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The Goose that Laid the Golden Egg: Can Microfinance Fulfill its Promise? Interview with Professor Paul Christensen, Kellogg School of Management, Northwestern University
Vibha Mehta
January 01, 2010
Prof. Paul Christensen’s career path has taken many interesting twists and turns. He started as a consultant with McKinsey, moved on to helping a local development organization and later founded ShoreCap International, a US$28 million private equity company. Now he is a Senior Lecturer of Finance and the Associate Director of International Business & Markets at the Kellogg School of Management in the Northwestern University. The one thing that has stayed with him throughout his work life is his passion for supporting businesses that none of the banks would. He treats business as a vehicle for bringing about social change and in this interview; he uncovers, layer by layer, the real face of microfinance.
Microfinance Insights (Insights): What is the biggest myth about microfinance?
Prof. Paul Christensen (Christensen): The one myth that seems to be in the news a lot is that commercial approaches to microfinance are exploitative. The other interesting myth is that the only way to reach scale and therefore improve outreach is through the commercial approach. There are some really interesting examples of organizations, like BRAC in Bangladesh, which have reached scale without taking the commercial route. But the myth that is shared more so by outsiders than microfinance practitioners is that microfinance is seen as the most important solution to global poverty. It is true that microfinance improves lives at microeconomic levels, but I don’t think it is, in itself, a solution to global poverty. Microfinance practitioners in some way are responsible for perpetuating this myth, because if you look at some of the largest international groups, they all talk about solving global poverty through microfinance.
Insights: The commonly stated number for “unmet demand” in microfinance is 60-90 million of the total 400-600 million people that could use microcredit. Is it correct to assume that all these people are appropriate targets for microfinance? If not, who are the “appropriate” targets?
Christensen: I believe that the unmet demand in microfinance, not just for microcredit, is to the extent of 400-600 million people and current estimates are that upwards of 100-150 million people now have access. In most countries that I have done business in, the urban centers are getting very competitive with microfinance organizations in every corner. However, there are many poor people in the rural areas that still do not have access to microfinance services.
If you treat microfinance as financial services for the poor, then everybody is a target. But I tend to disagree when people say everyone is a target for microloans. There are people who are disabled, mentally or physically, or those whose lives and all of their assets have been destroyed by natural disasters or civil wars. Extending credit to such people, when they have no means to repay, does not make a lot of sense to me. What I think would be more appropriate for them is opening a savings account or offering them insurance services.
Insights: Over the last 30 years, we’ve seen that commercial microfinance can be quite profitable. Yet banks rarely reach out to this demographic on their own citing cost issues. If MFIs are doing this profitably, what prevents the banks from doing so?
Christensen: Microfinance, with the advent of group solidarity-based lending, has proved that there really is a market in lending to the poor. And increasingly banks have started to participate in microfinance. Many of them dipped their toes in the water by lending to MFIs before the financial crisis. But even today, you don’t see Citibank, which is well known in microfinance across the globe, making US$200 loans to the poor. Banks have their own set of myths that they carry around. Many of them will still admit to you that micro enterprises operating in the informal sector are less likely to pay back than a formal company or a larger organization, even though statistics prove that wrong. The other reason is partly psychological - most banking institutions have a tendency to do what I call “elephant hunting,” which is that it’s much easier to make a single US$100,000 loan than to go out and work your tail off and make a thousand US$100 loans. So the banks concentrate on the big corporate side of the business.
Insights: Is microfinance still worthwhile if it does not lead to enterprise creation?
Christensen: I actually don’t have a problem with microfinance being used for consumption purposes so long as there’s some sort of income-generating activity at the household level. When there is literally no business activity or no job in the house and when people are left with no means to repay the borrowed loan, that is where I tend to draw the line.
Insights: Microfinance interest rates in India hover between 24%-34%. The assumption is that increased competition among MFIs will see these rates dropping. Do you think they ever will?
Christensen: Be glad you’re not in Mexico, where the average interest rates are in excess of 50%. Countries like India, Bangladesh and others in South Asia have historically had low interest rates and I think they will drop in the future with competition.. And, the more MFIs you have past the 500,000 client mark, the more you will start to see the benefits of economies of scale. Another thing that is going to be important, and the microfinance industry in general struggles with this, is deposit mobilization from the customer base. Any advances in technology across the board will drive efficiency and therefore lower costs and hopefully bring down interest rates further.
Insights: Repayment rates are commonly quoted as 95-99%. But we know that many MFIs rollover their loans or are quite flexible in their collection. What do you think repayment rates really are?
Christensen: They are always 99%, aren’t they? It’s interesting because you know repayment rate as a measure is unique to microfinance. Traditional banks measure repayment in a more accurate manner; they will measure delinquent loans after 90 days, or the net charge offs. Repayment rates are a bit fuzzy and it would be much more accurate if MFIs talk about the portfolio at risk (PAR) at 30 days. In general, the trend that I have seen is that PAR has been going up. Back in 2003, when I first got involved in the industry, it was not unusual to see PAR of 1% or less. Today the same institutions are seeing an increase in PAR, even up to 5%. But, in general, the repayment rates are high and people return their loans, even if it takes them longer than they expect.
Insights: Is there a chance of microfinance experiencing a subprime crisis anytime soon?
Christensen: By my definition, microfinance is a subprime business. That said, if you look at the subprime crisis that happened in the US housing market, the problem was of over-indebtedness, i.e., giving too large a loan to a person with too modest a means to pay it back. And by that definition, I cannot say if there’s a subprime crisis looming ahead for microfinance, but the problem of over-indebtedness is occurring. The average borrower is now borrowing from more than one MFI and borrowing from one MFI to repay the loans of another. That is a problem and if the industry does not figure out a way to deal with that, there could be potentially high levels of loan default. MFIs will have to learn to step forward into the realm of SME lending where it’s no longer good enough to say, “As long as you’ve five members in your group and your group is ready to cross-guarantee everybody, we are willing to make the loans available.”
Insights: On one hand, it’s common to see a mass of success stories, rewards and recognition for MFIs. On the other hand, there’s the media publishing stories of failure. Where do you think the real story of microfinance lies?
Christensen: For the last ten years, microfinance was the darling of the development industry. There was the International Year of Microcredit, then Yunus won the Nobel Peace Prize and microfinance could do no wrong. It has grown so large now that it’s naturally attracting more attention, and with that, more criticism. If you, as a microfinance practitioner, are going to call poverty alleviation your goal, then you are putting yourself on a pretty high pedestal and it’s only natural that people are going to take a closer look at that. The true story, I guess, is somewhere in the middle. I don’t think Compartamos is exploiting over a million low-income Mexican borrowers, nor do I think it’s going to raise standards in Mexico to US$30,000 per capita income.
Insights: Many female borrowers obtain proxy loans, for business or for pleasure, that are actually meant for their husbands’ use. In such a case, how much does the claim of lending “only to women” hold true?
Christensen: I have read studies based on small sample sizes where they have identified that women are forced to turn over the proceeds of their loans to their husbands. It’s not a problem unless there is some sort of abuse involved. If the husband is coercing his wife and drinking or gambling with the money, then it’s not a good thing. On the other hand, I do not believe that MFIs are doing very much by way of policing it. They’re doing what they can by underwriting the women in their business and dispersing the loans physically into their hands. I don’t think they can or even should be involved at a household level in terms of where that money goes.
It is interesting that there are fewer and fewer MFIs that are still lending exclusively to women. It is more prevalent in South Asia where more than 90% of the borrowers are women. But, the world in general is becoming more gender neutral in its lending to men and women.
Insights: The research reports by Duflo & Banerjee and Karlan & Gine released this summer showed that the impact of microfinance is unknown. For how long do you think donors will fund microfinance with little evidence about the impact?
Christensen: Yes there are controversial or conflicting studies about the true impact of microfinance. But in microfinance, unlike some other development programs, the money goes directly to beneficiaries and it’s still the closest thing we have to a truly sustainable enterprise. The other dirty old secret is that donors need to find places to put their money and microfinance has been a place where literally hundreds of millions of dollars go every year. And even if the donors are not fully convinced of the social impact it’s making, they still need a place to put their money. In fact, CGAP just released a study, showing that, in 2008, the total funding in microfinance went up by 24%. Although MFIs will have to do a better job of measuring their social impact, and investors and donors are going to continue to demand that, I don’t think that the recent studies that have shown either a negative impact or inconclusive results are going to significantly cut down on that funding.
Insights: Recently we read David Roodman’s critique of the KIVA model. Should we be worried about cases where lenders are not directly lending to borrowers?
Christensen: I think that the online lending models are terrific. Although they were trying to represent a conduit between somebody sitting in the US and a poultry farmer in Ecuador, the money is actually going from a Netherlands bank account to KIVA, from KIVA to the MFI, and from the MFI to that borrower. So KIVA’s model makes the lenders believe that they are actually lending to a poultry farmer, and in effect they are, although it may not be their US$25 into the pocket of that individual borrower. Before KIVA and the other online lending models, there was no way that I could participate in microfinance as much as I wanted to except to hop on a plane and go to India to lend money to the poor. So KIVA is doing a good job; it only has to do better at explaining how the funds actually reach the borrowers.
Insights: Skeptics maintain that although provision of credit to the poor is an integral part of the poverty alleviation strategy, it is still only a part. Do you agree with that?
Christensen: It’s true that microfinance is making some impact: it is helping raise income, improve living conditions, contributing to a quality of life, but only at the margins. People who were making US$75-100 per capita per year are now able to push that a little bit. But when an economist talks about economic development in a country, he is actually talking about the macro-economic indicators: poverty rates, national incomes, and economic growth rates. And it is very hard to make a case that microfinance is contributing at that level, the reason being that microfinance is not even set up to do that. For example, Bangladesh where microfinance is more developed than in any other country still remains a poor country while China that has brought the most number of people out of poverty in the last decade or two has almost no microfinance. And they have done it through investments in infrastructure, education and job-producing export companies. Microfinance helps, but when it operates in a vacuum, it is not going to help as much as we want it to.
Zerodha (Trading & Demat Account)
RHP
