In microfinance, small is beautiful


Ever since monks had to take vows of chastity, obedience, and poverty, it has been assumed that in order to be saintly you have to be poor. This misconception has prevented many would-be-do-gooders such as charities and NGOs from harnessing the power of the profit incentive in their quest to change the world. However, the supposed sin of capitalism can deliver development results that are nothing short of miraculous. One particularly successful development trend has been microfinance, the issuance of small loans to would be entrepreneurs unable to secure credit from a conventional banks. A poverty solution that rests on hard work, innovation, and expanded market access? Perhaps microcapitalism would be a better term.

The original version of microfinance, as pioneered by Nobel Peace Prize winner Mohammad Yunus and his Grameen Bank, operated along a non-profit model. A recent reincarnation, however, still seeks to expand the access of the poor to credit – all while turning a profit. And while the non-profit groups are forced to rely on scanty donations from elderly hippy couples, for profit microfinance organizations can attract big name investors like George Soros and Goldman Sachs—big names means big contributions, and more capital means more loans can be given out to more people.

Recently, the microfinance industry, and in particular its for profit variety, has ballooned. Even conventional banks have launched microfinance branches, which by all accounts have become some of their highest performing areas. However, the industry’s growth has not been welcomed in all quarters. Local and national governments in India and Bangladesh have sought to regulate and even take over the microfinance organizations operating within their borders. This invasive regulation is defended as a response to ‘predatory lending’ and suspected ‘corrupt practices’. The Reserve Bank of India has decreed that microlenders cannot receive priority sector credit unless they agree to accept a hard cap of 26% on their interest rates. Furthermore, in the Indian state of Andhra Pradesh, local officials have actually instructed borrowers not to pay back their loans. Government manhandling such as this sends investors running – stocks in the microfinance group SKS have lost nearly 75% of their value since last year’s peak. The entire industry is now at risk.

Yes, microfinance banks may be lending to the poor at rates that a conscientious objector in the developed world might not agree to. But, in many communities, microfinance remains the only viable means for the poor to secure credit. The answer is not to regulate microfinance by imposing crude caps on their interest rates, but rather to allow microfinance to blossom into a profitable industry. As profits encourage more firms to enter the market, companies will be forced to compete for consumers, forcing down the interest rates. The free market therefore can achieve the very result that regulators seek, all while creating an environment in which both the consumers and the firms benefit.