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Why Careful Microfinance Works


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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.

Blog Tags: due diligence   impact   impact investing   investors report   microcredit   microfinance   poverty      

Microfinance that includes not just a loan but also integrated services like business education makes a major difference in the lives of people living in poverty.
An Alternativa Peru representative demonstrating a business education module. In GP's experience, integrated services like this, which not only provide loans but teach borrowers how to make the best use of loans and utilize other available resources, are essential to the long-term success of microfinance clients. Photo courtesy of Alternativa Peru.

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