India: Commercial MFIs Can Make Markets Work for the Poor
Mumbai, India, February, 16 2012 -
Commercial microfinance institutions (MFIs) are an exemplification of making markets work for the poor. Are they indeed? A recent piece of research, comparing the lending performance of for-profit MFIs with not-for-profit MFIs, shows that though for-profit MFIs serve close to three-quarters of the market, the evidence does not seem to indicate that these MFIs lend indiscriminately when compared to their peers.
Supporters and critics of microfinance agree that the demand for reliable financial services is huge. However, the role of fully-commercial, profit-seeking institutions in providing such microfinance loans remains controversial. Critics argue that MFIs are nothing but brute moneylenders, the very beast that microfinance was built to root out. Supporters, however, argue that several hundreds of thousands of poor customers that such MFIs serve would otherwise have had even worse financial options. Would not serving them be a better social outcome?
Since the for-profit MFIs would be expected to pursue profit maximisation disproportionately more than the non-profit ones, in a recent piece of research, I compare these two categories of MFIs to examine whether profit maximisation by an MFI compromises on its social objectives.
The following are the results. First, as seen in Figure 1 for the number of active borrowers and the number of loans outstanding, the for-profit MFIs in India serve more than three-quarters of the microfinance clientele. Second, contrary to the fears that profit maximisation by a microfinance institution would impel it to lend indiscriminately, we find no difference between the for-profit MFIs and the non-profit ones with respect to (i) the average number of loans outstanding and per borrower, and (ii) the outstanding loan balance per borrower.
If the for-profit MFIs were providing further loans to already indebted consumers and the not-for-profit MFIs were not, then we should have seen a difference between the for-profit and not-for-profit MFIs in these two variables.
Third, as seen in Figure 3 with respect to the revenue performance, the for-profit enterprises charge higher interest rates when compared to their non-profit counterparts. However, as seen in Figure 4, close to 97% of the for-profit MFIs in our sample lend at nominal interest rates lower than 30%.
Fifth, as seen in Figures 4 and 5, we find the operating costs and expenses for for-profit MFIs to be on average significantly higher than that for non-profit microfinance institutions. This may possibly be because the for-profit MFIs have to pay market-based compensation to their employees, which the non-profit MFIs may not. The for-profit MFIs pass on about two-thirds of these higher costs to their borrowers, which are reflected in the higher interest rates they charge when compared to their non-profit counterparts.
Using statistical methods that control for other differences between for-profit and non-profit MFIs, the for-profit MFIs in India are no more profitable on average than their non-profit counterparts. Last but not the least, the lending portfolios of the for-profit MFIs in India are no more riskier on average than those of their non-profit counterparts.
These findings indicate the apprehensions that profit-seeking objectives of MFIs led them to (i) charge usurious interest rates and/or (ii) push loans indiscriminately to their borrowers irrespective of the borrower's debt capacity may be exaggerated.
The close linkage between the costs and expenses faced by MFIs and the interest rate they charge their clients suggest that policy measures that increase the costs and operating expenses of MFIs will have detrimental consequences either in the form of increased interest rates charged or through credit rationing if a ceiling is imposed on the interest rates.