Reflections On Microfinance: Past, Present and Future
The microfinance sector is one of the most successful models of social entrepreneurship – it provides a critical service to the poor through a business model that has proven to be commercially viable and rapidly scalable. Living in remote rural areas, or even urban slums, the poor have limited access to formal banking systems and can often only access credit at usurious interest rates charged by local money lenders. However, my perspective has been significantly impacted by the phenomenal rise of microfinance, followed by the crisis that until recently threatened the sector’s very existence in India. More tangibly, developments within Indian microfinance have dramatically influenced my thinking about how organizations and industries that pursue financial and social returns should be managed.
First, it is imperative for social organizations to understand the capacity and needs of their target clients, and assess whether they continue to adjust to the changing needs of these customers. Most microfinance institutions (MFIs) began with a single product, the Group Loan, and failed to diversify their client touch points. This focus eventually led to a fundamental disconnect with both their clients and changing realities on the ground, largely due to the lack of innovation and impact measurement.
In addition, socially motivated organizations need to consistently re-evaluate their business models, in order to understand the changing landscape of risks along their distribution channels. For instance, the group liability model, in which clients co-signed each other’s loans thereby removing the need for expensive credit checks and collateral, was extremely innovative when it was conceptualized. However, for various reasons, this technique no longer served as an adequate underwriting mechanism as the industry evolved. A stronger periodic assessment of the microfinance business model and the changing financial situation of clients could have prevented the crisis that occurred.
Moreover, incentives that drive organizational performance need to be periodically evaluated and modified as per the industry lifecycle. Microfinance institutions depended on very low default rates coupled with rapid growth to provide adequate investor returns. In fact, the industry’s entire operational machinery was geared towards these two goals. For example, loan officers were incentivized to maintain high levels of collections while acquiring new clients at breakneck speed. This relentless pursuit by MFI collection officers led to significant social pressures on defaulters, even in the case of sickness or bankruptcy, given that the group liability model requires other members to cover a delinquent payment. Aligning loan officer incentives with repayment rates and customer service may have helped microfinance institutions become more customer centric.
Furthermore, institutions within an industry offering largely homogenous products must conduct fair and responsible operations, since disruptions caused by one organization could have far-reaching ripple effects. The entire microfinance industry came under fire for heavy-handed collection techniques employed by only a handful of MFIs. Strict self regulation might have facilitated amicable solutions, but most importantly, speaking up in industry and regulatory forums about these practices would have forced organizations to address such issues from the onset.
While traditional industries are often applauded for focusing solely on their core value proposition, social enterprises may need to approach solutions more holistically. Since socially motivated enterprises often cater to large, diverse and politically sensitive client groups, buy-in for services is imperative for longer-term sustainability. This may mean slower growth in order to establish deeper relationships, or having to provide non-core services to develop customer stickiness. Creating this buy-in through transparent and inclusive practices often leads to clients themselves becoming the voice of an organization when the industry hits a bump, which could have abated the microfinance crisis in the first place.