NextBillion - An Initiative of the William Davidson Institute at the University of Michigan

When Muhammad Yunus, Ingrid Munro and other microfinance pioneers, got together in the first Microfinance Summit in 1997, they adopted what for many was an impossible goal: to reach 100 million people living with less than $1 per day by 2005. Although the deadline was missed, the 100 million mark was reached in 2007, an incredible feat nonetheless.

The Microcredit Summit Campaign groups microfinance institutions with the common goals of reaching the poorest and of empowering women. In their State of the Microcredit Summit Campaign Report 2009, they confirm that, having double-checked 80% of the figures of their member microfinance organizations (totaling 3,552 organizations in 2007), the 100-million-poor mark was reached by the end of 2007. Just to get a feeling of the figures involved: it is estimated that these 3,552 microfinance organizations reached more than 150 million clients, of which more 106 million were “poor.”

Of these poor clients, 83.4% were women (or nearly 89 million). Assuming five persons per family (a relatively low family size in many developing countries), the more than 106 million poorest clients in turn had an effect on around 533 million family members. More than half a billion. Talk about the scalability of a business model.

As such, the Report was in a celebratory mood and presented their new seemingly “impossible” goals for 2015:

• To reach 175 million poor families;
• To ensure that 100 million families rise above their $1 a day threshold adjusted for purchasing power parity

However, the Report also pointed out some clouds in the not-so-far future. Chief among their worries is the financial crisis which has started to hit many of these institutions making it harder and more expensive for them to access financial resources. The ways in which this crisis may affect the microfinance sector and the BoP arena at large have been explained in more detail in one of my recent posts.

Suffice to say that the Institute for International Finance forecasted net private sector capital flows to emerging markets in 2009 to be no more than $165bn, less than half the $466bn inflow in 2008 and only one fifth of the amount sent in the peak year of 2007. Additionally, the IMF released on January 28 an update on its World Economic Outlook in which it decreased its projections for growth. Emerging market and developing economies are expected to grow 3.3%, with economies like Russia or Mexico actually shrinking (by 0.7% and 0.3% respectively).

Sahba Sobhani and Suba Sivakumaran from the Growing Inclusive Markets Initiative at the UNDP have recently penned an interesting paper (what I call a ’cappuccino’ document – short and tasty) offering suggestions about how to improve the design of microfinance products by virtue of a comparison with subprime mortgages. Since the paper is unpublished, I have attached it to this post as a downloadable document. The authors point out the following weaknesses in the microfinance business model:

• Credit scores and default models are frequently outdated or inappropriate to the particular market (Gwinner and Saunders, 2008).
• Microcredit does not access the poorest in all microcredit markets. For example, in Peru, Kazakhstan and Uganda, only around 15% of microfinance customers were among the poorest half of the poor (Morduch, 2005). Additionally, there are worrying signs that some borrowers may be starting to use one source of microloans to pay off another one.
• The increased use of securitization (roughly speaking, a process in which the lender sells bundles or packages of loans to investors in capital markets) may create a misalignment of incentives. Some microfinance institutions may be tempted to issue as many loans as possible knowing that they will not suffer the consequences if things take a bad turn. Another incentive misalignment may be in the making if lenders outsource their lending activities to other organizations in the field.
• Regulation in microfinance markets is opaque and quite diverse. Many institutions are largely self-regulated. For example, only few countries have pushed to have transparency regarding effective interest rates. Some microfinance institutions have been found to take advantage of the financial illiteracy of their customers and added excessive processing fees to the balance of the new loan.

Looking at the data contained in the State of the Microcredit Summit Campaign Report mentioned above I have an additional source of concern. Although the organizations surveyed are 3,552, it seems that microfinance markets are very unevenly spread. For example, most of the clients seem to be in the Asia and Pacific region, most especially the Indian Subcontinent and South East Asia. China has barely any relevance. Additionally, the market has a very high concentration on a handful of institutions. Around 10 banks serve more than 26% of the total microfinance market.

This is a quite dangerous state of affairs. If there was any adverse shock in the Indian or Bangladeshi economy and as a result some microfinance institutions collapsed, millions of poor customers would suddenly be thrown to the cold again. To avoid this danger, it is paramount to help more small-sized institutions make the leap into the big league and avoid the whole system being overly dependent on the financial health of a small number of banks.

On a lighter note and to conclude this post, I recently came across a great video done by a Kiva Fellow about how the lending process in Kiva works. It was very interesting and uplifting and so I would like to encourage everyone to check it out here.