Microfinance: An Island of Stability in the Global Economic Storm

The global financial crisis is opening eyes to creative ways to bank with the world's poorest borrowers, a move that could actually help struggling financial institutions generate more profit in difficult times.

While traditional investment markets freeze up or melt away, microfinance institutions (MFIs) that make small loans to poor people are now being appreciated as - ironically - a relatively safe investment in a potentially huge and largely untapped market. 

 "There was always money to be made serving existing, wealthier, and more profitable customer segments," says Jeff Semenchuk, Citigroup's Executive Vice President & head of Growth Ventures and Innovations. "But banks are now seeing how saturated the historically profitable segments are, and how many banks are competing for the same pool of these customers.

"So we see the potential in rapidly growing developing segments. Several microlending organizations, including a group we have within Citi, are showing that we can do good by serving poorer people and developing new models for them—without losing money."

Citigroup is not alone in launching investment portfolios to serve the world's poor—many of the world's largest banks are starting down this road. But Citi is probably the most ambitious big bank in this area, having established relationships with MFIs in some 20 countries, and it may soon expand to another 10 countries.

"Not only is this a business issue for us, it's really a broader social and economic opportunity that the financial services industry must address," said Semenchuck.

Banks Have Largely Overlooked Microfinance

If Citi succeeds, other big banks are likely to join its quest for a piece of the pie at the "bottom of the pyramid" of wealth, as will other types of investors. But Citi's biggest contribution to building this market could be its assertion that microfinance can be pursued as a valid, profit-making business.

"The key is to understand the true needs of poor people—how we can help them be successful, and then develop ways to serve them in a meaningful, scalable, and profitable manner," Semenchuck said.

Banks have largely overlooked MFIs, considering them small and relatively insignificant players. "Most bankers have never believed that banks could serve the poor and the emerging middle-class in a profitable way," Semenchuck said. "There isn't enough revenue there, it would be too costly to do this, and there is too much financial risk, etc. Recent sub-prime and credit crises have only underscored this perception."

However, odd as it may sound, the world's poorest people can be a safer investment in these troubled financial times. Microfinance lending has avoided the temptation to loosen credit regulations that helped created the current financial crisis, and microcredit repayment rates remain very high, at 97 per cent or 98 percent in many places, said Mary Ellen Iskenderian, CEO of Women's World Banking, a global network of 54 MFIs and banks in 30 countries, in a recent Time magazine interview.

Now Banks are Chasing Microfinance

Microfinance has been relatively unaffected by the banking crisis, she added, for one of the very reasons large banks have shunned it: because it falls outside the mainstream economy. Poor borrowers, living in remote, rural, mostly agricultural areas with limited access to markets, often are insulated from large-scale financial trends. Further, their large populations spread risk and they often are best prepared to deal with adversity because they have adapted to live with scarcity.

These factors have provided a buffer against the global financial crisis in Asia, said Rajendra Theagarajah, CEO and managing director of Sri Lanka's Hatton National Bank (HNB), during a business forum last month. His bank's statistics show 3.8 percent non-performing loans among MFIs, well below the bank's average of 7.52 percent.

Most Asian banks that survived the financial crisis of 1997-1998 were lending to small and medium-sized enterprises, and they had few non-performing loans in their portfolio, Theagarajah said. So many of Asia's global private equity players and domestic banks are now chasing MFIs to take a stake in them or extend term loans.

While MFIs have proven less vulnerable to economic hard times in recent downturns, according to statistical evidence published by Adrian Gonzalez in MicroBanking Bulletin, they are not likely to remain completely unscathed by the current economic crisis. Iskenderian warns of a "triple threat" to the microfinance sector from the current economic downturn and rising fuel and food costs. She said she sees many MFIs scaling back plans to expand, and some are raising interest rates due to the credit crunch and rising costs of borrowing.

Providing an an Island of Stability

In this difficult economic climate, MFIs cannot take their existing funding relationships for granted. While larger financial institutions can access big pools of funds, moving them around and repackaging loans to spread risk, small and medium-sized lenders are vulnerable to running out of funds, said microfinance expert N. Srinivasan.

Nevertheless, Muhammad Yunus, the Nobel Laureate pioneer of microfinance, sees an opportunity in the current global financial crisis if large financial institutions choose to strengthen their portfolios by incorporating microfinance loans. These loans offer the advantages of being solid and transparent, with extremely low default rates—and their rate of return cannot be disregarded today. In the Winter 2008 Human Rights Magazine, Yunus argues that microfinance organizations can be an island of stability during financial crises such as the Asian financial crisis of 1997, when microfinance continued to grow steadily.

"If you put in your money last year, or two years ago, you could expect a rate of return upwards of 70 percent," said Venky Natarajan, Investments Director for Lok Advisory Services which invests in MFIs. "Currently, the average returns stand at around 35 percent."

One thing remains certain: the microfinance sector will continue to grow. It is estimated that the poorer sections of urban and rural India have a combined credit appetite for about USD$1 billion, but barely 10 percent of this demand has been met thus far. Altogether there are some four billion poor people in the world with a combined estimated purchasing power of more than $13 trillion.

Pritha Sen is Senior Marketing Advisor to Ashoka Global Marketing, and Partner, Plural India