Microfinance pioneer Muhammad Yunus has slammed the commercial banks and private equity firms which have piled on to the bandwagon that he got rolling in Bangladesh three decades ago. He says this has all the makings of another subprime crisis. The world’s poor will be enticed to take loans they cannot pay.
There is no doubt that mainstream financial institutions have rushed into microfinance. The issue that Yunus has raised at an annual industry meeting at Bali first came into prominence in April 2007, when Mexico’s Banco Compartamos raised money from the public by selling shares. Activists criticized it for making huge profits by lending to the poor. Many Indian banks such as ICICI Bank, too, have rushed off into microfinance territory. SKS Microfinance has raised venture capital from Sequoia Capital.
There is no reason to hide microfinance behind a veil of morality. Let’s face it: It’s an awfully attractive business. The World Bank estimates that microfinance institutions charged an average 28% on the loans they made in 2006. It is returns such as these that have attracted the suits to the honey pot. One part of these high interest rates can be explained by the high risk that comes with lending to the poorest. The other part comes from the fact that there is still not enough competition in the business.
The global microfinance rush is likely to push down interest rates in the future. The founders of Compartamos wrote in a June letter to their peers that the interest rates charged by their company has dropped from 115% to 79% over the past seven years.
Microfinance is one of the great innovations of our age. The poor are constrained by the lack of credit and Yunus realized before anyone else that you can lend to the poor profitably. He worked through self-help groups. So do many others who follow in his footsteps. But if the goal is to provide more credit to the poor, he should realize that we need more types of microfinance organizations, not less. So what if a few of them come from the mainstream financial sector?
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