Reflecting on Microfinance: The Problem of the “Missing Middle”
By Brian Williams
Most Westerners did not know anything about microfinance until Muhammad Yunus, an early initiator in the field, won the Nobel Prize in 2006. However, microfinance has been a tool for poverty alleviation since at least the 1970s, when the Self Employed Women’s Association (SEWA) in India, BRAC in Bangladesh, and ACCION in Latin America became non-profit microfinance institutions (MFIs) lending at low interest rates.
The time has come to reflect on the successes and failures of microfinance. Has microfinance come of age? Is it the solution people thought it was? What challenges now face the sector?
One could credibly argue that microfinance has come of age: though it is far from the panacea some may have thought it to be, it does offer equitable lending services to millions of people across the developing world. By 2007, BRAC had reached 7.37 million people with microfinance services in Bangladesh. According to CARE’s 2009 state of the sector report, the number of total borrowers from MFIs in Africa is nearly 6 million while the number of savers is well over 9 million.
Some MFIs have become so profitable that private banks have bought majority shares in them. For example, Financiera EDYFICAR, an MFI founded by CARE in Peru eleven years ago, was bought in September by Banco Credito del Peru, which is Peru’s largest private bank. CARE reports that the 200,000 women it has reached in Niger have collectively amassed $14 million ($70 per person) in a country where most people live on less than $2 per day. BRAC states that its borrowers repay their loans at a rate of 99.5%. CARE’s state of the sector report also notes overwhelming non-monetary benefits from microfinance to the women who participate.
Yet, despite these gains, why are so many people still eking out an existence at the bottom of the pyramid? Though many may be saved from pure survival living due to microfinance, the upswell of development many hoped for with microfinance has not been fully realized. Much recent discussion has converged around a central problem in development that microfinance is not addressing: the missing middle.
CARE reports that 20 to 30 percent of members in its village savings and loan cooperatives will likely want a greater array of financial services in the future as they grow their businesses. CARE, like many other MFIs, cannot provide these services. However, neither can private banks. Microfinance is limited in the total value of loans it can give out because of capital constraints and the need to reach the millions of individually poor people in a given region.
The result of these constraints is that microfinance cannot facilitate the creation of small to medium sized enterprises (SMEs). SMEs are the “missing middle”. They are locally run enterprises that hire local people and operate with greater capacity and potential for scale than self-employed enterprises. Running a SME requires different skills than running a self-employed enterprise. Finding MFIs with the capital to make appropriate loans to SMEs, and locals who have the skills to run SMEs, are a rare combination.
Many MFIs and other organizations are now realizing the need to fill this gap. Such MFIs are becoming like micro-venture capitalist firms and offering less total loans than regular MFIs but greater capital in each individual loan. One example of this phenomenon is Root Capital, an MFI founded in 2000 and based in Cambridge, MA, that offers loans to SMEs in Central and Latin America worth an average of $182,000. Courtney Rountree, a student at the Harvard Kennedy School proposed a similar vision of a social venture capital firm at a recent forum of the Harvard Social Enterprise Collaborative group.
More business training for local entrepreneurs, greater influxes of capital, and more conduits of that capital are just some of the prerequisites for establishing financial products appropriate for the missing middle. What other factors will influence the future of MFIs? Certainly scalability and enabling micro-entrepreneurs to reach the point of becoming SMEs is important.
Muhammad Yunus’ recent book with Karl Weber addresses the concern that, within the MFI world, the original intention to keep interest rates on loans low to help the poor has deteriorated into cases where MFIs are charging interest rates akin to predatory lenders. This is alarming in a sector that is largely unregulated (i.e. only 22 African nations have laws governing MFIs). The buyout of CARE’s MFI start up in Peru is just one example of a private firm seeking profits through an MFI. The stakes are high for all involved in this industry: predatory MFIs could degrade people’s trust in legitimate MFIs, and donors may be more wary of funding MFIs if the sector remains unregulated.
Despite these concerns, microfinance has certainly had net benefits in terms of helping the poor along the path of development. Development is a long and complex process. The playing field is often unregulated and the problems are often difficult to define. Even though microfinance must continue to grow as a sector to meet new challenges, it has proven its worth as an essential part of the overall solutions to poverty.
Brian Williams is a Masters of Public Policy candidate at the Harvard Kennedy School. He formerly worked in development and relief in Morocco. He is now a military officer hoping to inform the military’s reconstruction efforts abroad with a greater understanding of development.
I found this article to be very insightful and supports my own intuitive observations and field experience. For the past three years, Sudex, on a very small scale provides grants and scholarships to students in Uganda, Ghana, and Thailand. The students include one in high school, two in vocational school (nursing and gemology), two in universities (engineering BS, and MBA). THe students have no repayment obligation, and no direct commitment to Sudex, but it is agreed that when they determine they are able, they support Sudex in assisting other students. Since a certificate or diploma does not necessarily provide assurance of a job in countries with unemployment rates in the 30 and 40s, one of the few ways to take advantage of their education is entrepreneurship including selp employment and SME (not sure I understand the differences referred to in the article– they do whatever they can, the best they can, with what is available.
Since there is a vested interest in the students succeeding, Sudex will offer low interest startup business loans (contingent upon its own resources), using limited ownership of the business as collateral which decreases as the loan is paid off. The interest is hoped to help provide loans to other ventures and so through both the education and business loan initiatives, a geometric scaling up will occur (theoreically at least). While some agreements have been entered into on the a basis of trust and mutual respect, there is no track record yet, and of course no one single strategy will be sufficient.
It seems to me that we tend to forget the magnitude of the numbers we are talking about. You read on the different websites of those cited above and others, the impressive numbers they have reached, which collectively may be in the hundred’s of millions, which could optimisticly be 15% of those in need, but as pointed out this may be no more than raising income to above extreme poverty levels without any substantive change, scaliblity or sustainability. And the reputedly the number of the those in need may well be increasing at the same rate, so that the net gain is zero.
It can be frustrating, but I think we need to stop thinking there is only one correct way–my way, but to work collaboratively from the top, the bottom and sideways in a coordinated concentrated effort to reach as many in need as possible, give them the strength to carry on, and then get out of the way. Wish it were that simple and not too sure it is not.