MFIs and the Crisis

In a recent televised debate among some of the world’s authorities on international economics, Robert Zoellick, president of the World Bank, stated that microfinance was a field that had weathered the global financial crisis particularly well, despite the slowdown of international funding.  In mentioning this to the Executive Director of the microfinance firm where I am currently consulting, I got the distinct impression that he did not agree.  Certainly others with whom I’ve spoken to on the ground in South Africa would second that notion – the last few terms had been much harder than before.  This made me wonder.  Many of the MFIs here have particular barriers to success as compared to other places in the world, partially for the reasons that I had outlined in my previous post.  However, this made me curious to find out how specifically the financial crisis had affected MFIs worldwide and in particular, how it had affected South African MFIs.  Were there factors that made MFIs more or less resilient in the face of such a crisis? If there were, how could MFIs best learn from what had happened and better prepare themselves going forward?  Some brief research into the matter, as well as conversations with those on the front lines led to a few answers, but in the end left me with more questions, and not all of them related to the current crisis. A summary of my findings is below.

First of all, looking at the field of microfinance as a whole in light of the current crisis, there are definitely signs of strain.  Though many argue that microfinance has managed to show some resilience, it has not shown as much resilience as in past crises, partly due to the fact that the field in general is now a lot more connected to the international markets, and partly due to the sheer size and pervasiveness of the current crisis[1].  In addition, the high prices of food and fuel are an issue, especially to the poor.  This could have even more consequences in a country like South Africa, which has such a high level of division between the rich and the poor, and therefore a high level of availability of all kinds of goods, many of which those at the bottom end of the spectrum simply cannot afford despite having physical access to them.  The chances of MFI clients in South Africa using their loans for consumer purchases then seems to be even more of a risk than other places simply due to the ease of availability of those goods as compared to other developing countries. According to KM (the director of the MFI where I work), this is the real challenge facing the industry.  He notes that firstly clients will tend to use their loans for consumption before thinking about growing their businesses, and secondly, their businesses are generally not doing well because the neighbourhood’s income has gone down due to retrenchments and high prices of the commodities.

This brings up the next risk of the overall availability of funds in the poor communities, which are needed in part to keep the micro-enterprises of MFI borrowers running. For example, many mining projects that were supposed to take place in South Africa have been put on hold, meaning that there was loss of jobs in this sector.  At the lower levels this would mean that those who would have had those jobs and spent some of their money with micro-entrepreneurs now cannot, meaning a loss of income for the entrepreneurs and therefore increased chance of them defaulting.  This may not be much of a risk in communities that are less connected overall to the international markets, like certain isolated rural areas, but in South Africa even the most rural communities have some connection to the large companies and industries, and are therefore at increased danger from the events taking place on the international sphere.

In terms of sources of funding, it would seem that in South Africa a lot of the funding tends to come from within country, or is filtered through that way so this would minimize exchange rate risks as well as mean that a slow of international funding would not necessarily affect the MFIs.  In addition, in terms of vulnerability, South African banks do not have a high degree of international owernship, like many other African countries, which helps reduce the effects of the financial crisis.  However, on closer examination many of the government funds and apex funding is coming from abroad, so the effects of decreased international funding would still be there in an indirect way.  The best thing for MFIs to minimize their risk in these terms is to make sure they have multiple sources of diverse funding.  In South Africa many of the good MFIs have 5 to 6 funders, while the ones with less than two tend to show more signs of strain.  In any case, it is a good risk management policy for MFIs to make sure they have as many different funders as possible.  Although it means answering to more sources, and may therefore increase administration time, the reduction in risk may well be worth it.  This is especially true for small and young MFIs which are still not financially self-sustaining and are thus more reliant on donor funds.

In researching this topic, it did seem that there are a lot of theories but little hard proof of the effects of the crisis.  This actually helps to highlight a big gap in the microfinance field – one of solid measurement and evaluation of impact.  We continually hear anecdotal stories of microloans helping throughout the world, but although there is an increasing call for more quantitative and hard evaluation of the effectiveness of MFIs, it seems that this data is still hard to find.   This avenue of thought led me away from the crisis and on to another topic – just how effective is microfinance in terms of economic development?

Is MFI really the solution to poverty?

Related to the above point, there are now more individuals who believe that microfinance may not be a cure all for the world’s poor, and that the lack of hard proof to show how much economic development microfinance brings about is actually due to the lack of such evidence.  Bateman and Chang[2] argue that the oversaturation of microfinance in certain areas may be doing more harm than good.  They suggest that because of the over availability of microloans many small entrepreneurs who would go out of business due to competition from much more efficient micro entrepreneurs are now instead being kept afloat and are thus artificially creating an oversaturation of the micro-entrepreneur market, which prevents any one microenterprise from scaling up significantly.  They suggest that while the more efficient enterprises might naturally scale up and develop economically on their own, due to this newly created artificial competition, they are unable to do so.  Thus while the presence of microloans ensures that more of the poor can have a slightly better lifestyle, they are still all kept together at the much lower level than middle and upper level business.  This is an interesting thing to consider, and a topic that I will have to do more research in to in order to speak on more fully.

Speaking again with KM, who has been in the industry for a long time, he had the following to say regarding the above: “CGAP has conducted several studies as have many other social rating organisations.  In South Africa I know at least one MFI had participated in such an Impact Assessment study whilst I was working there.  The agreement amongst practitioners and observers alike is that microfinance is not a panacea to poverty.  If microfinance was a doctor dealing with human bodies, I would liken it to a dentist.  That is, other doctors still have a role to play in the human body, not only a dentist.  The fact that 2006 was the Microfinance Year throughout the world because of the Grameen model having won the Nobel Peace Price, proves beyond reasonable doubt that there are hard facts out there to show the impact of the industry in the lives of the poor.”

Personally, I tend to agree.  I believe in the power of microcredit to make a difference in the lives of the poor.  However, I do think that more research needs to go into the actual impact and long term effects of microcredit programs and more needs to be done in terms of reporting.  Without a doubt, microfinance done badly can do more harm than good, but without it, what exactly are the alternatives?  As with anything, it seems that we simply need to think about possible outcomes, do more strenuous measurement and evaluation, and get more feedback from long term clients.  In the end, if the clients are happy that must show that at least something is working.

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[1] http://crisistalk.worldbank.org/2008/11/microfinance-an.html

[2] The Microfinance Illusion: http://www.econ.cam.ac.uk/faculty/chang/pubs/Microfinance.pdf

I have now finished my first month working in South Africa – both with a Cape Town based funder of microfinance as well as a small, struggling microfinance institution (MFI) based in the North East part of the country, in collaboration with a Canadian NGO.  It has been an interesting experience so far, and has definitely tested my academic notions of microfinance and helped put them in a real world context.

Microfinance in South Africa faces many unique challenges, as does the country itself.  The relatively recent end (1994) of the racial segregation that was so strictly enforced by the former Afrikaans regime leaves in its wake a country still heavily divided along racial lines. Strolling through the poorest regions of the country – the townships – it is virtually impossible to find anyone white there.  While there are more black and coloured people (South African designations that I will not fully go into in this post) entering mid and upper class, the transition has been slow.  In my opinion, the problem is compounded by the fact that the government wants to fix these problems quickly and so sometimes pushes under-qualified individuals into jobs while forgetting that the best way to close the gap would be to invest more in education and grass-roots initiatives instead.  The education gap seems to be a very serious issue.  The schools in good parts of towns and cities here look and feel just like your average Western school, with a high quality level of education.  Step into the poorer areas however, and you soon forget that this is a country with one of the most developed economies in Africa – the schools in these areas feature crumbling facades, lack basic amenities and are often staffed by underpaid and undertrained teachers. How can you close the gap between the rich and the poor when the poor are getting a 3^rd world education and have to compete with the 1^st world education of the rich when it comes to jobs?

In any case, in terms of microfinance it seems on the surface at least that South Africa should be a good place to implement and spread the development of such a grass-roots based approach designed to promote entrepreneurship through economic empowerment.  Certainly in most of the townships and the more traditional African cultures there seems to be a strong sense of family and community which should help promote the Grameen style approaches that so heavily rely on trust and group pressure. In addition, the South African government does want to promote business development and close the economic gap and so one would expect that government policies would therefore highly favour the development of MFIs.  However, for a number of reasons the successful spread of microfinance in South Africa has been slow and problematic.  There are certainly organizations that are doing it well, however there are many more who are struggling.  In addition, the government support is lacking in this regard, and the institutions set up to help often seem to do more harm than good.

One of the biggest barriers to microfinance in South Africa – meaning development oriented microcredit designed for poverty alleviation – is the fact that it gets so often confused with other forms of microcredit like small consumer loans and payroll lending which are hugely widespread in the country. These types of loans are often spent on non income generating activities and the high interest rates and quick payback periods mean that they do nothing to improve the welfare of the borrowers who take them on.  Some of these moneylenders, but not all, therefore perpetuate poverty, and have a deservedly negative reputation within the country.  However, what is now happening is that even MFIs with poverty alleviation as their main goal are facing the negative backlash from those who assume that they are the same as the consumer loan lenders.  This also creates risks for the MFIs in selecting their clients, since many may pretend to have a business premise but will then turn around and use the loans for consumer purposes, thus creating a larger risk of defaulting, as well as causing no movement towards the ultimate objective of the MFI.

A further significant problem is one that can be seen as a direct legacy of the oppressive apartheid regime – the overall reduction in entrepreneurial spirit in the poorest areas.  Many of the small business owners in the townships have similar businesses – hair salons and spaza shops perhaps being the most common.  It is much rarer to see something truly innovative, though innovation is in itself not a precursor to a good business. However, along the same lines, these businesses start out small and tend to stay that way.  It could be a lack of resources, and this certainly plays a role, but there also seems to be a pervasive frustrated resignation to the way that things are.  Not having lived here for a significant period of time I cannot say if this is something that is improving or not, but again it is something that well implemented microfinance should be able to help with by giving the power to change their own lives back to the people.  In this regard, as in the previous paragraph, it seems that a national media campaign on microfinance might be one of the best ways to deal with this problem.

Some International Organizations (IOs), like the ILO, are already trying to stimulate entrepreneurship through approaches like social entrepreneurship competitions in the townships.  This is a good start. A national media campaign designed to educate people on the different types of microcredit available and the varying aims of each would also help the right people get to the right loans.  If the South African government, in conjunction with IOs and NGOs, takes a top down approach to education on the resources available to those in the poorest regions, then the MFIs can at least enter communities with less false perceptions and a greater chance at success.

That being said, there will still be many challenges ahead.  South Africa is a large country and many of the poor towns and townships, especially in very rural areas, are quite spread apart and therefore hard to service.  This is also something to consider as many of the Loan Officers (LOs) do not have access to cars and will have to travel far in order to supervise groups of lenders, thus making very frequent contact a bit difficult. In addition, the salaries paid to LOs will have to be proportionally higher than in other countries in order to attract the right individuals, and this is important for funders of South African MFIs to be aware of.

Lastly, the government needs to develop a formal microfinance policy and stop opting for quick-fix solutions.  An example of the worst kind of quick-fix is of a government agency that was offering micro-loans with absolutely not verification of business potential and minimal supervision.  As the money was seen as coming from the government, many of the borrowers felt that it was owed to them and did not feel obligated to pay it back.  The program is now closing, and any MFI opening in that region will have a decidedly harder time getting a successful lending program in place due to the perceptions already existing in the region.  On this point, it is time that the government makes a comprehensive policy on microfinance and makes serious moves to support the MFIs that are doing it well, while putting in place capacity building resources and funding for those are starting out.

There is a lot of potential for MFIs in South Africa to make drastic changes.  If the government works with IOs and NGOs towards a national policy, as well mobilizes a media campaign to educate the people, the successful spread of MFIs should increase exponentially, thus providing a powerful tool for closing the economic and class gap created by the former apartheid regime, and allowing South Africa to finally move towards a real form of equality which is a long time coming.

Having recently finished the IOMBA programme — a specialized MBA with a focus on social entrepreneurship and international development — I am now happily in beautiful South Africa for an internship in the exciting and growing field of microfinance.

Ever since hearing about microfinance and its founder Muhammad Yunus some two years ago, I have wanted to become involved in the field.  Microfinance is to me the perfect marriage of social impact and business practices that signals the coming of a new era in international development.  As many large corporations try to demonstrate that they are socially and environmentally conscious through use of Corporate Social Responsibility (CSR) measures, NGOs and IOs have at the same time been trying to streamline their functions and adopt some of the efficiency and efficacy frameworks used in business.  The recent financial crisis has only heightened the need for this convergence as the public pushes for more ethics and regulation in businesses while the shortfall in development funding is forcing NGOs and IOs to use limited funds more effectively.  It is an exciting time.

In my opinion, there is no longer a need to separate genuine social and environmental benefits from the profit focused, efficiency of business.  Many have however argued that CSR is nothing but a PR strategy for large corporations accused of causing various harms to communities and the environment.  No doubt this is often the case.  However, when done well, CSR can become so much more than that.  Others will argue that a company’s duty is only to its shareholders, meaning that it should focus on profit only.  I would agree.  However, the difference for me is one of short term versus long term gain.  For example, if a company tries to streamline its processes so that it reduces carbon emissions it will save money in the long term, though it may post a loss in the short term due to investment in new technologies.  Similarly a company that invests in education in a poor, underdeveloped community where it has a factory set up will help ensure that it has a more highly skilled workforce available down the road despite garnering no immediate monetary benefit. If it also then pays fair wages it can use this fact as PR in order to attract business from socially conscious consumers who would be willing to pay a slightly higher premium for this fact.  These businesses may not initially grow as fast as their profit-only focused counterparts, but I would wager they will be around for much longer.  The effects of doing business this way will also be felt by the employees who are likely to feel more dedication to the company thus helping boost productivity, and surely someone should also ask the shareholders if they would like their investment to have a social as well as a monetary return on investment.

The NGOs and IOs on the other hand are now moving towards more social entrepreneurship models of business.  They may need more grant funding to start but if there is a demand for the service they are providing to the community then there is no reason why they cannot charge a small fee and become self sustaining.  This will allow both buy in and empowerment to the communities being helped and will also allow market forces to ensure that services and goods being provided are actually what the people want — and not some artificially engineered helping measure that none of the supposed beneficiaries ever asked for (as so often happens in international development).

In any case, this blog will follow my three month internship in South Africa in the field of microfinance, which is one of the best examples of a social enterprise. It will also include random thoughts on the general fields of social entrepreneurship and CSR.  If you aren’t on the social and environmental business bandwagon yet, I am sure you soon will be.