Those who have stepped remotely close to the world of social enterprise may have come across the story of microfinance. In brief, microfinance was born when an economist named Muhammad Yunus noticed how problematic widespread poverty and famine was in his home country of Bangladesh. He came across women from the villages that had their lives controlled by loan sharks and would inevitably spend the rest of their lives in poverty. Traditional banks deemed the women not creditworthy but the women needed money to earn a living. Muhammad Yunus first helped the women repay their debt to the loan sharks worth a total of $27 USD at the time and became a guarantor for the women so they could get loans from the bank. Overtime he realized that lending money to the poor was not so difficult because they were trustworthy, hardworking people. Working with the poor made him realize that they had problems beyond money. So it was decided. He created the first social business – a bank for the poor to eradicate poverty. That marked the birth of microfinance and a movement that would address mankind’s other problems.
A Bank for the Poor
The bank is called Grameen Bank. Grameen Bank operates differently than traditional banks. First of all, borrowers do not need collateral to get a loan. This allows the poor to gain access to loans, many of whom were initially women as a protest to traditional banks that refused to lend money to even the wealthier women. Second of all, loans are made in small amounts, hence the name microfinance. A loan would typically average $200 and carry with it an interest rate that never exceeds 20%. Third of all, the Grameen Bank is owned by the borrowers themselves. The bank is financially self-reliant as the model is structured so that borrowers must save money in the form of deposits. Finally, the Grameen Bank has more goals than to lend money to the poor. Borrowers with children can opt for education loans so that they become self-reliant entrepreneurs rather than enter the job market, a move that develops the country and harnesses the energy of the poor. Grameen Bank explains to the children that their mothers own the bank and have money to support their businesses. There is no need to work for someone else.
Criticism of Microfinance
Microfinance started more than 20 years ago. The Grameen Bank itself grew to serve over 80,000 villages in over 2,000 branches. Microfinance banks were popping up in all parts of the world, perhaps realizing that a 98-99% repayment rate of the poor is after all a viable business opportunity and that there are approximately 3 billion people in the world living in poverty. This is where the problems come in.
1) More Suffering
People are starting microfinance banks all over the world at a rapid pace. Owners do not realize this is not the same as starting a traditional bank, but that it is for the poor. The poor have trouble living day to day already and do not have the slightest clue how to manage their finances. They end up taking out multiple loans without any idea how to repay them. The original objective was to get the poor out of poverty by giving them money to start their own businesses and generate their own income, but they needed to use the money otherwise, whether for their children’s school fees, medical fees, or other household expenses. Many who were ashamed of having unbearable debt or could not see the day they were out of debt ended up committing suicide, which became a small epidemic in India where microfinance has taken off. Only a small percentage was using the money for business purposes.
2) High Interest Rates
Another criticism of microfinance is that while the Grameen Bank charged low interest rates, other microfinance institutions were charging people high interest rates. In Andhra Pradesh, India, this became as much as 35%. According to Muhammad Yunus some even charged over 80%.
3) Does it Work?
Perhaps the fundamental criticism was that given these problems, does microfinance work? Does it actually help eradicate poverty? Was this a case of good intentions and no capacity? The answer is typically one of mixed opinions. On the one hand, Grameen Bank has grown to a bank with worldwide branches, each of them financially independent and neither of which rely on each other for funds. The bank is 94% owned by the borrowers themselves which means they have respectable savings. Another successful organization of microcredit is Kiva, which lends as little as $25 to fund projects and obtains regular progress reports. Today, Kiva has a repayment rate of 99% and given loans totaling over $274 million.
Others who have benefited from microfinance have only found themselves deeper into poverty, as they struggle with daily lives and do not have enough knowledge or entrepreneurial spirit to get themselves out. They end up taking multiple loans to make ends meet. Some even resorted to selling their organs to pay off debt. It would seem that such a program would only function well with tighter regulations and support for the poor.
4) Scalability & Regulation
With 3 billion people in poverty, to get anywhere close to eradicating poverty would require some time. To speed up this process, some microfinance institutions are trying to get more funding so they can pull people out of poverty faster. In 2010, SKS Microfinance in India went public on the Bombay Stock Exchange. Immediately this led to two sides of an argument. First, the institution can benefit from funds to reach out to a larger number of people faster. Unique to this case is also the fact that legal frameworks in India do not allow microfinance institutions to collect deposits the same way microfinance institutions can do so in Bangladesh to fund their banks.
The other side of the argument told by Muhammad Yunus himself is that by raising an IPO, it is sending a wrong message about microfinance institutions, that there is a chance to make money out of the poor. Instead SKS Microfinance should apply for a banking license which would allow them to take deposits. The moral argument of making money from the poor is something Muhammad Yunus believes humans should not undertake. In the book Building Social Business, he says “I have no quarrel with the pursuit of profit. But first let’s give the poor people the help they need to escape poverty. Once they have become middle class, then I urge you to sell them all the goods and services you can – and make a handsome profit doing so! But wait until they are no longer poor before you exploit them. That is only the right thing to do.”
By going public, the institution would also have to juggle duties to the shareholder in addition to serving the poor. Under Muhammad Yunus’ social business idea, when social goals are being juggled with profit-making, the opportunity cost tends to fall on social goals. What should the business do if it has an opportunity to increase profit by slightly cutting social benefits? In economic stress when the business is trying to survive, it would defeat the original purpose of the social cause as the focus goes to sustaining the business. In a recent interview with Liam Black, Muhammad Yunus does not oppose the idea that to expand the programs rapidly may depend on the stock market and thus create gains for some people, but SKS Microfinance should not call it microfinance because it redefines the original meaning of a social business. Instead, it is a publicly traded profit-making social enterprise. Perhaps the answer to scalability would soon fall on the rise of social stock markets where only companies with clearly defined social purpose can be listed. There is also rising legal framework for businesses such as benefit corporations that protect the incentives of businesses with social purpose.
Future of Microfinance
If microfinance is supposed to help the poor out of poverty, it would seem that the criticism should not be against microfinance, but rather the businesses that use the term who have redefined it since. Problems show that the future needs stricter monitoring and systems for microcredit programs to work as well as a better understanding of the needs and abilities of the poor if it were to eradicate poverty.
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