Yes, Microfinance Is Alive, But Does It Still Matter?
Many donors, foundations and development finance institutions have moved on from microfinance, in search of the leading edge of innovation and impact. They have concluded that their work is done now that leading microfinance institutions (MFIs) have definitively cracked the capital markets with healthy balance sheets and several large, heavily oversubscribed Indian initial public offerings (IPOs) in recent years. Meanwhile, impact investors, particularly in the U.S., are divided on whether microfinance is, or ever was, an “impact investment.” In any case, they prefer to focus their attention on new “disruptive” business models. In impact industry publications, conferences and even terminology, microfinance is dead; yesterday’s solution at best.
Fortunately for people at the bottom of the pyramid (BOP), no one told microfinance that it has died. The robust IPOs and active trend of mergers and acquisitions indicate healthy commercial capital market interest. More importantly, the industry now has a central role in national financial systems all over the world, with hundreds of millions of clients, and penetration into the majority of low-income communities in the world. The idea that the poor can constructively use and be sustainably provided with a comprehensive range of financial services—unthinkable 20 years ago—is no longer debated. Policymakers and mainstream financial institutions have recognized that a dynamic BOP finance sector fosters both equitable and sustainable development and the health of national financial systems and economies. And from an institutional standpoint, MFIs employ tens of thousands of people often from the same demographics as the clients they aim to serve. It also bears mentioning that the poor people at the heart of the industry are overwhelmingly female.
Fortunately for people at the bottom of the pyramid (BOP), no one told microfinance that it has died.
In the context of these mirror image appraisals, 32 microfinance and impact investing practitioners, investors and analysts from around the world convened one year ago, hosted by Lehigh University’s Martindale Center, and sponsored by the Calmeadow Foundation and the Financial Inclusion Equity Council to explore what role microfinance will play going forward. Overall, the group agreed that while dead to some, microfinance is alive and kicking on the ground and vigorously generating diverse business models and approaches to building economies and social value.
Around the world, microfinance is employing evolving models as it takes its place in the financial and economic development landscapes: mainstream commercial banks downscaling; specialized banks branching into SME lending, housing and other subsectors; mobile banking; agricultural finance; and microinsurance. And in nearly all countries, a substantial subset of MFIs are continuously experimenting on ways to blend commercial and social missions, building on sustainable financial foundations to diversify product offerings beyond microcredit to meet more of their clients’ varied needs.
These various models challenge microfinance to revisit its role in creating social value for the client. The pursuit of scale and efficiency at times implies “mission drift.” It also remains to be seen whether mission-led MFIs are the most effective means to build social value for poor clients in a world where mobile and digital technologies can reach the previously excluded at a fraction of the cost.
More fundamentally, skepticism over the future of microfinance reflects doubts that today’s leading incumbent MFIs—once the disruptive innovators themselves—can ever generate disruptive forces of the magnitude needed to make meaningful progress towards achieving development objectives. Quite conceivably, the future lies with new models, blending digital financial services that reduce costs with traditional face-to-face “high touch” interaction to reduce risk via data and algorithms and increase outreach.
The future of microfinance and the challenge for those who prioritize social value for clients is in taking advantage of the strengths of incumbent MFIs, particularly their proximity to clients: a four-decades-deep, hard-earned understanding of heterogeneous needs at the bottom of the pyramid. As donor and impact investor attention is captured by shiny new frontiers—health care, budget schools, smallholder agriculture, off-grid energy—MFIs that want to build on the value of this experience face two fundamental challenges.
The future of microfinance and the challenge for those who prioritize social value for clients is in taking advantage of the strengths of incumbent MFIs, particularly their proximity to clients: a four-decades-deep, hard-earned understanding of heterogeneous needs at the bottom of the pyramid.
First, those in the microfinance sector must convincingly deliver to impact investors the message that MFIs—professionally governed, managed and staffed, with reliable access to capital markets, diversified product offerings, and unique penetration at the BOP—offer the best available platform to design, test and in many cases deliver products and services to create social value. Even where new channels or specialized institutions can be effective, as in the case of mobile money or housing finance, new entrants will need to learn how to fit narrow product expertise into the complex and sophisticated financial lives of poor people.
Second, while the bulk of microfinance portfolios may be fully commercially sustainable and attractive to conventional investors, reaching the still-excluded will continue to require innovation and experimentation supported by patient, mission-aligned investors, grant subsidies or below-market financing—the model that fertilized microfinance to begin with. This central and essential role of subsidy—not for market distorting price reductions, but rather for innovation, infrastructure and capacity building—is the salient takeaway from microfinance for impact investing more broadly.
The fact that so many donors and impact investors no longer view microfinance as an attractive funding option undermines the ability of the industry to further strengthen through trial and error the robust business model that underlies its current success and stature—and inspired today’s exuberance for “impact investing.” Microfinance is alive, well and firmly integrated into global mainstream capital markets. But to reclaim top rank status as a destination for impact investments, MFIs must redouble efforts to distinguish themselves by focusing on client outcomes and serving as labs of innovation in product design and delivery. They will need to adopt new and innovative technology such as digital finance and fintech, improve their governance as innovation increases the risks faced by MFIs which venture out, and continue to build social value in support of their clients.