05 January, 2009
Commercialization and Investment in Microfinance
By Tamsin Harriman at the Common Interest Foundation
Reflecting the increasing diversity of MFIs, there are a number of different funding options and organizational structures for microfinance. Some MFIs operate as NGOs (foundations, etc), while others operate as commercial banks. There is no standard definition of commercialization in microfinance, as different people understand it differently. According to Stephanie Charitonenko, Anita Campion and Nimal A. Fernando in their report on commercialization of microfinance in South and Southeast Asia, "Commercialization means different things to different people but international microfinance professionals are increasingly considering commercialization to be 'the application of market-based principles to microfinance' or 'the expansion of profit-driven microfinance operations'".
NGO MFIs are run and owned by a single person or a board of directors, often as a foundation. Commercial MFIs are private companies, owned or partially owned by shareholders. Many NGO MFIs become profitable, but they almost always put their profits back into their businesses, whereas commercial MFIs must always be profitable as they pay out a portion of their profits as dividends to their shareholders. Some commercial MFIs, such as the Grameen Bank, have only members as shareholders, thus ensuring that the poor reap all the rewards from the MFI's work.
Donations or grants from foundations and private donors have been and continue to be the most common source of funds for MFIs, and a very important one, especially in the start-up stage. However, as MFIs grow and want to expand their outreach, they sometimes find that grants and donations are not sufficient and are difficult to come by, with the grant application process being a little like the job application process - send out 100 applications and you might hear back from only one or two of the places you applied to. Thus many MFIs, especially commercial ones, are beginning to seek alternative sources of funding.
A relatively new source of funding for microfinance (previously mentioned on this blog) is investment, rather than donation, by companies, banks and individuals. This form of funding for microfinance has emerged with the evolution of profitable commercial microfinance institutions. In recent years, banks such as Citibank and Morgan Stanley, seeing the remarkable growth and profitability of MFIs, have started microfinance funds specifically for investing in MFIs. In addition, a few venture capital firms are starting to become involved in microfinance. Sequoia Capital recently invested in SKS Microfinance in India.
The amounts of these investments are often significantly larger than most donations or grants. However, since this money is a loan rather than a grant, the MFI is expected to pay it back, with interest, within a specified time period. Thus in order to take an investment, an MFI has to be sure it can grow enough and earn enough profit in order to pay that loan back.
This pressure to be highly profitable can, unfortunately, sometimes lead to higher interest rates and aggressive pressure tactics as the MFI struggles to recoup all its money and earn enough interest on its loans. This of course does the opposite of what the investment was intended to do, which is to help the poor. This pitfall can happen for non-commercial MFIs, too, and has less to do with the source of funding than with the culture and operating procedures of the MFI. All MFIs must be careful not to raise interest rates too high and not to be aggressive or intimidating in their collection tactics.
Commercial MFIs also sometimes drift away from lending to the poorest in favor of lending to the less poor or even to the middle class, as those loans (usually for small enterprises) are more profitable. This is not necessarily a problem. As long as there are MFIs that are diligent about lending to the poorest (whether they become profitable from it, as some do, or not) then other MFIs lending to the less poor is good, as it helps people out of poverty and often helps create jobs for the poorest when the small enterprises need employees.
Overall, the more sources of funding for MFIs, the better. It is encouraging that mainstream financial institutions are starting to become involved in microfinance, as there is a tremendous amount of money there that could be used for microfinance. The more money put into microfinance, either by donors or investors, the more poor people MFIs can help.
Reflecting the increasing diversity of MFIs, there are a number of different funding options and organizational structures for microfinance. Some MFIs operate as NGOs (foundations, etc), while others operate as commercial banks. There is no standard definition of commercialization in microfinance, as different people understand it differently. According to Stephanie Charitonenko, Anita Campion and Nimal A. Fernando in their report on commercialization of microfinance in South and Southeast Asia, "Commercialization means different things to different people but international microfinance professionals are increasingly considering commercialization to be 'the application of market-based principles to microfinance' or 'the expansion of profit-driven microfinance operations'".
NGO MFIs are run and owned by a single person or a board of directors, often as a foundation. Commercial MFIs are private companies, owned or partially owned by shareholders. Many NGO MFIs become profitable, but they almost always put their profits back into their businesses, whereas commercial MFIs must always be profitable as they pay out a portion of their profits as dividends to their shareholders. Some commercial MFIs, such as the Grameen Bank, have only members as shareholders, thus ensuring that the poor reap all the rewards from the MFI's work.
Donations or grants from foundations and private donors have been and continue to be the most common source of funds for MFIs, and a very important one, especially in the start-up stage. However, as MFIs grow and want to expand their outreach, they sometimes find that grants and donations are not sufficient and are difficult to come by, with the grant application process being a little like the job application process - send out 100 applications and you might hear back from only one or two of the places you applied to. Thus many MFIs, especially commercial ones, are beginning to seek alternative sources of funding.
A relatively new source of funding for microfinance (previously mentioned on this blog) is investment, rather than donation, by companies, banks and individuals. This form of funding for microfinance has emerged with the evolution of profitable commercial microfinance institutions. In recent years, banks such as Citibank and Morgan Stanley, seeing the remarkable growth and profitability of MFIs, have started microfinance funds specifically for investing in MFIs. In addition, a few venture capital firms are starting to become involved in microfinance. Sequoia Capital recently invested in SKS Microfinance in India.
The amounts of these investments are often significantly larger than most donations or grants. However, since this money is a loan rather than a grant, the MFI is expected to pay it back, with interest, within a specified time period. Thus in order to take an investment, an MFI has to be sure it can grow enough and earn enough profit in order to pay that loan back.
This pressure to be highly profitable can, unfortunately, sometimes lead to higher interest rates and aggressive pressure tactics as the MFI struggles to recoup all its money and earn enough interest on its loans. This of course does the opposite of what the investment was intended to do, which is to help the poor. This pitfall can happen for non-commercial MFIs, too, and has less to do with the source of funding than with the culture and operating procedures of the MFI. All MFIs must be careful not to raise interest rates too high and not to be aggressive or intimidating in their collection tactics.
Commercial MFIs also sometimes drift away from lending to the poorest in favor of lending to the less poor or even to the middle class, as those loans (usually for small enterprises) are more profitable. This is not necessarily a problem. As long as there are MFIs that are diligent about lending to the poorest (whether they become profitable from it, as some do, or not) then other MFIs lending to the less poor is good, as it helps people out of poverty and often helps create jobs for the poorest when the small enterprises need employees.
Overall, the more sources of funding for MFIs, the better. It is encouraging that mainstream financial institutions are starting to become involved in microfinance, as there is a tremendous amount of money there that could be used for microfinance. The more money put into microfinance, either by donors or investors, the more poor people MFIs can help.
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