ET : Aid Donors Have Shown Microfinance Can Work : Mar 30, 2007

Aid donors have shown microfinance can work. They should now leave their
successes behind

SUCCESS HAS MANY fathers. No wonder, then, that paternity suits are flying
in microfinance – lending small amounts to help the poor pull themselves out
of poverty. Thanks first to charities and, later, international financial
institutions (IFIs) like the World Bank, microfinance has been shown to
work. Now philanthropists such as Bill Gates and Pierre Omidyar, the founder
of eBay, are using their own charities to pour money into the field. So,
increasingly, is the for-profit sector, including “socially responsible”
investors and capitalists more interested in the bottom line than the
poverty line.

Microfinance is a promising way to get credit to parts of the economy
that are starved of capital. So it is a pity that all these lenders are
competing to support the same, small group of microfinance institutions that
cater to the most creditworthy borrowers. It would be better for the poor if
the IFIs and donors left the best credit risks to profit-seeking lenders and
concentrated instead on those still stuck outside the system.

Micromanagement

No doubt that sounds ungrateful. Microfinance is in vogue thanks partly to
the IFIs, which provided grants, loans and training to untested microcredit
institutions. The private sector shunned the risk – out of ignorance, a lack
of expertise and fears that making money from the poor would look predatory.
The pioneering work of donors means there are now some 10,000 microfinance
institutions lending an average of less than $300 to 40m poor borrowers
worldwide.

As a result, microfinance has become profitable. Toptier microlenders no
longer need subsidies or even commercial loans from IFIs or philanthropists.
ProCredit, made up of 19 microfinance banks in countries from Moldova to
Ecuador, was established in 1998 by some IFIs. Now wildly successful, it
boasts over 2.2m customer accounts and arrears by volume of a minuscule
1.2%. So many of its banks make money that it could even list its shares on
the stockmarket.

The Inter-American Development Bank has acknowledged that the best
microlenders can finance themselves either by gathering deposits to finance
loans or by attracting commercial investors. It is busily selling equity
stakes in its portfolio of microfinance investments. But other development
groups are less willing to cut the apron strings. They continue to devote
scarce aid dollars to the microlenders that need them least. Having nurtured
these outfits when for-profit groups would not, they now want to bask in
their successes. Some philanthropists, too, prefer to take the safe route
and invest in stable, profitable top-tier microfinance groups.

This trophy lending is harmful. By subsidising microfinance groups that
do not need it, aid bodies and philanthropists discourage private money,
which cannot compete with their soft terms. In the long run, this harms
microfinanciers, because it slows their integration into the
financial-services industry and thus hampers their transformation into
lenders able to stand alone.

Aid money is better spent where commercial cash fears to tread – such as
on the next generation of microfinance institutions. Subsidies are often
needed to lend to the rural poor, where small, scattered populations make it
hard for commercial lenders to cover their costs. Donor funds could be used
to invest in technology such as mobile payments, which promise to cut the
cost of providing microcredit. Top microfinance institutions themselves may
need help in expanding into insurance and other financial products for the
poor, as well as in tapping the capital markets. IFIs, in particular, can
press foreign governments to get rid of interest-rate caps and other
misguided regulations that impede microlending.

Only a fraction of the world’s 500m impoverished “micro-entrepreneurs”
have access to the financial system. There is not enough donor or “socially
responsible” money in the world to meet the demand. That’s why microfinance
needs private-sector capital. Aid agencies, philanthropists and well-meaning
“social” investors can help attract it by investing only where commercial
outfits will not. When the children come of age, the best parents step
aside.

The Economist

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