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Microcredit: “Back to responsible banking”

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It’s logical for profitable microfinance institutions (MFIs) to prefer prosperous customers, because they bring in more money. But to refuse needy clients is going too far. Dutch economist Pim Engels is calling for a return to responsible banking, serving even the very poorest.

In 2007 while a student at Maastricht University Mr Engels went on on a work experience placement at Grameen Bank in Bangladesh. This MFI had been set up by Muhammad Yunus, a celebrated pioneer of microfinance. Mr Engels decided to write his master’s thesis on the link between the profitability of microcredit organisations and the number of poor customers on their books.

“People with a bit more money borrow larger amounts in one go, need less time with banking staff and pay the money back over a longer period,” explains Mr Engels, who now works as a consultant in ‘inclusive finance’, a new term covering microcredit.

Poor customers refused
“It’s more expensive to finance poor business people: they borrow smaller amounts, sometimes want to come along every week to make a repayment or to ask advice, and they pay the money back quickly. If, because of this, institutions refuse to take on poor customers, they have lost touch with the reason why microfinance was set up in the first place.”

About 150 million people worldwide make use of MFIs, generating around 60 billion US dollars’ worth of business. The microfinance boom does not always improve transparency in the sector. Stories about exorbitant interest rates are commonplace. Mr Engels explains the development:

“In the 1980s and 1990s, profits were considered more important than the price paid by the customer for a small loan. The idea was that a profitable sector could attract more capital, enabling it to grow more rapidly and reach more poor businesses. That aim has now been achieved.”

MFIs are less reliant on donors, thanks to increasing interest from international commercial investors. Competition in the sector has grown across the board. This also improves companies’ flexibility.

Financial profit
Profits are now, however, threatening to become too important. Fine if incomes go up while costs come down. But, as Dutch Crown Princess Máxima said at Radio Netherlands Worldwide’s microfinance conference in 2010, the organisations’ profits shouldn’t overshadow sustainable development.

Mr Engels warns that the pressure on microcredit organisations to produce good financial results can lead to 'mission drift'. A number of successful organisations in Mexico and India have already opted to become companies listed on the stock market. “If they do this, they’ll have to take their shareholders into account. That could draw them even further away from their original mission.”

Huge interest rates
The Social Performance Task Force was set up in 2005 and researches sustainable businesses funded by microfinance organisations. The Smart Campaign goes one step further and tries to protect people by providing information on the huge interest rates charged by some MFIs. These attempts, however, to make the microfinance industry return to its raison d’etre have had little effect. There are no clear agreements on reporting abuse or on regulating the industry. Mr Engels says there's still a lot of work to be done.

He stresses that, despite all the developments, microfinance is still a going concern, even for the very poor. The influence of small loans on a country’s economy as a whole is limited, but they have still helped millions of people escape poverty.

The conclusion of Mr Engels' thesis is that MFIs have to find the right balance between commercial development and responsible banking. “The outcome of the discussion is essential to the future of microcredit.”

Mr Engels’ thesis, Mission Drift in Microfinance, earned him last year’s University Meets Microfinance Award from Planet Finance, Berlin’s Free University and the European Union. The work was published in August 2010 (ISBN 978-3838201238).

 

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This article is part of the RNW archive. RNW is the former Radio Netherlands Worldwide or Wereldomroep, which was founded as the Dutch international public broadcaster in 1947. In 2011 Dutch government’s decided to cut funding and shift RNW in 2013 from the ministry of Education, Culture and Science to the ministry of Foreign Affairs. More information about RNW’s current activities can be found at http://www.rnw.org/about-rnw