New Research from World Bank Highlights Tradeoffs in Microfinance
Asli Demirguc-Kunt, a chief economist at the World Bank, recently posted an article entitled “Microfinance: Dream versus Reality”. Her post provides an overview of the tough tradeoffs faced by microfinance institutions: between serving the poorest clients and achieving financial sustainability (and profitability). I highly suggest reading it, as it provides a synopsis of recent World Bank research and conclusions on the state of microfinance markets, including analysis using data culled from the MIX. The economists stress that their findings highlight the sometimes white-washed and downplayed tension between “meeting social goals and maximizing commercial success.” They conclude that “reaching the very poor with small-scale services remains a tough business and often entails charging high fees or depending on steady subsidies.”
To summarize in my own words, they point out the difficulty of simultaneously meeting 3 goals: commercial sustainability, financial access for the poorest, and reasonable rates (as illustrated by the graphic below). Any one side of the triangle connects two of these goals, but leaves the other behind.
In other words, to achieve any two of these simultaneously is possible, but involves sacrificing on the third: Institutions can increase profitability and keep rates reasonable, but then they must offer higher loans and forgo helping the poorest; MFIs can serve the poorest clients and be self-sustaining, but this requires high interest rates; and finally it is possible to charge reasonable rates and provide broad financial access, but this often entails reliance on subsidies and soft financing.
This situation is no doubt simplified, and begs several questions: what qualifies as a “reasonable rate” or a “high rate” and how does this change as we look at increasingly smaller loans? What external forces come into play and can they be used to ease the tension and better meet all 3 goals? What other variables might be making it more difficult for institutions to reach an optimal balance among these tradeoffs? How can multiple institutional models work together in a market to provide the best combination of services and expand access?
The answers to these questions are rarely straightforward, but their is substantial hope in exploring them further. Through this process the microfinance community can help find a balance and ease the tensions highlighted above. Microfinance markets the world over are changing fast. Their are promises for new technologies that can be leveraged to reduce the cost of providing these services. We here at MFTransparency are working to provide better information on prices, so that “reasonable rates” can be disentangled from the unreasonable, and all stakeholders can have better information with which to make decisions. We hope that through these and the many other prospects for a more responsible and efficient microfinance community, the challenge of negotiating tradeoffs can be met in such a way that allows markets to increase financial access at reasonable prices while also achieving sustainability.
The researchers at the World Bank of course note nuances in their data but their conclusion is simple one. They are right to point out the importance of recognizing the tradeoffs that their research highlights. Their is little to be gained by pretending that microfinance presents a simple “win-win” solution for the world’s poor and commercial investors. Microfinance is a tool, and for it to work best it has to be understood so it can be honed, refined and optimally utilized in the fight against poverty.