Micro-finance Institutions: The Ethical Battle

The Economist, in its 2009 article titled “Financial Innovation and the Poor: A Place in Society” defines Social Finance as a movement based on the belief that financial innovation can be used directly to help society's neediest people. It goes on to cite microfinance as a main form of social investment that has grown dramatically in the past few years, even generating profits. While it is true that some of microfinance is targeted to sustain the poorest of the poor (a concept pioneered by Muhammad Yunus of the Grameen Bank), literature and examples around the world show that self-sustaining, profit -generating micro finance institutions (MFIs) are only targeting those strata of society that are not the neediest. This is because any capital given to the poorest of the poor goes to fund their daily requirements such as bread and water. Entrepreneurial ventures are only sustained when people have room to think beyond their basic necessities, and thus can generate a return to make lending to them viable (for a profit generating MFI).

The balance between social responsibility and financial return is fragile. While some believe that the poor must not be deprived of their rights, others believe that MFIs have a right to be self-sustaining in order to improve financial services for the poor. These considerations have led to a passionate debate within the microfinance world, primarily represented by Grameen Bank versus Banco Compartamos.

Muhammad Yunus asserted his belief in the non-profit microfinance model by stating, “When you discuss microcredit, don't bring Compartamos into it . . . Microcredit was created to fight the money lender, not to become the money lender” (Bloomberg Businessweek). Compartamos founders responded with an open letter asserting: “We believe in people, we believe that microfinance is finance and has to be sustainable, that economic value is a consequence of social value, that the main contribution of microfinance is the expansion of the market, that microfinance has great economic value, and that the challenge of combating poverty is much larger than microfinance itself” (Danel 2008).

The basic argument essentially boils down to three specific areas: interest rates, market forces, and self-interest.

Interest Rates

Grameen has long accused Compartamos of charging exorbitant interest rates. In Compartamos’ early years as a commercial bank, interest rates could total 100 percent annually. Compartamos claims that it is easier to reach a larger market because the high interest rate brings in more money that they can lend out to other people. The company has grown fast and the number of borrowers has increased from 60,000 to 900,000 over an eight-year period (2000-2008). This is hardly an indication of manipulation. The fact that people still borrow and have a 99 percent repayment rate is justification enough for the higher interest rates of Compartamos (Menon 1).

Furthermore, Compartamos argues that the increase in the income of the poor, after receiving a loan, is over 100 percent and sometimes even 200 percent. If the borrower has enough money to buy more raw materials (a sewing machine etc.), then their productivity will increase rapidly, because the individual can make more products that they can sell on the market. Thus, it is better to get financed at a rate of 100 percent than to not get financed at all.

Market Forces

Another argument claims that Compartamos is not facing true market pressures. Areas most in need cannot sustain a truly competitive market for financial services. However, as the commercial approach to microfinance becomes more popular, more banks will enter into microfinance therefore expanding the breadth, depth, and scope of microfinance. As commercial microfinance grows, there will be market pressures due to competitive access to borrowers. Commercial banks will face market forces with lower interest rates, expanded services, and increased access to the area’s poor. Furthermore, commercialization requires a great deal of transparency and accountability – to its investors, competitors, and the general public.

Self-Interest

            The last major argument is that Compartamos and other commercial banks are more interested in generating high returns rather than helping the poor. While others claim the bank is emphasizing profits over social returns, Carlos Danel defends this as necessary to allow Compartamos to fulfill its ultimate mission of helping the poor (PBS). Strong profits have allowed Compartamos to become self-sufficient so that it no longer relies on donor aid. Their return on equity was 55 percent compared to average MFIs that have an ROE of about 7.5 percent (Ashta, et al. 2009:5). Thus, the company makes high financial returns – over 7 times more than the average MFIs – that attract additional investors so that microfinance can be more sustainable, increase its access to more people, and continue to reinvest in its borrowers. Though it has expanded its approach over the years, Compartamos remains true to its original mission to help the poor (Danel 2008).

Conclusion

Grameen Bank has a business model driven by its social mission to reach the poorest of the poor. Due to its success it has been able to help more than 50 million people rise out of acute poverty. Its vision and implementation has helped to inspire other institutions to lend to the poor. Compartamos is one such institution which has taken the foundation of microfinance, and tailored it to its specific client base. While Compartamos offers similar services – loans and savings to small groups and poor individuals – it also has a broad range of services including insurance, emergency funds, and financial literacy programs. At the same time, as a commercial bank it seeks out private investors, encouraging an expansion in the microfinance world in order to achieve poverty reduction on a larger scale without dependence on outside funding sources. Compartamos is working toward self-sustainability while at the same time bringing transparency, accountability, and advanced financial services to microfinance.

The global demand for microfinance services is estimated to be $250 billion; existing institutions serve only about 10 percent of that demand (Weinstein).  Both the Grameen semiformal model and the Compartamos formal model could go a long way in meeting this demand. Compartamos could serve the lower-risk, vulnerable non-poor, and Grameen could continue to target unbanked poorer individuals (Weinstein).  All in all, microfinance is relatively a young industry.

A few questions arise regarding social financing: which model is better- which one serves the poor more, whether generating profit from the poor is even ethical or not. However I believe these arguments are premature since there are still billions of individuals in need of microfinance services and the concept of ‘financial dualism’ can work well in most developing countries: people have the option of choosing to borrow according to their needs and so, both systems can co-exist.