Although there are countless heartwarming success stories ranging from micro-entrepreneurs starting their own water supply business in Tanzania, to a $1,500 loan that allowed a family to open a barbecue restaurant in China, to immigrants in the U.S. being able to build their own businesses, microfinance has sometimes fallen under criticism.
While microfinance interest rates are generally lower than conventional banks’, critics have charged that these operations make money off the poor. Especially since the trend in for-profit microfinance institutions, such as BancoSol in Bolivia and the above-mentioned SKS (which actually began as a nonprofit organization (NPO) but became for-profit in 2003.)
One of the largest and most controversial, is Mexico’s Compartamos Banco. The bank was started in 1990 as a nonprofit. However, 10 years later, management decided to transform the enterprise into a traditional, for-profit company. In 2007, it went public on the Mexican Stock Exchange, and its initial public offering (IPO) raised more than $400 million.16
Like most other microfinance companies, Compartamos Banco makes relatively small loans, serves a largely female clientele, and pools borrowers into groups. The main difference lies in how it uses the funds it nets in interest and repayments. Like any public company, it distributes them to shareholders. In contrast, nonprofit institutions take a more philanthropic stance with regard to profits, using them to expand the number of people they help, or to create more programs.
Concerns about For-Profit Microfinancing
In addition to Compartamos Banco, many major financial institutions and other large corporations have launched for-profit microfinance departments, including Citigroup, Barclays, and General Electric, for example.1718 Other companies have created mutual funds that invest primarily in microfinance firms.
Compartamos Banco and its for-profit peers have been criticized by many, including the grandfather of modern microfinance himself, Muhammad Yunus. The immediate, pragmatic fear is that, out of a desire to make money, large microfinance bankers will charge higher interest rates that may create a debt trap for low-income borrowers.
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But Yunus and others also have a more fundamental concern: that the incentive for microcredit should be poverty alleviation, not profit. By their very nature—and their obligation to stockholders—these publicly-traded firms work against the original mission of microfinance, helping the poor above all else.
In response, Compartamos and other for-profit microfinanciers counter that commercialization allows them to operate more efficiently, and to attract more capital by appealing to profit-seeking investors. By becoming a profitable business, their argument goes, a microfinance bank is able to extend its reach, providing more money and more loans to low-income applicants. For now, though, charitable and commercialized microfinanciers do co-exist.
Nonprofit vs. For-Profit Microfinance
In addition to the divide between the nonprofit and for-profit microfinance enterprises, other criticisms exist. Some say that individual microloans of $100 are not enough money to provide independence—rather, they keep recipients working in subsistence-level trades, or just cover basic needs, like food and shelter.
A better approach, these critics maintain, is to create jobs by constructing new factories and producing new goods. They cite the examples of China and India, where the development of large industries has led to stable employment and higher wages, which in turn has helped millions to emerge from the lowest levels of poverty.
Other critics have said that the presence of interest payments, however low, is still a burden. Despite the healthy repayment rates, there still are borrowers who cannot, or do not, repay loans, because of the failure of their ventures, personal catastrophe, or other reasons. So, this added debt can make recipients of microcredit even poorer than when they started.
What Are the General Terms of a Microfinance Loan?
Like conventional lenders, microfinanciers must charge interest on loans, and they institute specific repayment plans with payments due at regular intervals. Some lenders require loan recipients to set aside a part of their income in a savings account, which can be used as insurance if the customer defaults. If the borrower repays the loan successfully, then they have just accrued extra savings. Because many applicants cannot offer collateral, microlenders often pool borrowers together as a buffer. After receiving loans, recipients repay their debts together.
What Are the Benefits of Microfinance?
The World Bank estimates that more than 500 million people have directly or indirectly benefited from microfinance-related operations. The Consultative Group to Assist the Poor (CGAP) estimates that, as of 2021, more than 120 million people have directly benefited from microfinance-related operations. Additionally, the IFC has helped establish or improve credit reporting bureaus in 30 developing nations. It has also advocated for adding relevant laws in developing countries that govern financial activities. The benefits of microfinance extend beyond the direct effects of giving people a source for capital. Entrepreneurs who create successful businesses, in turn, create jobs, trade, and overall economic improvement within a community.
What Are Some Criticisms of Microfinance?
While microfinance interest rates are generally lower than conventional banks’, critics have charged that these operations are making money off of the poor. Also, many major financial institutions and other large corporations have launched for-profit microfinance departments raising concerns that, out of a desire to make money, these larger bankers will charge higher interest rates that may create a debt trap for low-income borrowers. Additionally, some have argued that individual microloans are not enough money to provide a realistic path to independence. Finally, critics have said that the presence of interest payments, however low, is still a burden.