Microfinance Faces a "Quarter-Life" Crisis

Microfinance has been the darling of the international development community, and increasingly the financial services sector, for the past twenty-five years. The model of "banking for the poor" pioneered by Muhammad Yunus through the Grameen Bank became an international sensation when he won a Nobel Peace Prize for his work in 2006. Microfinance programs have evolved from the original Yunus-type model, focused on the betterment of society rather than profit maximization, to develop into a full-blown commercial micofinancing industry. Last week The Wall Street Journal reported the state of Andhra Pradesh - India's microfinance hub and one of the largest microfinance markets in the world - has enacted rules against lenders whose aggressive recovery practices have allegedly led to 30 suicides by poor borrowers. Critics claim that high interest rates and coercive loan collection by some institutions are responsible for this distressing trend. At the urging of government officials thousands of borrowers have stopped repaying lenders in protest, and India's commercial banks have frozen credit to microlenders. A group of India's largest microfinance institutions have sued the government in an effort to block the strict new regulations.

It may not be a coincidence that the Indian microfinance crisis comes on the heels of the hugely successful IPO of SKS Microfinance, India's biggest microlender. In August 2010, SKS Microfinance raised $358 million in an IPO that made millionaires of its founders while further proving the business case for microfinance, albeit raising serious questions about whether social or financial returns should be emphasized in the commercialization of 'social enterprises'. SKS Microfinance follows entities such as the highly controversial Compartamos Banco in the transition from non-profit to for-profit. While the returns from commercial microfinance are evident, the social impact of the model in alleviating poverty remains unclear. In fact, there is increasing evidence from academic researchers to validate anger expressed by the Indian government and microfinance clients. At the recent Microfinance Impact & Innovation Conference in New York City, more than 250 academics from institutions such as MIT, Harvard and Yale presented a sobering assessment of the industry. Researchers concluded that microloans that are often given at high interest rates and with strict repayment terms can actually further impoverish and indebt poor people. This is noteworthy given the growing size of the microfinance sector - at the end of 2009 there were 1,084 microfinance institutions serving 74 million borrowers, representing $38 billion in loans.

As commercial microfinance continues to scale and mature as an industry, there is a growing interest and desire to obtain market intelligence. Leading the way, Compartamos has agreed to provide its data to a group of Yale University Economics Professors in order to better understand the demand for its services. As Carlos Danel, co-founder of Compartamos Banco explained in New York, "There are more assumptions than evidence in the MFI industry. This was an industry born out of supply, not demand. (The loans) reflect what we can do, rather than what the client wants." Learning from microfinance's "quarter-life" crisis, social enterprises would be wise to conduct market research as they transition from non-profit to for-profit models to ensure the formation of sustainable business growth strategies.