The
Microfinance movement began in the developing world during the 1970s. Dr.
Muhammad Yunus, considered by many to be the grandfather of microfinance. He
studied the needs of the poor in the surrounding areas and found that in the
absence of financial institutions. They were forced to turn to local money
lenders and loan sharks who charged them steep rates of interest. The Grameen
Bank was formed by Dr. Muhammad Yunus applying microfinance concept. Today, the
Grameen Bank services loans to over 7.5 million individuals, with over $1
billion assets under management.
Microfinance
was developed in response to mainstream financial institutions which failed to
provide financial services for the poor. Microfinance is unique from mainstream
finance in that it has a double bottom line mission: both social performance
and financial performance. Since the 1990s the industry has evolved to include
for – profit models which have caught on with investors who seek socially responsible
investments and diversified returns. Today, the microfinance movement has gone
global. It is estimated that there are over 10,000 microfinance institutions
worldwide.
One of
Mexican microfinance institution named Compartamos was originally conceived as
a non profit in 1990. A decade later, it adopted the for profit model, in an
effort to increase the scale its operations. By 2007, Compartamos was
established as a publicly traded microfinance bank and managed to raise $458
million in its IPO. When it was revealed at the time of the IPO that
Compartamos was charging annual interest rates of around 86% on its loans, some
industry practitioners and politicians accused the bank of usury, Including
Dr.Muhammad Yunus accused the bank of
exploiting the poor for the benefit of investors and of straying from the
original mission of the movement. However, when viewed within the context of
the local market, their rates proved to be lower than local lending standards
which were charging around 175% interest.
Another
microfinance institutions which IPO to make headlines was SKS microfinance, the
India’s largest microfinance institutions. SKS evolution from a nonprofit just
over a decade ago to becoming a for profit lender in 2005 serves as a beacon
for many in the industry. Regulated by the Reserve Bank of India, the
organization now operates 2,029 branches in 19 states with the total number of
members served reaching over 6 million. According to a report published
microfinance insights, only a fraction of the market for micro credit market in
India is being serviced. In 2009, a total of INR 200bn (roughly $4.5 billion)
in microloans were serviced while the total market is estimated at INR 2400bn
(roughly $53 billion). It is due to this largely untapped market that SKS has
been able to double its borrowing list each year.
The Debate
Microfinance
institutions are serving the poor, they should not be chasing profits and
instead they must give them loans at low rates of interest. And the debates
‘are the interest rates charged by the microfinance institutions high?’ In
simple terms, interest rate on loan is the amount of interest (%) paid by the
borrower for the use of the money they have borrowed. On the other hand, to
understand why high rate are often necessary, one has to understand the high
administrative costs inherent in microfinance operations.
There are
several costs a microfinance institution must cover when it provides microcredit.
The operational expenses related to offering small, uncollateralized loans are
higher than in commercial lending. The process by which these loans are made,
tracked and recovered is time and resource intensive. The motive behind this
debate is to search the answer for the question that “what should be the ideal
or optimum rate of interest?” The ideal situation would be the interest rate
should be enough to cover the operational cost of microfinance institutions and
would also have some profit as microfinance institutions needs to expand their
services.
While
administrative costs do justify higher interest rates, there are cases where
microfinance institutions charge unnecessary or even abusively high rates. In
response to this problem, industry leaders have called for protocols to verify
that interest rates charged to micro entrepreneurs
are reasonable and transparent. Transparency will also have to take on an
important role for the microfinance industry in order to retain the trust of
those on both sides of the equation.
Dr. Yunus,
in a recent debate with SKS founder Vikram Akula at the Clinton Global
Initiative, acknowledged the capital raising power of for profit models, but
voiced concern over the implications of their involvement. He argued the need for locally owned and
operated banks to prevent against the volatility of global capital markets. He
also stressed the need for a clear definition of the term microfinance so that
it could only be applied to microcredit lenders with social objectives. The
argument from commercial lender that with increased margins, microfinance
companies can reinvest in the development of new product lines to address the
myriad needs of the poor.
Conclusion
The debate
in microfinance industry had challenged all the parties (practitioners, governments,
donors, banks, corporations, NGOs, foundations, wholesale funds, civil society,
and others) to think about how microfinance institution that pursue financial
and social return should be managed. Microfinance institution needed to improve
their operations by creating robust and transparent delivery systems in order
to serve the poor better and achieve long term sustainability.
To support
microfinance transparency, there are organizations like MFTransparency and the
Smart Campaign which also working to improve loan pricing disclosure to protect
clients. Another organization, like Oikocredit also supports microfinance
transparency and to improve information sharing and reporting on pricing in the
microfinance sector in over 30 countries, Oikocredit also dedicated to
investing in people and take pricing transparency as a serious matter.
References:
Eva pereira.(2010) . Re-Examining The Microfinance Mission: Should Interest Rates Be Capped? Retrieved from http://www.forbes.com/sites/evapereira/2010/09/30/re-examining-the-microfinance-mission-should-interest-rates-be-capped/
Abhishek Bose. (2009). The Interest rate Debate in Microfinance. Retrieved from http://dynamicscope.blogspot.com/2009/09/interest-rate-debate-in-microfinance.html
Eva pereira.(2010) . Re-Examining The Microfinance Mission: Should Interest Rates Be Capped? Retrieved from http://www.forbes.com/sites/evapereira/2010/09/30/re-examining-the-microfinance-mission-should-interest-rates-be-capped/
Abhishek Bose. (2009). The Interest rate Debate in Microfinance. Retrieved from http://dynamicscope.blogspot.com/2009/09/interest-rate-debate-in-microfinance.html
Luminis. Debate in Microfinance. Retrieved
from https://www.luminismicrofinance.com/AboutMicrofinance/Debate
Ramakrishna
Nishtala. .(2010). Microfinance: in whose Interest?. Retrieved from http://articles.economictimes.indiatimes.com/2010-12-16/news/27596407_1_mfis-charge-interest-rates-microfinance-companies
Unitus Lab.
About India Microfinance Innovation Initiative. Retrived from http://unituslabs.org/projects/india-microfinance-innovations/?gclid=CNiz4Ynrw7YCFREP6wodLXQARw
Oikocredit.
(2011). The Interest Rate Debate: How is Oikocredit Protecting Clients?.
Retrieved from http://oikocreditusa.org/k/n2090/news/view/2490/2336/The-Interest-Rate-Debate-How-is-Oikocredit-Protecting-Clients.html
