Reflections on the Commercialization of Microfinance

19 December 2011

I run a microfinance institution (MFI). It was born of the strong conviction that market forces can help solve social issues.

Having worked earlier in the formal financial sector, I am acutely aware that the market is a double-edged sword: the benefits of price discovery, innovation, and customer centricity can sometimes be undone by an excessive focus on profit. Recognizing this, our approach was to design our MFI—Janalakshmi—in a two-tier structure: a non-profit company where all the promoters’ shares are held; and a for-profit non banking financial company (NBFC) operating company that works as a commercially viable enterprise. This dual structure ensures outside investors can earn a fair return for investing in the for profit, but it places a higher bar on me as a promoter …. Because……

I get no economic benefit from the success of my company. MFIs have chosen different institutional forms, but for the most part, our purpose is the same. The vilification of all MFIs because of the questionable behavior of a few has to stop.

Various voluntary efforts for MFIs to behave better in Andhra Pradesh went unheeded. Unfortunately, these voluntary commitments were never honored, resulting in a metastasized problem in AP in 2010. The conclusion from this was that for-profit MFIs are not to be trusted. The distinction between “profit” and “profiteering” is an important one, and a possible cornerstone for how to regulate MFIs.

The issue in AP was not for-profit MFIs per se, but weakly-regulated for-profit MFIs. It would not be unreasonable to claim that if only a tighter regulatory regime were present, many, if not all, excesses of MFIs in AP would never have come to pass.

Regulators put in place proper checks and balances for mainstream banks and others engaged in the financial system. Why should we assume “noble” behavior on the part of market participants solely based on the client base being poor? Weak regulations can lead to moral hazard, i.e. unprincipled behavior by MFIs.

Indeed, the AP experience shows the need for more, not less, regulatory clarity, given the sensitive nature of the client base. Unbridled laissez faire is perilous when it comes to the poor. Relying solely on market equilibrated prices and behavior is misplaced for three reasons: structurally inappropriate due to massive information asymmetries in the marketplace; morally unacceptable, given the vulnerability of the poor; and politically unfeasible, given the entrenched patron-client relationship between politicians and the poor.

There is no question that the role of for-profit institutions in addressing social issues needs to be thoroughly debated. But it is certainly not clear that “for-profit” institutional structures are fundamentally anti-poor. Evidence from a range of other industries suggests that for-profit models are in fact making a difference—from mobile telephony to consumer goods to healthcare innovation.

There are serious operational implications that arise from the different positions that we take in relation to for-profit and non-profit models for service delivery. For which economic strata of clients is the for-profit structure acceptable? Where do we cross the threshold for profit-based service? How will the baton of customer relations get handed off between the non-profit and for-profit entities to match clients’ rising prosperity, or do we expect the poor to remain poor? How will these benchmarks get recalibrated year-on-year with India’s changing development trajectory? Without such operational clarity, what we have are policies as statements of intent, not enablers of action.

The poor existed long before the idea of an MFI was even a gleam in someone’s eye. It is convenient to make MFIs the whipping boy of financial inclusion in India, when the real failure to solve the challenges over six decades has been that of our public institutions and regulators. Sixty years of trial and error on mandated targets, new public institutions, and branch proximity-based formulae have barely made a dent on the desolate landscape of financial inclusion. In the line-up of those who have failed the poor, our regulators and government must stand first, well before the handful of unscrupulous MFI promoters.

Microcredit is a small part of microfinance, and microfinance itself a small part of financial inclusion, whose canvas includes deposits, remittances and other financial services. Financial inclusion cannot be divorced from economic inclusion, or else we could end up artificially boosting the poor with credit steroids without the commensurate economic capacities to repay loans, resulting in exactly what happened in AP.

Any strategy for increasing access to financial services will require the creation of a vibrant ecosystem that enables financial inclusion. This means moving away from a “bank-only” model to a “bank-centric” model of inclusion, with many participants in it. Certainly the mainstream commercial banks will be at the centre, connected to a range of other players, including specialized financial institutions—some of which are for-profit—that cater exclusively to the needs of the poor, rural or urban. This kind of ecosystem will not only drive innovation on the customer front, but also in other areas of financial inclusion infrastructure—human resources, business processes, information systems, technology, and so on.

In such an ecosystem, for-profit MFIs can play a credible, responsible, sustainable role. These MFIs need to operate under and be held accountable to clear regulations.

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