Microfinance: Why is it in the hot seat?

By Maureen Aylward

It seems like microfinance has been in the hot seat recently. We asked Zintro experts to explain the key factors behind the questioning.

Sophia Velissaratou, a risk expert and founding member of the Women Advancing Microfinance (WAM) UK chapter, says that due to its high repayment  rates (more than 98 percent) and low risk profile, microfinance is an attractive new asset class for commercial investors. “Funding was pouring in and the sector experienced a rapid growth and competition increased,” explains Velissaratou. “As a result, the focus shifted from clients’ needs to high profitability for the microfinance institutions themselves. Investors wanted their money back sooner rather than later, and something changed in the industry.”

Velissaratou says that the Banana Skins 2011 survey, which was conducted by the Centre for Study of Financial Inclusion, reports that the main concerns within microfinance are credit risk, unethical lending practices, fierce competition and reputational risk. “Worldwide there are numerous microfinance initiatives that use best practices and make a difference in the lives of the poor. However, controversy in microfinance should be a wake-up call for practitioners, donors and investors alike,” says Velissaratou. “There should be more focus on clients and their needs. Microfinance institutions should become more professional with robust risk management but remain flexible and avoid overregulation. In addition, they need to better educate clients about their needs and educate practitioners about their work ethic. Lastly, microfinance needs to be continuously in search of simple and effective solutions and avoid one-size-fits-all quick fixes.”

Patricia Tyre, an expert in microfinance who created a microfinance investment fund for people living in poverty in Southeast Asia, says that she sees several reasons why microfinance is under scrutiny at the moment:

  • Aggressive lending practices brought on by an abundance of lenders,
  • A lack of intimacy with the clients or borrowers, and
  • The dilution of the mission.

“Microfinance was developed as a demonstration of a pure value chain. “Those people who received their resources from working gave to those who needed resources to expand. The result of everyone’s hard work was the free flow of money,” says Tyre. “There wasn’t any need for regulations when the implied contract was in the fundamental understanding of the mission.” Tyre says that the recent economic crisis exposed this pure value chain of financial return to a larger market that wanted to enter microfinance. “In late 2008, when the credit markets seized up, microfinance was nearly the only game in town,” she says. “This left it vulnerable to players with non-mission related agendas. Those new players flooded the markets in places like India, which put pressure on lenders, and a microfinance sub-prime market was created.”

Theo Baken, an expert in microfinance since 1980, says that microfinance has been in the hot seat for many years now. “It operates in a vulnerable environment, and due to its outreach, it has reached levels of sustainability and achieved success,” says Baken. “Microfinance has also become an easy target for finger pointing; however, it should be acknowledged that microfinance represents just one of the elements in poverty reduction.”

Baken says that the growth of the microfinance industry through its outreach to the poor population has captured the attention of politicians in many countries in Africa, Asia, and Latin America. “Politicians are eager to misinterpret common parameters, such as the costs of financial services, and paint it as charging unreasonable and excessive rates of interest,” he says. “Institutions in the financial sector express doubts on the basis of their own risk management policies and handling of securities, and therefore, artificially keep microfinance institutions at arm’s length making microfinance an easy target.”

Nevertheless, the microfinance industry is developing itself in a rigorous manner. “Product development of financial services is increasing through financial inclusion and supports income generation and business development,” says Baken. “Capacity development supports performance, and regulations are stricter than the formal financial sectors.” Baken also points out that the industry sees client protection as a major issue and that bilateral and multilateral agencies contribute to equitable and efficient local markets for microfinance.

By Maureen Aylward

What do you think?

If you have a question or comment about the microfinance industry, we would like to hear it. Click here. Would you be interested in signing up to be a Zintro expert and generate free leads for your business? Click here.