Making Microfinance Work

This story originally appeared in the June 2nd, 2011 issue of Beyond Profit.

Beyond-Profit---The-New-Microfinance-12Aida Patricia took her first microfinance loan of $100 when she was just 20 years old. Fifteen years later, she employs 45 people at her clothing company.

In 1996, Aida Patricia, then a young woman of 20, turned to a small sewing machine in a corner of the house her in-laws owned. To earn extra money to support her family, Patricia began a small clothing enterprise she called Oscaritos. Banks wouldn’t loan her money because she had no assets with which to secure her loan.

A microfinance institution (MFI) based in Masaya, Nicaragua, gave Patricia a loan of 2,000 córdobas—the equivalent of $100. She invested the money in fabrics and materials, and continued to take loans from MFIs to grow her business.

“These loans also allowed us to obtain loans from other institutions, giving us the opportunity to diversify our financial risks,” Patricia recalls.

In 2005, Patricia and her husband, Oscar Garcia, began attending workshops of Agora Partnerships, an impact investment firm that works with early stage companies in Central America. Agora has helped Oscaritos develop a formal accounting system and improve the company’s general business administration.

Today, the company employs about 45 people—mostly single mothers—and provides them with training and support. Patricia is also very conscious of the environmental impact her business is having and tries to lower that where she can.

“Her story is not just about growing a business and employing people but about leadership,” says Ben Powell, the Founder and Managing Partner of Agora Partnerships.

Microfinance has been receiving its fair share of criticism of late—especially in India—but Patricia is an example of one an entrepreneur who benefited from microfinance the way it was intended. This wasn’t by chance but through a deliberate effort.

“We were conscious that the money we handled was not ours, that there was a commitment that we had to grow and return it,” she said. “It’s important to learn a little about how to administer your money.”

As for the problems of the microfinance sector, Patricia hopes they can be turned into solutions and can continue the progress banks have made in lending to small and medium enterprises. She also says it’s important not to forget that microfinance’s mission is reaching the poor and “encouraging them to start small businesses through loans.”

But Patricia also understands the limited benefit of simple credit.

“It is also important to mention that every time I received a loan from an MFI, I was trained in finance, marketing and strategies that helped the growth of my company,” she says.

Learning from the Microfinance Fallout

This story originally appeared in the June 2nd, 2011 issue of Beyond Profit.

Beyond-Profit---The-New-Microfinance-6The Indian microfinance sector is making strides in recovering from the crisis last fall. What lessons can the global community learn from what happened in Andhra Pradesh?

Late last year, the Indian microfinance industry, which had seemed like an unstoppable juggernaut, came to a grinding halt after the state of Andhra Pradesh passed an ordinance to prevent coercive collective measures. As collections slumped, microfinance companies failed to settle their own borrowings, leading to a lending freeze from commercial banks.

The chain of events has now all but derailed microfinance in the country. After several years of growth, Sanjay Sinha, the Managing Director of Micro-Credit Ratings International Limited (M-CRIL), estimates that the industry has likely shrunk by 30% in the financial year ended March 2011.

In January 2011, the Malegam Committee, charged with investigation into the crisis, released its recommendations, and last month, the Reserve Bank of India (RBI) released its guidelines—largely accepting those of the Malegam Committee but with some ease of operations for MFIs.

And while the fallout will be felt for a long time, there are valuable lessons to be learned from the Indian experience that can inform both the global microfinance and social enterprise sectors.


Law of the Land

According to Sinha, the biggest issue in Indian microfinance has been the reluctance of regulators to take charge

“This has been has been in the mistaken belief that because microfinance did not represent a significant proportion of the financial sector in terms of money, it did not deserve significant attention,” he said.

According to his own calculations, in March 2010, the outstanding portfolio of MFIs constituted less than 1% of the financial sector in India, which the RBI estimates at $270 billion.

“The piece that they missed, of course, is that it’s large numbers of people,” says Sinha. “Just because those people represent the low-income segment of the population doesn’t mean you can ignore them.”

It’s more important to look at the number of people affected rather than just the size of the financial contribution, he adds, pointing to the interesting contrast in China, where Sinha recently spoke about the Indian microfinance crisis. Although there are fewer than 1 million clients compared to an estimated 100 million clients in India, the regulators just released a 50-page document outlining guidelines for microfinance.

“It’s an impressive document in terms of size and weight,” he said. “Perhaps not all of it was necessary, but the point is that the regulator appears to have taken charge right from the start.”

A recent analysis by the Microfinance Information Exchange (MIX) shows that most MFIs were operating within the guidelines for interest rates and margin caps, an issue that critics have used to label the Indian microfinance industry as usurious.

“It’s an interesting commentary on how the policy doesn’t always fit the reality,” Liz Larson, Liz Larson, the Asia and Pacific Regional Manager at MIX, said.


Operating Barriers

One of the key differences between microfinance in India and other countries where the industry has seen sustained success – such as Bangladesh – is that Indian MFIs are not allowed to take deposits.

“As a result, what we’ve got is MFIs that are highly dependent on a single source of funds—which is commercial borrowings from domestic banks,” Sinha says. “At the first whiff of trouble, [banks] promptly stopped all their lending, [and] even committed contracts have not been honored over the past seven or eight months. The MFIs have nowhere to go, even those who don’t have a single rupee outstanding in Andhra Pradesh are not getting their current contract disbursements.”

Sinha himself asked the RBI recently about allowing MFIs to collect deposits and was told that ghosts of the CRB Caps failure – a pyramid scheme that collapsed in the 1990s – still walk the corridors.

In addition to diversifying where MFIs get their money from, Leo Hornak, who formerly worked in the microfinance industry and now covers the sector as a journalist for the BBC, questions the value of credit only. Hornak – who made it clear that he was giving his personal views on the subject, not those of the BBC – says that while credit can be useful in certain situations, it’s also a double-edged sword.

“Credit can help you start a business, it can help you get through a difficult period, it can help your own liquidity and it can manage economic shocks, but the other thing with credit is that it can actually get you into more trouble,” he says. “One of the things we found in our research is that there are many areas in Andhra Pradesh where people had taken on multiple loans, and they were taking on microfinance loans to pay off other microfinance loans. That was a recurring pattern.”

Thus, credit on its own, he points out, is not necessarily a beneficial tool. An organization that has taken this lesson to heart, Hornak says, is BASIX. After conducting a study that found simple credit wasn’t very beneficial to their clients, the Hyderabad-based institution changed their products to include other services such as training.

In response to the regulatory challenges, BASIX announced last week that they will open their clients to gold and agriculture loans from partner organizations which will allow it to rely less on core lending to sustain the business.


Responsible Growth

One of the most common attacks on the microfinance industry in India has been that its rapid fast growth led to multiple loans to the same borrowers, questionable collection processes and overall sloppiness. One of the lessons to draw from this is the idea of responsible growth.

A cautionary tale is that of SKS Microfinance, whose initial public offer – the first for an Indian MFI – in July 2010 raised more than $358 million, an event that was hailed as a coming of age of sorts for the microfinance industry. On May 6, the SKS scrip hit the lower circuit when the stock fell almost 20% on news that JP Morgan had cut its target price by almost half.

“We have certainly learned that too much growth might be a bit risky,” says Larson.

Larson doubts that MFIs had a proper picture of how much it really costs – in terms of financial cost and time to properly train staff – to add as many borrowers as quickly as many MFIs did.

Sinha, who believes the central bank should only “regulate what is controllable,” would be in favor of a regulation that limits the number of states an MFI can work in.

“We have seen over the past couple of years how countrywide operations have resulted in management at head offices not being fully aware of what’s happening in their branch offices,” he said.

For example, in March 2010, MFIs were saying they at a portfolio at risk (PAR) of 0.5% when an independent assessment by M-CRIL put the PAR at 5-7%.


Changing the Perception

Hornak, who worked in the industry in India, says that the problem that microfinance has yet to face is a problem of perception.

“The microfinance industry got used to promising much more than it really could deliver,” said Hornak.

In addition, the industry still projects their mission as one of poverty eradication even though it’s really about financial inclusion.

“No one within the industry is talking about ending poverty anymore,” Hornak said. “People are talking about financial inclusion. I have never met anyone in the industry who actually still believes that microfinance is a route to ending poverty.”

Part of the solution, he says, is coming clean.

“If they’d been a bit more on point – ‘We’re not the solution to global poverty. We’re not ending it’ – then they would have been much less vulnerable,” he said. “The world would have been much less surprised to find out that sometimes financial inclusion does go wrong.”

That brings up the issue of financial inclusion—a term that Hornak sees as mostly a buzzword that is “almost as vague as the original purposes.” Sometimes just being financially included isn’t good.

“Social entrepreneurs need to realize that financial inclusion on its own is not necessarily a benefit to the poor,” he said. “The dalit women I met in Andhra Pradesh who were in debt for thousands of US dollars to MFIs were definitely financially included—in fact, they were over included.”


Lack of Reliable Data

In addition to redefining the mission of microfinance, the way the industry measures that intended impact also needs to change. Currently, MFIs measure impact in terms of loans disbursed and portfolio size even though many of them still define their missions as poverty eradication. In other words, outreach is being mistaken for impact.

Hornak says this leads into the greater lesson that the microfinance sector – as well as the social enterprise sector as a whole – needs more reliable research.

“A lot of money was invested in the microfinance sector before really thorough research had gone into its effect on the poor,” he said. “Even though microfinance has been going for over two decades now, it’s actually only in the past two or three years that academically respectable, large-scale studies have been done.”

The issue with studies like the ones Hornak recommends is that they’re expensive and time-consuming, but billions were spent to start the microfinance sector in India.

“It doesn’t compare to that kind of money if that money was misspent or wasted,” he said. “It’s still a drop in the ocean.”


The Road Ahead

While the RBI recommendations about interest rates and margin caps will play a role in the future of the microfinance industry, Hornak thinks those involved are shying away from talking about the larger implications.

“I think what has happened in India is that there’s been a lot of focus on the specifics of the ordinance,” he said. “I think people have used that as a distraction from the wider lessons. To be honest, I think both sides have wanted to talk about those details because they don’t want to talk about the wider lessons for the future.”

But perhaps, just talking about the larger lessons and attempting to learn from past mistakes is the greatest lesson from this crisis.

Can Capitalism Reach the Poorest of the Poor?

Here’s my post on Triple Pundit as part of a series from Beyond Profit and Triple Pundit that will explore innovative business models aimed at tapping the bottom of the pyramid (BoP) market.

More than 3 billion people worldwide live on less than US$2.50 a day—less than a morning coffee at Starbuck’s for some. Traditionally, reaching out to these populations involved aid and charity. Recently, however, this has begun to change, and private, for-profit ventures are thriving. These are often known as social business—a term coined by Nobel Prize winner Muhammad Yunus.

Read the full post on Triple Pundit.

Microfinance + Property Rights

This story originally appeared in our October 8, 2010 e-magazine. Click here to subscribe.

Microfinance institutions have been hailed for the trusting relationships they have forged with the poor across the world. How can these networks be utilized?  Some believe they could serve as an important tool in helping the poor understand their property rights, and access secure land title. Abby Callard reports.

“Microfinance plus” is an evolved state of microcredit that utilizes the far-reaching branch networks of microfinance institutions (MFIs) to distribute impactful products like sanitary napkins and LED lights. Quite a few MFIs are already working with private sector and NGO partners in order to enable customers to have access to new products and services. But, what other services can be provided through MFIs? Is there a meaningful way in which MFIs can leverage their relationships and networks to educate the poor about their legal rights?

Sanjoy Patnaik, state director of the Rural Development Institute in Orissa,  says “It’s time that MFIs get beyond finance.”

MFIs are well positioned to become key partners in the effort to educate people about land rights; loan officers usually have a trusted relationship with microfinance clients and understand their most critical needs. MFIs can also allocate loans specifically for the purchase of land.

Many microfinance loans go toward the purchase of land, but MFIs are likely to be unwilling to make this a formal agreement due to the risks involved. The land rights situation can be difficult to navigate—unclear trusts, illegal squatters, and customary laws—making it a hard market for an MFI to enter. In addition, MFIs are reluctant to add the responsibilities of land rights education to their already overstretched loan officers.

However, there are several institutions that are adding value to clients through innovative means. BRAC, an MFI operating in several South Asian and African countries, educates its clients about their land rights informally through their legal aid program. The MFI identifies women in the Joint Liability Group and provides them loans that cover the cost of legal education, titling to the land and financing for the title.

Sinapi Aba Trust, an MFI in Ghana, is leveraging its loan officers to collect information that is being used to build a database about access to property for the poor.  Peter Rabley, President of International Land Systems, the technology partner involved in the project, said, “It’s a paradigm shift to get the loan officers and the MFI to function as the delivery mechanism for generating this information. Traditionally, that has only been done by the government.”

MFIs can serve as a remarkable asset in the work to collect information about borrowers and their access to property because they are trusted and well-known by the communities.  Sinapi Aba has 50 branches in Ghana, whereas there are only three land registration offices in the country. Because of this, the organization has a greater presence in the community.

There are other one-off projects happening in regions all over the world. SEWA Bank, an MFI based in Ahmedabad, Gujarat, has helped secure 400 plots of land in women’s names under the Land Act. The MFI gives loans to use for purchasing land as well as recovers mortgaged agricultural land in women’s names. This breaks the traditional male-to-male inheritance path. Among other things, this prevents widows from being kicked off their land by their late husband’s families.

Although MFIs have only begun to enter into the land rights struggle due to the risk involved, pioneering MFIs have shown that their networks and the relationships they’ve developed with their clients can be used to further the land rights movement.  When government policy is slow to materialize or implemented ineffectively, MFIs may serve as a great resource to reach the rural poor to educate them about their rights and help them access land.