Dealing with inefficiency in microfinance (1)

Microfinance has got a problem – a problem of considerable magnitude; one that hits at the heart of its existence, and we had better acknowledge that. The first step in solving a problem, it is often said, is a successful diagnosis that reveals the root cause of the problem. The founding fathers of microfinance had their heads squarely on their shoulders with regard to what they wanted to achieve. They wanted to create, in the words of Muhammed Yunus, a world without poverty; one in which the active poor are assisted through affordable credit and other services to beat poverty.

Pioneers of microfinance figured out a way to assist the over 500 million striving men and women, who wake up early every day to write their own pay cheques out of sheer hard work. They cashed in on the key characteristic of this group of people – their abundant energy, drive and resilience; their fundamental honesty and desire to do the right things; lack of bankable assets both intellectual and physical, and their irrepressible survival spirit. These pioneers and, indeed, operators and stakeholders in microfinancing, have succeeded to a large extent, at least in calling the attention of the world to what could be achieved if a way was found to address some of the key challenges of the active poor such as – lack of finance and lack of capacity. That’s how microfinancing came about becoming a driving force in poverty reduction. Without any doubt, much has been achieved.

Today, we are looking at a whole new world of finance that mirrors the nature and needs of the active poor and seeks to improve their welfare, and perhaps in the process, create a world without poverty. If one is worried about the size of the ambition of eradicating poverty or creating a world without poverty in a competitive world, one may skip one’s doubts and settle for the more general and less concise aim of poverty reduction. Even that is equally a tall ambition in a world of dwindling resources and expanding private greed.

Microfinancing has however been at the forefront of improved living conditions for several millions of people around the world. Major institutions have also evolved from activities focused on the provision of credit and non-credit services to the active poor, and in a bid to harvest the perceived fortune at the base of the pyramid. It has grown from unrecognized and, sometimes, illegal activity of money lenders, itinerant bankers and other informal credit market phenomena to a modern, procedural and technology-driven activity. It has moved from microcredit – the provision of credit alone – to offer a basket of services, including capacity building and insurance facilities, with millions of dollars in credit out there with the poor.

But a problem seems to have arisen. Microfinance is now rapidly transforming itself often incorporating elements of formal or regular financing with services too expensive for the poor to enjoy. In other words, microfinancing is gradually shedding its own cloak to mimic expensive and unaffordable commercial banking finance – the basic reason for which it was created. The cost of microfinance loans now mirrors the cost of funds in the regular banking institutions – an anomaly of gargantuan proportions that now threatens the entire industry worldwide. This development has brought considerable ill feeling to microfinance, and led many otherwise well-meaning, and even erstwhile supporters of the financing strategy of microfinancing, to castigate it.

Recently, a world-class professor of Economics in an Ivy League-type European university had this to say: “The whole hype about microfinancing is exactly what it is, hype”. The professor was probably venting his frustration with the worsening poverty around the world, including those countries where much publicity has been given to microfinancing and its achievements. And if the above statement sounds like an affront, its impact may pale out when confronted with yet another even more disparaging comment, also by those who should be in the know and whose opinion should matter. This time, the negative opinion is that of the agents of a world-renowned international organization, focused on development, which said something to the effect that the “microfinance craze is built on a foundation of sand…and there was yet no evidence to show that the programme has positive impact on poverty reduction”. So, no matter how we look at it, microfinance is gradually coming under powerful attack.

Many people are beginning to develop a feeling of disappointment with microfinancing, due mainly to the way and manner in which the operators of the programme, worldwide, are carrying on their work. People are wondering, and rightly too, how financial services which target the active poor, who have been effectively excluded from every financial and economic activity, can be so expensive. They wonder how such people can benefit from services that have become as expensive as those of the formal financial sector. Microfinance services, especially microloans, have become so expensive that only the well-to-do can afford it. And this is dangerous.

We may therefore need to ask ourselves the salient question: why is this so? What suddenly happened to raise the cost of microloans to a level so high that even the formal sector lenders have become jealous of microfinance institutions? It is inefficiency. Simplicita. We are transferring the cost of inefficiency on the part of operators to clients of microfinance. Although there are still a lot of non-profit organizations working hard to reduce poverty, the fact remains that much of the activity in this sector is now commercial with serious implications for cost recovery.

There should be no doubt that given the changed nature of microfinancing, some uncharacteristic features may manifest around it. For instance, microfinance has moved from microcredit, targeted at the very poor, to microfinance – a social business that combines the provision of a complex mix of services – to commercial microfinance, whose social credentials have become so opaque. These developments would expectedly change some of the traditional features and outcomes of it. It may be the case. It may just be.

However, it is vital for the survival of the industry that a clear dividing line must be maintained between what I may call White Collar Banking (commercial banking) and Blue Collar Banking or microfinancing. That dividing line, which surely existed at the beginning of microfinancing, has become so blurred that the impact is written in bold letters on the subsector – INEFFICIENCY.

 

Emeka Osuji