Can Charity Work With A For-Profit Motive?

from the long-term-vs.-short-term dept

A few weeks back, the always excellent Planet Money podcast played parts of a debate held at the Clinton Global Initiative between famed microfinance guru Muhammad Yunus and successful microfinance entrepreneur Vikram Akula (moderated by Planet Money host Adam Davidson), considering whether or not a for-profit microfinance effort can really work in terms of enabling better financial opportunities for the poor. Yunus argued that a for-profit effort simply cannot do good. Since it has a profit motive and outside investors, its efforts will always be on transferring money away from the poor to those investors.

Akula disagreed, strongly, by pointing out that you can align both of their interests, and his company appears to have successfully done so. In the talk, he gives an example of the fact that they only lend money to women and they charge well-below market interest rates. He also notes that, unlike most banks, they don't pay those in charge of lending the money based on how much money they lend out (or make). The idea there, is that they want the people there to figure out the right amount that the person needs, rather than creating incentives for them to try to get the person to take more, to make their own numbers look good.

Now, he argues that, compared to other banks, you could say that his firm, SKS Microfinance, is leaving money on the table, but he doesn't see it that way. The woman who takes out a small loan and successfully pays it back this time, can come back later, when the timing is appropriate and take out a larger loan, which might never have happened if she had been pushed into a bigger loan earlier, or charged much higher interest rates.

And, while no one specifically says it in the podcast, this is a much bigger point than Yunnus seems to recognize. There are two factors that Yunnus doesn't seem to consider in condemning all for-profit microfinance efforts: (1) this is a non-zero sum game and (2) this is a multi-round game (i.e., there's a long-term strategy horizon). Yunnus is right that for-profit charities probably can't work in a situation that is a zero sum game, or in which the time horizon is very short, such that there are unlikely to be repeat customers. But, just taking a straightforward game theory look at what Akula and SKS are seeing, they can increase the overall pie more efficiently in a for-profit setup. It's not "taking away" from the poor. It's expanding the overall economic pie for everyone, including investors, and part of the way that's done is by focusing on building strong relationships with those using the service. That means, the temptation to screw them over is tempered by the incentives to be fair to encourage that long-term relationship that pays off (for everyone) over the life of the relationship.

I have to admit that I was a bit disappointed in Yunus, who is so often held up as a financial genius for his microfinance theories. As the podcast makes clear, his focus involves heavy government involvement and regulation to create a special type of community-owned microfinance bank, which apparently works okay for the community he's in, in Bangladesh, but that doesn't mean that a for-profit microfinance operation can't help the poor quite a lot, while also helping investors.

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  1. identicon
    Rajan Alexander, 31 Oct 2010 @ 6:26pm

    Interest rates: The Poisonous Fangs of MFIs

    MFIs were touted to provide the poor access to affordable credit, reduce poor people’s need to use moneylenders and indebtedness. In short, provide a much kinder, cheaper alternative to the village loan shark. Instead, they evolved as the new class of institutionalized loan sharks which neo-liberals gave respectability to. MFIs did improve access to micro loans but failed in their touted mission to provide affordable and gentler credit and above all, one that lifter people from the clutches of poverty. Objects of institutional financial sustainability exhort them to charge interest rates and fees high enough to cover the costs of their lending and other services. MFIs argue that they need a spread apart from all costs to provide for contingencies and growth. Fine but the moot question is how much should be this spread. MFIs argue that economies of scale and competition will drive interest rates down. This remains only a theoretical argument. “Mexican microfinance institutions charge such high rates simply because they can get away with it”, said Emmanuelle Javoy, the managing director of Planet Rating, an independent Paris-based firm that evaluates micro lenders!! If at all, the average Indian MFI interests rates appear more benign than in Latin America or Nigeria, then it simply because other than factors internal to the MFI industry, the sector faces strong competition from governmental and NGO SHG micro-saving programmes in the absence of which, these MFIs would have formed a cartel. Past angry public and government reactions that resulted in a backlash against them, which included the arrests of MFI top leaders, like Uday Kumar of Share Microfinance Ltd as in 2007, keeps their profiteering impulses under check. The sooner MFIs are seen as profit enterprises, the better. The longer they pretend they are pro-poor, the longer they discredit the NGO sector that gave birth to a Frankenstein. By 2014, they target to reach 110 million borrowers. Remarkably, despite two decades of operations, if statistics are to be believed, these MFIs only reach just 20 million people in the country, a good proportionate of them, multiple counted. Yet, they succeed in gaining an attention, so disproportionate to this miniscule reach. Act now to prevent they becoming an epidemic in the country. Act now, when they are most vulnerable. And how do know they are vulnerable? Because Vijay Mahajan, the father of MFIs in India tells us so: “We are facing collapse. Unless something changes on the ground, the industry as we know it is basically gone. ” Mahajan, we have news for you. The day when the likes of you are gone, that will be the turning point for the fight against poverty! Read More: http://devconsultgroup.blogspot.com/2010/10/whats-wrong-with-micro-finance.html

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