The Microfinance Business Model: Enduring Subsidy and Modest Profit
Microfinance institutions aim to serve customers ill-served by traditional commercial banks and thus the associated business model is challenging by definition. And yet the industry has achieved impressive scale reaching 211 million customers globally in 2013. Paradoxically, recent evidence suggests that the benefits of microcredit to borrowers may be modest. For example, six prominent randomized controlled trials found small impacts of access to microcredit on the incomes and consumption levels of marginal borrowers, though the studies found some “potentially important” (though modest) impacts on “occupational choice, business scale, consumption choice, female decision power, and improved risk management.” (Banerjee et al., 2015, p. 14).
Even if one takes those modest benefits at face value, it would be wrong to consider the microfinance business model a failure without paying greater attention to the costs incurred to achieve those benefits. Modest benefits to borrowers could nonetheless feed into sizable benefit-cost ratios if the costs are also proportionally small. Indeed, this was a fundamental premise of microfinance.
To better understand how microfinance institutions target their customers and cover the costs associated with reaching them, we use proprietary data from 930 microfinance institutions that jointly served 80 million customers in 2009. We show that there is no single microfinance business model, but rather a number of models pursued by different types of institutions. Those chartered as non-governmental organizations (NGOs) tend to make smaller loans (panel A), which are substantially more costly per dollar lent (panel B), and thus require higher interest rates (panel C), than microfinance providers chartered as banks or non-bank financial institutions (NBFIs). Not only do they make smaller loans (the proxy for lending to poorer borrowers in much of the literature and in our analysis), NGO microfinance institutions also lend substantially higher shares of their portfolios to women.