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Business News/ Opinion / The business of microfinance
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The business of microfinance

The business of microfinance

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SKS Microfinance, India’s largest microfinance institution (MFI), on Friday sought regulatory approval for an initial public offering that has the potential to change the nature of microlending in the country and add fuel to the debate over the industry’s profit motives.

Microfinance started off in the 1970s with the principle of bringing financial services to the sections of society traditionally excluded by conventional financial institutions; the germinal idea was that even the poor could repay loans if these were properly structured and their size regulated. Forty years down the line, that inclusive focus has brought in funds from socially motivated donors and investors, both foreign and domestic. But cost of capital has been considerable, prompting microlenders to charge high interest rates.

Microfinance proponents such as Grameen Bank founder Muhammad Yunus have objected to these high rates. But Yunus’ formula of a less than 10% interest rate spread for an MFI to be in the green zone of socioeconomic acceptability has had few takers other than Grameen itself. Mexico’s Banco Compartamos, for instance, has made its fortunes charging rates in excess of 85%.

However, all this is not enough to prove that MFIs have moved away from their stated social objectives. The Bharat Microfinance Report, released by Sa-Dhan, an association of Indian MFIs, shows that average loan sizes increased across the country in 2009, with few borrowers of very small loans. During the same period, the number of microfinance clients grew 60%. In fact, Yunus’ formula loses out for its poor practicality. Large numbers of very small loans demand high rates, and artificially lowering rates may disincentivize MFIs from expanding their reach to the very poor.

In this context, SKS’ equity offering has lessons for the larger microfinance industry. A share sale provides MFIs with long-term mainstream commercial capital rather than the socially motivated short-term sources they have been tapping. First, this gives MFIs the incentive to deepen their reach to the very poor, and even lower interest rates. More importantly, a commercially viable enterprise is able to take the risks entailed in encouraging clients into entrepreneurship rather than simply servicing their day-to-day requirements. In the long run, this has positive ramifications for financial inclusion in the country.

Microfinance: for-profit business or non-profit venture? Tell us at views@livemint.com

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Published: 29 Mar 2010, 01:15 AM IST
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