Nitin Rao

Imagination with Realism: What Works for Microfinance

Microfinance, in its for-profit avatar, is attracting capital, talent, blogposts – you name it – and a fair bit of criticism. So when Alex Counts, President & CEO of the Grameen Foundation proposed his vision for Reimagining Microfinance in the Stanford Social Innovation Review, he targeted the right issues. The problem, as I see it, is that elements of Counts’ vision are simply not realistic.

I agree with Alex that microfinance is better placed as a platform from which to develop and distribute a range of products and services?not just financial ones. I also agree that microfinance institutions stand to gain by structuring themselves to gain from high volume, not high margin models. This will help not just in terms of revenue, but also in terms of managing what can be a precarious political environment for MFIs and their investors.An excerpt from an article (The Big Trouble With Small Loans) in TIME Magazine illustrates the line MFIs must tread:

Consider the time a bank chairman asked if SKS could raise its interest rates. Akula said yes (in most markets it has a monopoly) but that SKS wouldn’t do so because it would be exploitative. The banker scoffed that Akula didn’t understand economics. Akula shot back that the banker didn’t understand customers, who would turn on SKS if they felt abused. “We’re maintaining a loyal customer base that will stay with us as they get out of poverty,” says Akula.

(Full disclosure: I work at SKS Microfinance)

However, in my view, Counts goes too far and becomes too idealistic in the proposals that follow.

Limits on Private Benefit
Counts recommends that MFIs limit the private benefits its leaders receive through restricted executive compensation and equity options. I beg to differ here.

There is no compelling evidence to believe that compensation at well endowed foundations is more “modest” than microfinance organizations with a double bottom line. Indeed, there may be a bigger disconnect when charities pay premium compensation.

However, it is true that the microfinance sector receives implicit subsidies, and these grants need to be increasingly structured to facilitate faster innovation where markets simply take too long to work.

I find it uncharitable when Counts writes, “MFI executives who have received paltry salaries for years are tempted by the prospect of becoming wealthy in the wake of public offerings.” This is nearly equivalent to saying that because employees have been working at sub-market compensation, they deserve to remain isolated from opportunities to use the market to reward their effectiveness.

Third-Party Certification
Counts proposes that MFIs receive objective third-party certification before claiming to be double bottom line organizations, based on four criteria: social performance, private benefit, consumer protection, and reinvestment of profits.

Consumer protection is critical, and the need of the hour is to require MFIs to be more transparent about their fees and interest rates.

However, the proposed “obligation to allocate some portion of their surplus in a manner consistent with their overarching social purpose” is both ambiguous and can severely restrict the type and amount of capital available to MFIs, and hence to clients.

Indeed, when Counts advocates capping compensation for executives, his suggestion is driven by idealism and will likely reverse a new breed of quality talent entering the sector. Add to this (and this probably deserves a post by itself) the fact that the development sector is increasingly dependent on a large chunk of “fad” talent that is attracted to development for the very short term. At a time when current levels of management experience and financial skills are seen as the greatest risk for the microfinance industry, capping executive pay and requiring MFIs to donate profits may scare away the very people microfinance needs to meet its challenges.

Also, many of these policing arguments could well be extended to any socially responsible business. How about businesses experimenting with mobile banking channels? Low-income housing? Microinsurance? Where do we draw the line?

Great intent does not always translate into great results – and I believe that when we reimagine microfinance, we can’t imagine away real motivations of the individuals who will make this social change happen.