phenomenal salaries for salesmen-turned-CEOs, and so on. The social costs of are not noted till a later stage, and when it is, there is the violent reaction of the kind we are seeing now.

Second, commercial equity capital is not necessary for microfinance for the poor. Simple calculations inform us that the financial capital needed to reach out to the poor of the world, is a pittance compared to the size of global economies. There are some 1.3 billion very poor people in the world, that could perhaps be associated with some 300 million households. If each household were to receive Rs. 10,000 as startup capital, say US$ 225, that would require a lending capital of some $ 67.5 billion. At a debt/equity multiple of say 7, this requires equity of some $ 8.5 billion dollars, with the onlending capital coming from banks and other institutions or investment mechanisms. Even a 10-X multiple of this required equity amount is a drop in the ocean when we look at the size of global economies, levels of global aid and available social financial capital. If we are truly driven by the social mission, our united efforts would be more worthwhile spent on ensuring that capital from social investors including governments is utilized effectively, rather than the easier but disastrous route of approaching commercial equity investors.

3. A third argument is offered by commercial MFIs - if we don't grow, we will not survive, and commercial capital is needed for growth. Again, not true! A reasonably efficient MFI can be sustainable at a size of some 40,000 to 50,000 members on small ticket loans. If growth beyond that is purely to serve more of the under-served, if it results in reduced costs and improved services for the poor, well and good! But that has not happened. Millions of people in India and Africa are still not served, while the slum households of south Indian cities seem to have some 5 to 10 commercial MFIs serving them. This is a natural outcome of commercialization - commercial equity investors value high financial returns, and in the short term the highest returns come by serving easier-to-reach urban clients.

Both commercial and social investors are attracted by the potential of microfinance to build a delivery channel for non-financial services. But while social investors look at this channel to supply essential social services, the commercial players look to supply consumer and electronic goods. It is easy to see which route improves the lives of the poor, and which will place them under more of an unsustainable debt burden.

Is human civilization still at such an early stage of evolution, that despite having far more resources than all of humanity needs, we believe only money and material self-gain can motivate us to do good, to help our fellow humans who share this moment in history and this space on earth with us?

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