"Microfinance in the Real World: For-Profit Growth Will Benefit the World’s Poor"
In recent weeks, a backlash has crystallized against for-profit microfinance ventures in general and Mexican microfinance bank Compartamos, which had a successful IPO this past April, in particular. It's been alleged that those microfinance organizations (MFIs) that pursue profit inevitably lose sight of their social mission as they become answerable to shareholders and institutional lenders; that Compartamos has enriched shareholders at the expense of its poor clients; and that loans to the poor in the high-interest Mexican environment in particular can do more harm than good.
At ACCION, we have long been committed to helping MFIs meet the high standards of transparency and operational efficiency required of regulated financial institutions. That usually means operating on a for-profit basis, but it does not mean abandoning the social mission. Many MFIs, Compartamos among them, are finding ways to hold themselves accountable to both halves of the double bottom line – profitability and positive social impact.
Some Key Facts about Microfinance
- Access to financial services helps alleviate poverty. Just as the poor often lack basic physical infrastructure, they also lack the basic financial infrastructure that is a foundation of middle-class stability and risk management. That means access not just to credit, but also to savings accounts, checking and electronic payment services, and insurance. Without these services, life is a precarious, day-to-day enterprise, in which a fire or poor growing season or illness can cripple a family’s fortunes and stunt its children’s future prospects.
- Microfinance has a long way to grow. After two years of accelerating growth, MFIs worldwide had a collective outstanding portfolio of more than $23 billion loaned to some 52 million people, according to the Microfinance Information Exchange (MIX). According to the World Bank’s CGAP, the Consultative Group to Assist the Poor, there are approximately 500 million poor 'microentrepreneurs' worldwide who lack access to financial services and could benefit from them. That demand cannot be met without for-profit investment.
- Business loans at 'high’ interest rates can be a boon to the poor. Because servicing loans as low as $100 to poor clients is labor intensive, microfinance interest rates are high by developed-world standards. Standard APRs range from 20-30% in East Asia to 80-85% in Mexico. These rates, however, are a small fraction of those charged by 'informal' lenders who are generally the only source of credit to the poor. At the same time, returns on investment for micro-enterprises are generally quite high. A small loan often provides enormous increases in productivity – as when a carpenter moves from a hand saw to an electric saw – and labor, infrastructure and legal costs are low. And because loan terms are generally short – two to six months – the actual interest paid is a fraction of the APR.
- For-profit MFIs can and do hold themselves socially accountable. MFIs, working individually and collectively, are developing social performance frameworks and subjecting themselves to regular audits. Key metrics include success of outreach to targeted populations, measured by average size of loan as a percentage of per capita income in that country; client retention and repayment rates; full transparency of loan terms and costs, affirmed by client feedback; regular board assessment of social as well as financial performance; and implementation of regular impact surveys.
Some Key Facts about Compartamos
- Clients are satisfied. Interest rates have not surfaced as a lead issue in the extensive customer feedback that Compartamos elicits. Clients of Compartamos have been willing to pay the rates charged, as attested by low delinquency (<1%), high retention rates, and rapid client growth – today in excess of 750,000 nationwide.
- Rates are competitive. In Mexico,interest rates are high because capital and labor are expensive compared to other developing markets. Mexican MFIs also provide relatively small average loans (measured as a percentage of GDP), raising operational costs. Compartamos’s rates are clearly within the market range for microfinance. For example, three MFIs – FINCOMUN, FINCA and FINSOL – charge interest rates ranging from 81 percent to 103 percent, compared to 82 percent at Compartamos. Compartamos is more profitable than the others because it is more efficient.
- The range of viable rates is relatively narrow. According to an analysis by Richard Rosenberg, a consultant with CGAP, Compartamos could have reduced its interest rates to the range of 65 to 70 percent while maintaining a level of profitability in keeping with other banks (e.g., return on equity of 15 percent). The costs Compartamos faces, which are detailed in the CGAP paper, mean that rates could not be reduced further than this without sacrificing the ability to attract risk capital in the future, even from socially-motivated sources. That’s not to say that Compartamos can’t or shouldn’t lower – or isn’t lowering – its rates as the market develops, but it’s important to recognize the range of the possible to date.
- The IPO is a market stimulus. Since the Compartamos IPO in April of this year, five new Mexican banks targeting the low-income sector and 26 new savings and loan companies have been approved – compared to a mere 16 approved from 2000 - 2006. Three additional banks targeting this segment and 60-80 new S&Ls are seeking approval for 2008. As competition increases, Mexico's notoriously high interest rates are dropping. ACCION’s experience in Bolivia, Ecuador and Nicaragua shows that competition works to reduce prices and increase range and quality of products and customer service.
- Compartamos uses profits for building financial strength. High profits have given Compartamos a wide range of options for growing and expanding its range of services, as it is now planning to do. Compartamos’s strong equity base, built from retained earnings, as well as its profitability, were undoubtedly factors in the decision of the Mexican government to authorize Compartamos’s banking license.
- Compartamos uses profits for growth. Compartamos has kept the vast majority of the profits generated by high interest rates as retained earnings and used them to finance rapid expansion. Retained earnings were quickly lent out to new clients. Compartamos has used this strategy to grow its client base from 64,000 in 2000 to over 765,000 today.
For a more detailed analysis of the Compartamos IPO, please visit http://publications.accion.org/ and download InSight #23: The Banco Compartamos Initial Public Offering.