(Last of four parts)
In 2009, I was a young investment banker, caught in the midst of the worst financial crisis in recent history. I witnessed and was part of mass layoffs and, at 21, was completely disenchanted with the financial industry — an industry whose greed caused the destruction of many lives and livelihoods, an industry I desperately wanted to leave. It was at that point that I decided to pursue a Ph.D., but lo and behold — I had no background in anything else, except finance. It was inescapable to have to do a research project related to my field, and so it was a Eureka moment for me when I came across Microfinance and read Yunus’ books. To me, I felt I could somehow contribute to repairing the industry by making capitalistic models work for poverty alleviation.
The years following, I spent my time examining mainly Responsible Investing in Europe, which was much more accessible in terms of data, but still kept a foot in Microfinance, especially later on in my academic career when I would supervise students who themselves had worked in internships in the field. It was gradually through the years that I observed the changes in this beloved business model. The past couple of months, I have dedicated my column towards explaining the shift. I had written in March about how in the developing world, the identity crisis is in the increasing commercialization of the model — there has been a shift in client focus towards less poor (but more profitable) clients and correspondingly the exclusion of those who need it the most, whereas in Europe, the mission is succeeding but at a high financial cost, that to some is not sustainable.
One key factor is the rivalry between microfinance institutions (MFIs) and traditional financial institutions. The division between the two is not so clear-cut because some MFIs also serve bankable clients. However, MFIs bear the cost of non-financial services such as training programs, which traditional banks do not, positioning the former at a competitive disadvantage. Further, strong regulation limits the interest rates MFIs can charge, effectively restricting them from passing on costs to customers. Finally, the high dependence on donations and public subsidies are a big drawback. Looking for new funding sources and support takes time and limits the productivity of this type of structure, with amounts varying from year to year as a function of government policies. Some even point out that their survival really depends on the type of government in place.
This puts Microfinance in Europe in a dangerous situation. In order to remain competitive, European MFIs are thus becoming stricter and ultimately more and more exclusive. For instance, the migrants they support must be documented or already possessing legal residency status, largely excluding the majority of the migrant population with more professional, financial, and social inclusion needs. Entrepreneurs need to have a certain level of education and literacy and financial know-how in order to have a loan approved, again imposing standards upon the beneficiaries in need. And because of the interest rate restrictions, MFIs tend to be more and more selective in providing loans to less risky and therefore less needy clients.
Given these, what then is the way forward? We conclude this series with some suggestions for practitioners and policy makers.
• Positioning vis-à-vis commercial banks: MFIs need to have a clearer positioning vis-à-vis traditional banks, perhaps by labeling and categorization of microfinance products. MFIs should offer complementary products and services rather than substitute products compared to traditional banks and focus largely on excluded individuals.
• Separation between non-financial services and financial services: A model that seems to work in Europe is the separation between non-financial and financial services wherein the former are provided by nonprofit intermediary organizations and the latter are provided by the for-profit Microbank. Doing this excludes the costs from the for-profit entity and provides a more dedicated service to the beneficiary, also mitigating her risk of default by providing her with tools and knowledge for success.
• Diversification of product categories: MFIs should diversify their products and services and offer different types of products targeting different levels of clients to avoid “standards of inclusion.” This would allow them to compensate for a loss in one product category with high-risk loans with another category with lower risk products while continuing to target populations in need. This would also allow them to clearly position their interest rate views and adapt them accordingly. For instance, in the very poor (high risk) customer base, interest rates can be affordable and allow poor populations to repay their debt. Whereas cost transfer can occur in other products for less poor clients.
• Funding from institutions with a clear social mission. MFIs should foster partnerships with various institutions to diversify their funding sources and the quality of products and services offered. However, these should be limited to sources that clearly have a strong social mission. In order not to lose its social mission, the growth of the MFI should happen organically and not be based on the amount of funding sources available.
POLICY SUGGESTIONS:
• Flexibility of interest rates and more appropriate regulation. Our research suggests that capping interest rates has the effect of exclusivity and being more selective of clients. As the interest rate is a function of the diversity of funding sources and the mission of the firm, policy makers should see how to regulate rates based on business model rather than on an average market rate by traditional banks.
• Legal distinction between Microfinance Institution and Commercial banks’ scope of activities. Our research supports a distinction between Microfinance Institutions and Commercial banks based on key differentiating missions. The competition between the two is unhealthy from a social perspective and from a financial sustainability perspective of the Microfinance Industry. Further, funding sources can be a source of distinction with MFIs funded by commercial sources or entering the stock market considered as commercial banks.
Notes: This article is based on a co-authored working paper originating from the Master Thesis of Hélène Laherre under the supervision of the author at the IÉSEG School of Management (Catholic University of Lille) in Paris, France. References are available upon request.
Daniela “Danie” Luz Laurel is a business journalist and anchor-producer of BusinessWorld Live on One News, formerly Bloomberg TV Philippines. Prior to this, she was a permanent professor of Finance at IÉSEG School of Management in Paris and maintains teaching affiliations at IÉSEG and the Ateneo School of Government. She has also worked as an investment banker in The Netherlands. Ms. Laurel holds a Ph.D. in Management Engineering with concentrations in Finance and Accounting from the Politecnico di Milano in Italy and an MBA from the Universidad Carlos III de Madrid.