ON TIME: Officials from an Indian microfinance organisation receive a weekly payment installment from a borrower in the village of Vadod, Gujarat.
Microfinance is, at its heart, an effort to provide financial services to people who are not served – or are under-served – by the formal banking system. With appropriate, accessible, and fairly priced financial services, people can build their savings, cover the costs of unexpected emergencies, and invest in their families’ health, housing, and education.
The International Finance Corporation estimates that microfinance has reached some 130 million people worldwide in the last 15 years. Over this period, microfinance has been lauded for its potential to advance financial inclusion and enable people to escape poverty. But it has also faced harsh criticism, with some lenders being accused of profiteering.
Despite the industry’s widely publicised pitfalls, its potential to improve the lives of the poor cannot be ignored. The question now is how to ensure that microfinance becomes the industry that the world needs.
To this end, three important steps must be taken.
The first step is better regulation. Microfinance institutions (MFIs) come in many forms – mainstream banks, specially licenced banks, non-financial companies, finance and leasing companies, non-governmental organisations, cooperatives, and trusts – and follow a variety of business models. All of these intermediaries must be recognised and regulated according to the needs of the economies in which they operate.
Inadequate regulation is most damaging to those who need microfinance services the most. Nowhere was this more apparent than in the 2010 microfinance crisis in the Indian state of Andhra Pradesh – a hub of MFI activity – when a decade of explosive growth, fueled by aggressive and reckless lending practices, came to a head.
The second step, to be taken by the microfinance industry itself, is to create effective mechanisms for assessing the industry’s impact. As it stands, some governments and academics are uncomfortable with the fact that MFIs, which are supposed to be providing a public good by advancing financial inclusiveness, are pursuing profits.
But the failure of some MFIs to differentiate between profit-seeking and profiteering does not mean that sustainable microfinance should not yield returns above costs. The business of providing financial services to the poor requires commitment. Without profits, MFIs are unable to invest in the talent and product development needed to serve people for the long term.
Many governments have now implemented interest-rate ceilings and margin caps to curtail excessive profits for MFIs, while ignoring the margins of the market’s non-organised alternatives, like pawnbrokers. In order to provide a more balanced perspective on the microfinance industry compared to other kinds of financial-services providers, MFIs need to do more to measure and explain their social and economic value.
The third step concerns technology. Mobile connectivity is transforming the global financial system by enabling remote, rural populations to access financial services for the first time. Mobile-payment systems like M-Pesa are changing how people transfer, receive, and save money in many developing countries, including Kenya, Pakistan, and the Philippines.
For the microfinance industry, such systems represent an important opportunity, as they enable borrowers to apply for, receive, and repay loans on their mobile phones, using a network of local agents to deposit and withdraw cash. But without robust regulation, MFIs cannot make the most of these developments.
Although microfinance has already helped countless people worldwide, the World Bank estimates that some 2.5 billion adults still lack access to financial services. It is the responsibility of all stakeholders – including governments, regulators, banks, and civil society – to ensure that microfinance continues to be part of the solution.