Why Careful Microfinance Works
by Mark Coffey, chief investment & operating officer, Global Partnerships
Within the impact investing industry, microfinance has historically been viewed as a fine example of an investable, market-sustained solution to poverty. Hundreds of millions of dollars have flowed to microfinance institutions (MFIs) and microfinance investment vehicles—across asset classes—generating social impact alongside consistent and stable financial returns.
Yet despite the popularity of microfinance as an investment sector, recent press has questioned its social impact in the lives of the people being served. For example, a recent article in The Guardian argues that most microfinance loans are used for consumption—not income generation—and therefore "end up making poverty worse."
While Global Partnerships invests into many types of channels, such as agricultural organizations and solar businesses, our roots are in microfinance institutions (MFIs), and we continue to selectively invest through this channel. Over our 20+ year history, we have learned many lessons, and one guiding principle has been "it takes more than a loan to lift someone out of poverty." We observed, for example, that extending credit to someone living in poverty that led to over-indebtedness clearly had a negative social impact, and providing a loan for consumption or non-productive purposes at unnecessarily high costs did not lift people out of poverty, and might make their situation worse.
On the other hand, certain models can be highly effective. For example, the combination of women-centered credit and tailored education—especially when delivered through the group lending platform at a reasonable cost—can have a meaningful impact at the household level. Clients become empowered and informed decision makers and are able to smooth their incomes and consumption, build assets and increase their capacity to anticipate and deal with major expenses.
So, the question should not be whether microfinance as a whole results in positive or negative outcomes, but rather "what MFI models are most effective at the household level?" As with any product or service, we believe that the most positive impact occurs when the provider has the best interests of the household in mind. We work with a relatively select portfolio of MFIs, but have examined hundreds with which we have chosen not to work. We begin our process by understanding whether the institution is more focused on the household or on their own growth and financial returns, and to what extent their model delivers value in a sustainable and scalable way. We are wary of institutions that cannot provide meaningful metrics of how they evaluate impact, or that serve the interests of the owners and managers more than their clients.
Noting that many MFIs exclusively provide financial services and have moved up-market to better-off clients to enhance growth and returns, GP primarily seeks out small and mid-size MFIs that have a combination of solid financial performance and positive impact at the household level. We look for business models that have carefully been built to leverage and integrate various services that a person in poverty needs. Alternativa Peru, a GP partner since early 2014 and the featured partner in our most recent Investors Report, represents this type of model where we seek to invest, for highest impact and a well-managed fund investment.
Are there microfinance lenders interested primarily in maximizing profit? As in most industries, yes. However, there are also many dynamic social enterprises that recognize that microcredit is just one small piece of what people living in poverty need in order to improve their lives. These organizations are client-centered and understand their needs far better than anyone looking on from abroad. At GP, we work to identify and partner with the best of these organizations and learn from them what combination of goods and services has true impact at the household level. We then seek positive social returns at the household level by carefully directing our capital to these types of organizations.
Speed dating with purpose in Ecuador: 3 themes from the annual FOROMIC conference
by Nathalia Rodriguez Vega, financial and economic analysis officer, Global Partnerships
Earlier this month, I was one of seven members from the GP team that flew to Ecuador to attend FOROMIC, an annual conference held by the Inter-American Development Bank. It’s the largest event about the financial inclusion industry in Latin America and the best occasion to meet – in just 3 days – most of our partners as well as other organizations that help us do our work in the region.
For me in particular, this event was a unique opportunity to step away from the spreadsheets and lengthy reports, fly all the way from cloudy Seattle down to sunny Guayaquil, and get a first-hand impression about the people we work with, what excites them about their latest achievements, what worries them about the future, and most importantly, hear how we can help them.
How to speed date at FOROMIC
I met with representatives from 20 of our current 46 partners, in meetings that lasted about one hour on average. If you want to know how this works, picture an area in the middle of a convention center called the “Meeting Point”, which is filled with about 50 tables that are conveniently numbered and that can seat about four people at a time. Before the annual conference begins, the FOROMIC website allows you to see who is attending and gives you the option to schedule meetings with as many people as your agenda and body can take. Therefore, once the conference starts, you just need to go to the meeting point and someone from the team running the event will take you to your table. Every hour either this same person will come to tell you your time is up, and that someone else is meeting at that table, or you can just walk to the next table where you have your next meeting. It’s basically speed dating with a purpose.
These meetings could go in many different ways depending on the type of partner and how many years we have worked together. However, most of the time we would ask them to highlight the most important things that happened over the past year, the challenges they anticipate for the next couple of months, and their funding needs.
To sum up, here are three broad insights from my conversations with our partners:
1. The marketplace is very crowded:
Likely reflecting ample global liquidity, I was surprised to see so many lenders offering funding at very low interest rates. Although this “buyer’s market” probably makes many of our partners happy, it’s worth noting that current market conditions are unlikely to be like this permanently.
Furthermore, this abundant liquidity worries me, as it might create the wrong incentives and cause our partners to deviate from their mission. Therefore, as an impact investor we need to do an even stronger screen of the people we work with in the region. We need to follow up closely on any changes in their strategy, including the type of products they offer and how they care about raising the quality of life of people living in poverty.
2. Paradoxically, over-indebtedness co-exists with low financial inclusion rates:
Over-indebtedness is one of the key concerns addressed by many of our partners. This reminded me of my last trip to Peru, when I visited the small town of La Merced that had streets lined with all types of financial institutions. Even though Peru ranks as the leading country enabling financial inclusion (prudent regulation, agents and branches, and dispute resolution), financial inclusion is still relatively low (only 20 percent of the adult population held an account at a formal financial institution in 2011, according to the World Bank’s Global Financial Inclusion Database (Global Findex).
This signals that our work is not done. Vulnerable populations – women, indigenous groups, etc. – remain without access to financial services. However, not all organizations have the cost structure to fulfill their needs. We need to work with them to find ways they can reach vulnerable populations and at the same time have the right policies, risk mitigants, and controls to prevent over indebtedness among their clients.
3. Changing legal climate:
Most of our partners are changing their legal structure; some are looking to become regulated entities while others are planning on converting into cooperatives. In Bolivia, the 2013 Law of Financial Services, still undergoing implementation, requires that all non-governmental organizations or Instituciones Financieras de Desarrollo (IFDs) obtain their license over the next two years. With this license, our partners will have access to additional sources of funding, including deposits from the public, which is likely to reduce the need for international investors.
Given this context, we discussed with our partners what the future of our relationship would be. Overall they highlight that we have worked with them for many years, even in periods when funding was scarcer and they were just starting to run their operations. They value our role in helping them be the type of organization they are now and we are exploring other ways to keep our partnership in the future. We’re going to need creative ways to achieve this, for sure.
After three days of “speed dating” my brain felt somehow bigger with all these new learnings. I felt re-energized from all the conversations I had and impressed with the talent I met. This trip gave me a new sense of responsibility; we have a strong commitment to our partners and they see us as people that can provide them guidance and advice beyond funding. I can’t wait to go back to FOROMIC next year.
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