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April 22, 2010 / compassioninpolitics

Possible Pitfalls of Mixing Charity and Business in Microfinance

Possible Pitfalls of Mixing Charity and Business in Micro-finance

The following a guest post by Fehmeen who blogs at Microfinance Hub. Fehmeen points for the need for a balance of compassion and accountability. Too much of either risks the financial stability for the micro-finance client or the donor organization.

It has been established and accepted that microfinance needs to work in the form of a business rather than charity because:

• Microloans allow entrepreneurs to build credit histories to access commercial financial services
• Most micro entrepreneurs are dignified and would not prefer cash handouts accompanied with sympathy
• The business model is financially sustainable.

At the same time, microfinance institutes (MFIs) need to incorporate a social dimension in their operations and this is often a difficult balancing act considering the lack of corporate governance and experience of certain institutions. While some of them completely lose touch with their social objective, others forget that the microfinance model needs to be financially sustainable at the end of the day.

At one end of the spectrum lies the story of Bidi Mehidana, an Indian villager who became trapped in a spiral of easy debt after the pre-mature death of her cow, which she had bought with her microloan. The bank refused to sympathize with this unexpected calamity and turned down a request for another loan, yet continued to charge her interest on the defaulted amount. To make matters worse, Bidi was constrained to borrow another fortune from a loan shark. You can see the details of her story here.

Grameen Bank’s approach is noticeably different: since Bidi had little control over the death of her cow, her debt may have been rescheduled, or paid for by an emergency fund set aside for this very purpose. At the same time, her request for a new loan (on easier terms) would be approved, but at the cost of clearing away any credit history she had previously earned.

At the other extreme lie MFIs with improper delinquency management through risk-assessment tools and loan-recovery systems, which are a function of corporate governance. This may not seem much of a problem but as Professor Yunus puts it, ‘credit without strict discipline is nothing but charity’. Therefore, in the absence of strict obedience, micro entrepreneurs may perceive it is acceptable to default on payments, which makes the MFI financially unsustainable. Even though MFIs may end up loosening internal controls to improve their profits, they unwittingly set aside financial objectives for the sake of social gains.

This predicament balancing social and financial motivate applies to all MFIs but most manage to find their equilibrium through experience. Nevertheless, the existence of this quandary, one of many challenges for MFIs, simply goes to prove microfinance is more complex than we generally imagine.

One Comment

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  1. compassioninpolitics / Apr 22 2010 7:03 pm

    This article by Nathaniel Whittmore on the coming public and media relations issues for micro-enterprise demonstrates how timely these issues are:

    Actually, the comments of that post point to growing conversation which is bubbling up over these micro-finance issues on several fronts. The issue of accountability and transparency is huge–on issues of investment return and interest rates.

    One way social enterpreneurs have attempted to solve these underlying problems include:
    1) financial training
    2) micro-banking/micro-saving
    3) micro-franchising
    Certainly those should be pursued based on sound models which take BOP circumstances, cultures, and people into account–and it ways that do so with larger transparency. In areas beset with corruption–financial transparency and accountability is critical to mission success. Models which best incorporate transparency and accountability (and in ways which create good feedback loops) will win–and be truly transformative.

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