Microfinance is a Sound Business Strategy

In defense of microfinance, I'd like to correct the notion that it is unsound and only works as a semi-charity activity. In the Jonas Gonats "Banker for the Poor" article (http://jonatsgonats.co.nr/), the author cites that lending to the poor is too risky and disserves the bank's shareholders.

This is untrue. For these reasons:
1) Lending to the poor is not a trust issue. It is pure business. As regular banks can only get around 12% to 15% per annum returns on their loans, microfinance offers 20% to 60% per annum returns- and this is being conservative!

2) It is risky but the returns will compensate for that. Take the popular 5/6 loans of the local "bombays". If it isn't that profitable, these mobile bankers will stop to exist.

5/6 works like this. For every 5 Pesos you loan, you have to pay 6 Pesos. You pay everyday but you have to close your loan in 40 to 60 days. Sounds affordable right but if you compute it in a per annum basis, you'll see that the return is actually 120% conservatively.

3) There are ways to minimize microfinance risks. One is through peer pressure. The way microfinance institutions lend out money is through peer pressure groups. These groups continue to get access to credit as long as their credit standing as a whole is good. This is where the pressure begins.

Let's say in a group there is Farmer A, Farmer B and Farmer C like in Bangladesh. They each get a loan of 1000 pesos to buy necessities while waiting for this season's harvest. If for some reason Farmer C suddenly stops paying his loan, Farmer A and Farmer B will have to shoulder the cost. If Farmer A and Farmer B decline to pay, there credit line will stop. They can't borrow anymore. How can they stomach this as they don't have any income source for the next three months. They will now pressure their friend/ neighbor Farmer C. As Farmer C is known to the local community, he will be ostracized and scolded for burdening his peers. This will then force Farmer C to return and continue paying his loan.

4) Another way of minimizing risks is by niche marketing. Russian as other European banks have discovered that women are more diligent in paying their dues. They are also easier to scare. This is why these banks now have subsidiaries that cater to women alone. This is also the niche Mr. Yunus' Grameen Bank has targeted with 97% of whom are women. http://www.grameen-info.org/bank/index.html

5) Mr. Yunus' Bangladesh operation is not a break-even operation. Its repayment rate is 90%, meaning its Non-performing loan (NPL) ratio is just a low of 10%. This is a big difference with the Philippine bankers NPL ratio of 12.7%. (http://www.senate.gov.ph/publications/PI%202005-05%20-%20Banking%20on%20Banking%20-%20Issues%20and%20Challenges%20Facing%20the%20Banking%20Sector.pdf) Take note that the Philippine bankers' NPL ratio is low only because of the Special Purpose Vehicle (SPV) Act, while Mr. Yunus succeeded in having a low NPL ratio of 10% without any SPV Act.

Special Purpose Vehicle Act is a special law meant to unload banks of non-performing loans aka bad debts. There is an entity called SPV. It is a company that buys non-performing loans from banks. They handle collection of the loan. They get a cut for doing this service. Banks like this SPV because they immediately remove some of the bad loans that appear on their balance sheets. Better balance sheets mean better confidence from investors. Don't forget that the bad loans don't just disappear. They are transferred to another entity. Until they get paid, the actual NPL of a bank will be high. To learn more of how an SPV works read http://www.ey.com/GLOBAL/content.nsf/Philippines/SPV_Act:_The_answer_to_the_Philippine_NPL_problem

6) Mr. Yunus has been targeting the rural poor and not the urban poor. This means his customers are the farmers and village vendors. Small entrepreneurs and not loafers.

Conclusion:
These microfinance facilites are unsecured but they provide one of the vital necessities the poor need: access to credit. The poor does not mean they do not have income, they just have seasonal droughts as their livelihoods are seasonal.

There are a lot of creative ways to tap this unseen market. Mr. Yunus just showed us a few of the popular ways.

I therefore believe that microfinance is a good business strategy. It is not charity as my arguments have shown. It is viable and can be proven with statistics and balance sheets. Lastly, it is profitable enough to absorb the risks of giving out unsecured loans.

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