As the CEO of Accion Texas, Janie Barrera has plenty of lending success stories to tell. There’s the Colombian woman in Dallas who launched a translation business, and today counts the likes of 3M and Southwest Airlines as clients. Or the African-American man in Houston whose idea of leasing beds to nursing homes was met with skepticism by traditional banks and today is doing well. She also has some odd tales to share, including the one about the woman in southern Texas who pledged goats as collateral for a small loan to start a restaurant. “The next time I visited her, I asked to see the goats,” Barrera recalls. “She said, ‘What do you mean? We used them for lunch.’”
The underlying theme among Accion Texas’ clients is that they tend to be on the fringe of society, entrepreneurial people with poor credit scores or missing credit histories—many are recent immigrants—who bankers don’t want to touch. That’s fine by Barrera, whose nonprofit microfinance institution, or MFI, seeks them out, offering not only small-business loans but also credit and business-development counseling.
Accion Texas doesn’t turn a profit—no MFI in the United States does. Even so, its model, complete with a proprietary lending scorecard based on experiences with past borrowers, is compelling enough that Citigroup recently agreed to buy up to $30 million in excess loan production over the next three years. Accion Texas “is serving a whole client segment that we otherwise wouldn’t be able to reach,” says Robert Annibale, Citi’s London-based head of microfinance. “They are demonstrating that small entrepreneurs in the United States who are offered the right products can thrive.” Says Barerra: “We’re proving that you can create a quality, investment-grade portfolio” from borrowers that banks traditionally shun. “That’s very rewarding.”
Successes, like everything else in the microfinance world, are relative. Accion Texas is one of the largest MFIs in the country, yet its $21 million loan portfolio looks tiny compared to most any U.S. bank—and next to the global microfinance market, which counts an estimated $30 billion in small-business loans outstanding and is growing by double-digit percentages annually. In Bangladesh alone, three giant MFIs each boast some 7 million customers. In the States, by contrast, roughly 260 MFIs originate just 15,000 loans per year, according to Elaine Edgcomb, director of microenterprise research for the Aspen Institute in Washington, D.C.
Chalk it up to the complexity of the U.S. financial system, with its relative abundance of financing alternatives, tougher regulation and culture. MFIs globally charge interest rates that average about 30 percent, a figure that would be considered usurious at home. And for all the talk of U.S. entrepreneurship, most Americans “would rather work for Wal-Mart or some other big company than compete against it,” says Jonathan Morduch, a New York University economics professor who tracks microfinance activities.
“Strong microfinance companies in south India add one customer every 10 minutes. For most American MFIs, getting 100 new customers a year is really good,” Morduch adds. “It will never be the big phenomenon here that it is elsewhere.”
The lack of scale has left American MFIs standing on the sidelines as the global movement—with its torrid growth and, yes, profits—grapples with a fierce ideological battle over what one pundit calls “the soul of microfinance.” Most MFIs don’t accept deposits, which makes funding a challenge, and the global appetite for loans is far outstripping the ability of traditional capital sources—philanthropies, governments and non-governmental organizations—to fill. A December 2007 Deutsche Bank report estimates that only about 10 percent of potential borrowers globally get loans, due mostly to MFIs’ funding limitations.
Additional capital would allow MFIs to serve more people and decrease global poverty, and Wall Street appears willing to help. In recent years, big banks have been investing more time and money into microfinance activities, often positioning those efforts as part of their emerging markets strategies. Investors have shown willingness to put money into MFIs, too, either by purchasing securities backed by microfinance loans, or as shareholders.
Those types of players often expect a payoff in return, and therein lies the conundrum. Microfinance has traditionally measured success more in social terms than the bottom line. Susan Davis, CEO of BRAC USA, a New York outpost of the successful Bangladeshi poverty-fighting nonprofit, describes it as a means to an end—a “strategy to solve big problems, [in areas] like health care, literacy, education and hunger”—rather than an end itself.
Yet if the movement is to get the private capital needed to achieve its objectives, then it might need to compromise some of those principles. “As MFIs reach deeper into the for-profit capital pool, more and more of their investors will seek to maximize profits, potentially at the expense of the MFIs’ social mission,” Davis warns. “Profits, per se, don’t compromise the mission,” she adds. The challenge is finding investors who see eye to eye with the mission, and “aren’t too greedy.” And that, as anyone who’s been paying attention to Wall Street recently will attest, can be tricky indeed.
Consider it one of several growing pains as microfinance morphs from a modest philanthropic movement into a more professionalized industry. Begun in the 1970s to provide tiny working capital loans to small businesspeople in the developing world, microfinance has exploded over the past decade. In 1997, 618 MFIs had 13.5 million customers. By 2007, more than 3,000 institutions boasted 154.8 million customers and had an estimated $30 billion in outstanding loans, according to the Consultative Group to Assist the Poor, or CGAP, an umbrella organization housed at the World Bank that tracks and assists microfinance activities.
The growth has sparked talk of consolidation. Marge Magner, former head of Citi’s global consumer bank and an active MFI supporter, listens frequently to funding pitches from small institutions. “They’re all heart-rending, but they’re all the same,” she says. “And the result is, there are too many organizations chasing money.” Consolidation would shorten the learning curve in new markets and add efficiency, “and everybody knows it,” she says. Even so, the notion clashes with the local roots of microfinance, which “makes getting it done difficult.”
Greater outside scrutiny, meanwhile, has highlighted the need for better measurement. A lack of quantitative knowledge about the long-term effects of microfinance makes it difficult to assess objectives and to attract more funding. Some institutions have begun tracking individuals and communities to get better data. “But for now, we don’t know enough,” Magner concedes.
What is known about MFIs is appealing on several levels. While most remain true to their do-gooder roots, more are turning to fee-based businesses, such as check cashing or facilitating remittances, adding products in their quest for “sustainability”—a big buzzword. Charge-offs on the typical MFI’s loan portfolio, meanwhile, are only about 3 percent, according to Laurie Spengler, president of ShoreBank International, a subsidiary of Chicago-based ShoreBank that advises MFIs around the globe.
Add it all up, and the average return on assets of 344 MFIs in a recent CGAP study was 2.8 percent—about half of what a profitable pre-crisis bank would earn. “Oftentimes, microfinance companies’ returns on equity are higher than in the banking system,” Annibale says.
Such numbers, combined with the philanthropic aspects, have caught the eye of developed-world investors. A growing number of big banks, including the likes of JPMorgan Chase, HSBC and Deutsche Bank, have dipped their toes into the global market, providing services through—or small amounts of capital to—MFIs.
Citi has been in the space through its foundation for nearly three decades, and in 2005 turned it into a business line. Today, it works with 85 MFIs in 35 countries, according to Annibale, and turns a profit. Among its activities is an agreement to buy $40 million in excess loan production from SKS Microfinance in India, much as it does with Accion Texas. It also offers SKS customers deposit products and Citi ATM cards. In Mexico, Citi has begun offering life insurance through MFIs.
“It’s expanding our reach in terms of our ability to build relationships and provide access to finance in areas where we don’t have a footprint,” Annibale says.
(Here at home, many banks invest in, or lend to local MFIs, as a way to fulfill part of their CRA requirements and help create new customers. One example: The Opportunity Fund, a San Jose, CA, MFI that lists 18 banks as “partners,” including Wells Fargo, City National and Silicon Valley Bank.)
In Madagascar, France’s Société Générale is operating its own microfinance operation — a definite rarity, since microfinance’s raison d’etre is to provide money to people banks either can’t or won’t serve. “I always say, ‘Bankers only want to lend to people they’d be happy to have over for dinner,’” says Magner. “These are not borrowers they would invite to dinner, so something different is needed.” Adds Spengler: “For a commercial bank to get engaged, they need to believe in the business model. … It can be difficult for them to wrap their brains around.”
Either way, bank participation isn’t nearly enough to fill the funding void. A fledgling group of specialized funds, including Blue Orchard and Microvest, now invest private money in securities backed by pools of MFI loans (they have even have their own microfinance rating agency). Some wealthy benefactors have earmarked funds specifically for MFI investments, as well. In one arrangement, eBay founder Pierre Omidyar contributed $100 million to Tufts University with the requirement that the resulting fund seek its returns only through microfinance investments.
Fallout from global liquidity woes has hit the space hard. Only a year ago, Spengler says, the market for securities backed by micro-loans “was a vibrant business.” Today, it’s been ground to a halt. Camilla Nestor, director of capital markets for the Grameen Foundation in New York, knows of one MFI in India that “has a waiting list of 50,000 clients” seeking loans, but can’t fund them. “Most MFI portfolios are doing well, and the loan demand is growing,” she says. “But with the liquidity crunch, the institutions are not able to access the capital or funding they need to get them done.”
Even so, these are moneymaking investments, says Gil Crawford, CEO of Microvest, a Bethesda, MD-based fund manager with $70 million of MFI loans on its books. He compares it to investing in a credit-card portfolio — “a high volume of small, unsecured loans with high interest rates” — and says his first fund earned a 20 percent return last year. “It’s beating our targets.” And because they involve a lot of hand-holding and the loans go mostly to local endeavors, credit quality has been relatively unaffected by the global economic slowdown.
The ideological purists can live with securitizations, because the local MFIs still control the frontline operations. More controversial are direct investments, which also are on the rise. Sequoia Capital, the same venture capital firm that helped bankroll Google’s startup, has invested $11 million in India’s SKS. Helios Investors LP, a London-based private equity firm, in 2007 paid $175 million for a 25 percent stake in Equity Bank, a Kenyan MFI intent on expanding its reach and competing with bigger banks.
When Banco Compartamos, a big and profitable Mexican MFI, raised $467 million in a partial IPO that valued the company at $1.5 billion, it sparked a revolt. Critics, including Muhammad Yunus, the Bangladeshi economist who founded Grameen Bank, one of the world’s largest and best-known MFIs, in 1976, and 30 years later won a Nobel Prize for his efforts, asserted that Compartamos, which charged 100 percent interest on some loans, was generating profits on the backs of poor people to win investors’ money, compromising the movement’s idealistic principles.
“[You are] on the moneylender’s side,” Yunus said in a public denouncement. “Your aim is the moneylender’s aim. Your thinking is the moneylender’s thinking. So I don’t want to associate with you. I want to battle with you and fight you.”
The harsh words from the iconic Yunus “really polarized the community,” turning the pursuit of private money “into a lightning-rod issue,” Spengler says. Supporters of the deal, including the heads of some other MFIs, hailed it as a model for future growth. Crawford argues that without outside funding for MFIs, entrepreneurs will be forced to look more to loan sharks, which charge even higher rates, or corrupt government officials. Furthermore, pumping capital into the market helps foster more competition, he says. In Bolivia, lending rates that once were 100 percent are now less than 30 percent, due to increased competition. “And we’re already seeing more competition in Mexico,” because of increased private funding.
It’s an uncomfortable debate for an MFI community that, while spread around the globe, is both close-knit and passionate, connected strongly by beliefs. Adherents speak the same language, join many of the same groups and frequent the same Web sites, including one that lists MFI job openings. If you have the right language and business skills, you could land as a CEO of an MFI in El Salvador or Pakistan. “Microfinance is a lot like the diamond trade in Antwerp,” confides one insider. “Everybody knows everybody else.”
At its core, microfinance is about making small loans, typically between $100 and $1,500 in markets outside the U.S., to entrepreneurs who already have some sort of business idea or existing business, and merely need working capital to kick-start or expand it. The lending model is decidedly local, with borrowers financing businesses, such as food stalls, farms or small stores, which serve their communities and provide their households with a modest income.
The loans, often with durations of less than a year, are originated and overseen by an MFI employee, who travels from town to town, meeting with small groups of borrowers to get updates and make weekly collections. Absent tools like credit scoring and histories, or even collateral, many MFIs rely heavily on character assessments and “peer group lending” to keep borrowers in check. Small groups of five or six people are banded together in a carrot-and-stick approach. Fellow group members provide support to each other; and if one fails to keep up on his or her loans, the entire group can suffer the consequences in terms of losing access to future loans — a so-called “cross-default mechanism.”
While quantitative data is scarce, there are plenty of success stories. Crawford tells of a Bolivian shoemaker who was so cash-poor he made one pair at a time, sold the shoes, then used the proceeds to buy materials to craft the next pair. “When he got a microfinance loan, he was able to buy raw materials in bulk and employ his cousin to sell them,” he recalls. Today, it’s a viable business. “Two families won, and he repaid the loan.”
In the end, most expect that a hybrid funding approach will arrive — one that meshes government, non-profit and business ethos in pursuit of a “double bottom-line” that measures success in terms of both social benefits and financial returns. The Deutsche Bank study predicts outside investments will grow tenfold by 2015, to $20 billion. If the industry continues its strong financial performance while serving the poorest of the poor, everyone will win.