0 years of world bank support for microcredit in bangladesh

8/7/2019 0 Years of World Bank Support for Microcredit in Bangladesh

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0 Years of World Bank Support for Microcredit in Bangladesh

Microcredit in Bangladesh

Project Document: Poverty Alleviation Microfinance project Project Document: Second Poverty Alleviation Microfinance Project

Project Document: Financial Services for the Poorest Feature Story: Microcredit for the Poorest of the Poor Feature Story: What Will the Nobel Peace Prize Mean for Microfinance?

Official Bank Sites

Bangladesh Country Website

Related Information

Palli Karma-Sahayak Foundation

November 5, 2007 -- Since 1996, the World Bank has reached more than 6 million poor in Bangladeshthrough microfinance projects worth over US$260 million.

90% of micro-credit borrowers are women.

Micro-credit borrowers have used the funds to start small grocery shops, set up trading activities, rearcattle and poultry, farm fish, and start up businesses such as tailoring, rickshaw pulling, paddy husking,among other activities.

Micro-credit has significantly helped improve their lives:

y 99% report increase in income, often by more than 15%y 96% report improved quality of lifey 99% eat better and more foody 99% are clothe bettery 86% live in better housingy

88% are now able to send children to schooly 83% have betteraccess to sanitationy 55% of rural borrowers now own land

* Data based on an assessment of the impact of microcredit on a sample of borrowers carried out in 2001.

Reaching the Poorest of the Poor

In 2002, an innovative World Bank project, Financial Services for the Poorest, extended micro-credit tothe poorest of the poor, who couldnt qualify for conventional micro-credit programs (such as beggars,sex workers, or household help ). The project was initially piloted in 18 districts covering 20 Upazilas inBangladesh, reaching 60,000 of the poorest people. Around 12,500 borrowers received job skills trainingto become gainfully employed. Most of them are now gainfully employed.

The government replicated the project all over Bangladesh and as a result:

y Around 450,000 of the poorest of the poor have benefitedy Repayment rate has been more than 95%y Already 20,000 of those who received micro-credit 3 years ago can now access regular rural

microcredit programs

y More than half of these borrowers no longer live on less than a dollar-a-day. They have alsoupgraded their housing conditions from jhuprito semi-durable structures within 3 years


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A Decade of World Bank-Supported Microfinance Projects in Bangladesh

The first World Bank Poverty Alleviation Microfinance project (1996-2000) expanded the outreach ofongoing successful microfinance programs and enhanced the institutional and financial sustainability ofPalli Karma-Sahayak Foundation (PKSF) and its Partner Organizations (POs).

Palli Karma-Sahayak Foundation (PKSF) is an apex microfinance institution that reimburses microcreditloans of its Partner Organizations (POs) and their borrowers.

Prior to Bank assistance in 1996, PKSF financed the microcredit activities of 124 POs through loansoutstanding of Tk.459 million to 300,000 borrowers.

Today, PKSF is financing 212 POs with loans outstanding of over Tk.10 billion to around 6 millionborrowers.

The PKSF Board includes leading personalities, such as Nobel Laureate Dr. Yunus. Moreover, Banksupport to PKSF has helped leverage funds from IFAD, EU, ADB, USAID, and DFID.

The Second Poverty Alleviation Microfinance project reached a greater number of poor people,diversified micro-credit to include the urban poor and microenterpreneurs, built sustainable institutional

capacity of PKSF and its POs, and established a legal and regulatory and supervisory framework for non-government organizations and microfinance institutions.

This project reached around 350,000 urban poor, and 60,000 microenterpreneurs who graduated fromthe regular rural microcredit programs. The average loan size has increased to Tk.7,800 signifying thatbigger loans are made to repeat borrowers who are expanding their economic activities, increasing theirincomes and improving their livelihoods.

The impact of microcredit continues to grow as borrowers increase their loan amounts and as newborrowers take microcredit for the first time.

Social indicators relating to health and education of microcredit borrowers also continue to improve as aresult of continuing the microcredit programs.

Given the projects success, the Bank is processing a proposal for additional US$15 million to providemicrocredit services to an underserved segment of the urban poor, mainly the rickshaw pullers affectedby the ban on non-motorized transport on certain Dhaka roads.


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October 16, 2006 -- Last week, the Nobel Peace Prize went to Muhammad Yunus and Grameen Bank, themicrofinance institution he founded 30 years ago.

The World Bank interviewed Syed Hashemi, a senior microfinance specialist at the Consultative Group to Assist the

Poor(CGAP), who assessed the awards impact on the microfinance industry. Before joining CGAP, Hashemi, aBangladeshi national, directed Grameens Program for Research on Poverty Alleviation.

What will this honor mean for the microfinance industry?

"I think first of all it will remind all of us who work in microfinance that our work is indeed about improving peopleslives. That the Nobel committee has chosen to recognize this is really an honor for the entire industry, especiallymicrofinance practitioners in developing countries worldwide. And no one is more deserving than Professor Yunus.

I had the good fortune of working closely with him for several years at Grameen, and I can echo what the entire worldknows about him now -- that he is a tireless champion of the poor and has dedicated his life to this work. He has beenan inspiration to me personally and to literally millions of others, including the more than six million clients ofGrameen Bank itself. Their achievements -- and Grameens role in supporting them -- will now take center stage inthe debate over how best to attack and conquer poverty.

I think the Nobel really underscores that microfinance is no longer a niche development field, but has become part ofthe financial mainstream."

How has microfinance changed since Yunus started Grameen Bank 30 years ago?

"The original Grameen business model -- group lending, and mostly to women -- has been adapted and developed bythousands of microfinance institutions from Latin America to Africa to East Asia and beyond.

But microfinance today is also about much more than small loans. Its about providing a full range of financialservices, like safe places to save and transfer money, to ever-larger numbers of poor people. And its being done bymuch more than donor-funded NGOs.

Microfinance has actually matured into one of the most successful and fastest-growing industries in the world. InAfrica alone, its growth is probably second only to that of cell phone use. According to a recent analysis conducted byCGAP, the compound annual growth rate of the worlds leading microfinance providers over the last five years hasbeen an incredible 15 percent. Worldwide, these leading microfinance institutions are nearly twice as profitable as theworlds leading commercial banks."

What about its impact in Bangladesh, the home of Grameen?

"When Professor Yunus gave his first loan to a group of women in Bangladesh, that act was about confrontingsystems of inequity and exclusion. It wasnt out of a development playbook somewhere or out of a commercial banksoperational manual. In fact, Professor Yunus himself has said that he deliberately did the opposite of whatconventional banks did; if, for example, a traditional bank client had to go to a branch, Grameen instead brought thebranch to the client. That kind of bold grassroots effort built much more than a single microfinance institution; it built amovement.

The movement has quite literally changed the face of Bangladesh. For one thing, women have become visible,productive, assertive members of society. If this seems like an overstatement, consider that Grameen and othermicrofinance trailblazers like BRAC have branches in tens of thousands of villages across Bangladesh."

What has been the impact of microfinance worldwide?

"Its no secret that small loans to poor people, especially women, can support micro-enterprises, helping familiesboost their incomes. But poverty is about much more than the lack of money; its multidimensional. Over the long run,


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access to finance -- loans, but also savings and money transfer services -- has been shown to contribute to betternutrition, education, housing, and other essentials.

Poor people with erratic incomes can also manage their consumption better and cover the costs of medical or otheremergencies. But proving the direct impact of a micro-loan on the health or education of a poor person is never astraightforward task, which is why its important not to think of microfinance as the "magic bullet" when it comes topoverty alleviation. Its one of many strategies, but it can lead to empowerment and social stability, as the Nobel

committee has acknowledged."

How will the Nobel affect CGAPs work?

"As a global organization, we remain focused on the central challenge of microfinance today: reaching the nearlythree billion people who still lack access to financial services. Getting there will take partnership with a wide range ofstakeholders -- including commercial banks, telecommunications companies, and other private players -- that canhelp us adapt existing payment systems and technologies like cell phones to reach massively larger numbers ofpeople. Its also important to remember that many of these people are in remote areas, some of them at the verybottom of the economic ladder. Helping these people reach the first rung of that ladder will take some innovativethinking. At CGAP, for example, were working with social safety net programs in several countries to see if we cangraduate some of their beneficiaries into microfinance programs and out of absolute poverty."

Part 3More People to Gain Access toMicro-Credit: New project aims toreach larger numbers and thepoorest of the population

Press Release No:2001/203/SAS

Contact Person:In Dhaka: Ismet Zerin Khan 880-2-966-9301E-mail: [email protected] In Washington: Zita Lichtenberg (202) 458-7953E-mail: [email protected]/developmentnews

DHAKA, January 19, 2001--The World Bank has approved a US$151 million credit for a project toimprove and expand micro-lending in Bangladesh. The Second Poverty Alleviation Micro-financeProject aims to increase access to credit and ensure sustainability of the country's micro-lendingprograms. The credit is provided by the International Development Association (IDA), the World Bank'sconcessionary lending affiliate."Providing micro-credit is one of the most effective means Bangladesh has of directly improving the livesof its poorest people, especially women," said Reazul Islam, the World Bank's team leader for theproject. "Since it began around 20 years ago, micro-lending has provided a path out of dire poverty formillions of people in this country.With this project we hope to reach more of those who have been left outor under-served so far, and to ensure that micro-lending is sustainable into the future."

The project follows an earlier $105 million IDA credit provided in 1996. The first micro-finance projecthelped provide micro-credit to about 2.2 million borrowers by the time it closed on December 31, 2000.The project has had a strong impact on poverty by helping to stabilize income and consumption,improving quality of life (through increased access to clean water, and better health and hygienicconditions), increasing school enrollment rates, and enhancing family assets. It has improved financiallythe viability of partner NGOs who retail microcredit, enabling them to seek part of their funding needsfrom the financial market as well as allowing their gradual integration into the formal financial sector.


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The project aims to:y Expand rural micro-credit, responding to unmet demand and the need for larger loans per borrower.y Extend access to credit for the poorest of the population, including providing smaller loan sizes, flexiblerepayment plans and possibly linking micro-credit to safety net programs such as skills training and food

aid.y Expand micro-lending in urban areaswhere current micro-credit is limited to less than 15 percent ofurban poor people, as compared to over 60 percent of rural poor people. The potential for growing out ofpoverty through micro-credit is high in urban areas because of proximity to large markets.y Provide micro-enterprise loans to entrepreneursto help them scale up their activities and in turn createemployment for the poorest people.y Strengthen institutions providing loans, including the Palli Karma-Sahayak Foundation (PKSF), theorganization set up by the government to administer funds, and its partner organizations (NGOs andmicro-finance institutions) who on-lend the funds to individuals.The project will also help the government design a regulatory and supervisory framework which willimprove credit-worthiness of NGOs and micro-finance institutions and accelerate their integration into theformal financial market.

Partner organizations have estimated an expansion of around 4.5 million borrowers in the next five years.The Bank-sponsored project is projected to reach an estimated 1.2 million new borrowers and support19,500 micro-entrepreneurs.The US$151 million credit to the Government of Bangladesh is made on standard IDA terms with 40years' maturity. The government will on-lend the IDA funds to PKSF at 1 percent for 20 years, with fiveyears' grace. PKSF then re-lends to its partner organizationseligible micro-finance institutionsat interestrates ranging from 4.5 to 7 percent. The partner organizations will be free to set the final lending rates tothe beneficiaries (expected to be in the 25-30 percent range--which reflects administrative costs). Totalproject costs are US$181 million with the Government providing US$ 30 million.

Part 4

Economics and Governance ofNGOs in Bangladesh

Also available in BanglaBangladesh has made striking progress on a range of social indicators over the last 15 years anachievement which is credited to the countrys pluralist service provision regime, including the large networkof NGOs. A recently released report by the World Bank titled Economics and Governance of NGOs inBangladesh recognizes these contributions and addresses the current debates surrounding NGOs.

The main NGO services are by and large successfully targeted to poor households. For instance as thefollowing chart shows almost half the studentsin NGO primary schools are from the poorest 20%of the population far higher than in other schools.

The impact of these services is also clearlypositive, and highlyvalued by the communitiesthat they serve. For instance micro-credit programsthat now reach around 70percent of poor households, have led to significantimprovements in female empowerment and led togreater stability of incomes for the poor. Educationaland health outcomes have improved for NGObeneficiaries due to social sector programs. NGOadvocacy campaigns have also led to greater


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awareness, and some progress, on pro-poor issues. Hence the rapid growth of NGO activity over the pastdecade is a positive development. Moving forward, NGO services will need to be scaled up even further asNGOs can have a critical impact on Bangladeshs PRSP targets.

The share of aid to NGOs as a portion of total aid to Bangladesh has risen from 14% from 1990-95 to24% between 1995-2004. At the same time micro-finance interest income and profits from commercialventures have become increasingly important for NGOs. The scaling up of NGO activity will require different

sources of funding depending on the type of service provided. The micro-finance sector has matured to thepoint where the sector ought to move towards commercial sources of funding. In the social sectors, there is astrong case for financing of NGO programs throughthe Government Budget, using donor funds ordomestic revenue. However in order for this to beeffective in practice, contracting procedures need toimprove significantly as part of an overallstrengthening of Government procurement. Foradvocacy type work, financing sources ought to beindependent of Government, raised from privatedonations or external grants. Several NGOs haveestablished commercial enterprises whose profitstream is earmarked to support their developmentprograms. This endowment model is an innovativesolution characteristic of charities elsewhere.

However NGOs should incorporate suchbusinesses as independent entities to create a levelplaying field with the private sector.

In order to further capitalize on the potential of the NGO sector, the report argues for a strategiccompact between Government, NGOs, donors and clients. The implicit compact would be where eachactor strengthens various areas that are within their own mandate. The combined impact of theseimprovements will go a long way in achieving the common goal of improving services to the poor inBangladesh and help achieve the Millennium Development Goals.

As part of this compact, the main role for Government is to facilitate the provision of quality NGO servicesunder a modernized regulatory framework, developed in close consultation with NGOs. The regulatory focusshould change from government micro-management of NGOs foreign funds to support for better corporategovernance, strengthened accountability, and transparency by NGOs. Moreover regulatory reforms for NGOs

need to be linked closely to the new micro-credit law under consideration. The framework should recognizethat NGO advocacy fulfils an essential function in a democracy such as Bangladesh, and must be givenspace, except for activities that promote one political party, or election candidate, over another. Regulatorycapacity must be strengthened significantly one option is that Government set up an independent NGOCommission to perform many of the current regulatory bodies functions. Government ought to strengthencontracting procedures to improve the effectiveness of aid that is channeled to NGOs through the Budget. Aspart of this lessons from PKSFs successful NGO contracting procedures could be mainstreamed withinGovernment. The Government-NGO Coordination Council (GNCC) ought to be revived to provide a forum forregular Government-NGO discussions.

Donors should continue to support NGO activities in Bangladesh, both to improve pro-poor service deliveryand to promote a broad-based civil society, while ensuring that they do not undermine the accountability ofNGOs to Bangladeshi stakeholders. Moreover donors need to be accountable for the occasions when poorproject design or inadequate supervision contributes to unsatisfactory implementation of projects involving

NGOs and institute mechanisms to prevent these from reoccurring. While financing social sector activitiesdonors also need to develop a clear strategy for sustainability, as has occurred in micro-finance. This strategyought to be developed in tandem with Government and NGOs where in the medium run the Budgetprogressively absorbs the costs of financing of various social sector programs. In areas such as advocacy,where the conflicts of interest with Government financing are significant, donors could work with NGOs to tapthe market for greater private charitable contributions. Donors should also reduce the transaction costs oftheir financing by harmonizing reporting requirements, upgrading financial management skills of their ownstaff, and retaining institutional memory within their organizations.NGOs also clearly have an important agenda in front of them if they are to continue to be effective partners indevelopment. Priorities include the need to (i) strengthen financial management and corporate governance;


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(ii) scale up efforts to provide public disclosure with respect to financial and programme information alongwith a public information strategy to address misconceptions about NGOs (iii) make greater efforts tocoordinate with local and national Government officials and act as facilitators of Government, private sectorand community service provision (iv) revisit strategic directions periodically based on national developmentneeds and internal capacity constraints (v) develop a middle management layer to oversee more complexdevelopment programs.

Clients may also support the strategic compact using mechanisms that improve their capacity to demand andmonitor services, for example, through vouchers enabling choice between public, NGO and private providers.

May 2006

_____________________________________________________________________________

MicrosharksRapid expansion of Indian microcredit leads to a turf war with the government

Microcredit in India

Aug 17th 2006 | HYDERABAD | from the print edition

y y

MONEYLENDERS bad; microcredit good. That has been the common view about financial

services in much of the Indian countryside. Traditional moneylenders charge extortionate

interest rates to those in desperate need. Microcredit-providers, which are charities that

lend tiny amounts to the poor without necessarily expecting to make a profit in return, are

globally trendy and socially responsible. So it came as a shock earlier this year when the

government of Andhra Pradesh, the Indian state where microcredit has spread fastest,

accused some leading microfinance institutions (MFIs) of behaving no better than old-style

usurers. The lenders say they are being defamed, in a row that raises questions about their

future in the state.The dispute centres on one poor rural district, Krishna. Some women were reported to have

killed themselves because they could not repay the MFIs. In March a top government official

in Krishna temporarily shut 50 branch offices of four MFIs, seized and destroyed their

records and told their borrowers not to repay their loans. He accused the microfinance

groups of charging exorbitant rates.

Udaia Kumar, who runs SHARE, one of the affected four, says that, in fact, its loans cost

about 21.5% a yearnot excessive, since its cost of funds is 11% a year, the administration

of a portfolio of more than 800,000 small loans in Andhra Pradesh is expensive, and not all

loans are repaid. It is also less than half the rate a moneylender would charge or what a

poor borrower would end up paying for a bank loan. Even so,SHARE has since agreed to cutits rates by about four percentage points.


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Related itemsy Microcredit and disasters: Starting overDec 14th 2005y Microcredit in India: Helping themselvesAug 11th 2005

Related topicsy World Banky Public financey Central bankingy Government and politicsy Andhra Pradesh

There had been abuses. Viswanatha Prasad of Bellwether, a fund that finances microcredit-

providers, blames indiscriminate expansion (see chart). The MFIs were flush with money,

partly because commercial banks saw them as a good vehicle for lending to rural areas.

Some microcredit lenders were charging interest rates on the full amount of a loan, rather

than the declining balance, and some borrowers were bullied and humiliated. Aggressive

competition and a failure to share information meant some people were in hock to

numerous lenders. That is what seems to have led to the suicides. Mr Kumar says SHARE's

own average outstanding loan was only 4,000 rupees ($86).

The root of the dispute, he says, is competition between non-governmental MFIs and a

subsidised microcredit scheme, financed by the state and central governments and the

World Bank. According to the bank, some 30% of SHARE's clients overlap with government-

supported self-help groups. Mathew Titus, of Sa-Dhan, an association of Indian

microcredit institutions, sees the row as a battle of ideasbetween the non-government

sector and those ideologically opposed to its working with the poor.

The fear is that the state government will now try to regulate the lenders, perhaps by

capping interest rates at levels that could put them out of business. Legally, this would be

difficult. SHARE and the other big MFIs are regulated as non-banking financial companies

by the central bank, the Reserve Bank.

Bellwether's Mr Prasad thinks the scandal could even have some positive consequences. The

microcredit groups will have to stamp out abuses, adhere to a code of conduct and

recognise that they cannot ignore the government. For its part, the government will have to


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realise that the MFIs are a force to be reckoned with, and that their mission is not

necessarily to exploit the poor.

It is not as if too much credit is available. There should be room for both private lenders and

subsidised schemes for the very poor. There may even be room for the despised

moneylenders, whose local knowledge and extensive business mean they cannot be ignored

either. According to one survey, 30% of MFI clients in Krishna took loans from

moneylenders. Nationwide, moneylenders are estimated to account for about one-third of

the debt owed by rural households. The Reserve Bank is reviewing the laws on

moneylending. One option is for banks to lend to registered moneylenders, using them as

intermediaries. Priya Basu of the World Bank, an expert on India's rural credit market,

thinks the idea makes sense if they can co-opt moneylenders into the formal system.

Microcredit good; moneylenders not so bad after all.

from the print edition | Finance and Economics

Microfinance

May 15th 2008 | NEW YORK | from the print editiony y

SINCE CompartamosBanco, aMexican lender to the poor, went public a year or so ago, a rift has beengrowing in the booming microfinance industry. To supporters of traditional charitable microfinanceproviding loans and other financial services to help lift people out of extreme povertytheCompartamos initial public offering has come to symbolise an aggressive move by capitalists to profitfrom the poor. To its backers, on the other hand, the success of Compartamos, despite the recentlacklustre performance of its shares, symbolises how the profit motive can help lift many more peopleout of poverty than charity alone could ever do.

Critics of Compartamos includeMuhammad Yunus, a Bangladeshi economist who won the Nobel peaceprize in 2006 for his work in popularising microfinance through the Grameen Bank. He was reportedlyshocked by the IPO, and has argued that microfinance should be about protecting [poor people] fromthe moneylenders, not creating new ones. Another critic, Chuck Waterfield ofMicrofin, a provider ofsoftware to microfinance institutions, accuses Compartamos of monopolistic exploitation of the poor.He alleges that it is charging interest rates of over 100% a year, little different from what illegal loansharks demand, and that it is deliberately making it difficult for poor borrowers to understand howmuch they are paying for their loans. He andMr Yunus are campaigning for the microfinance industry toagree on common standards on disclosing charges to help borrowers.Compartamos concedes that its rates may seem highthough it reckons they are closer to 70%butsays they are set to allow the bank to grow quickly to meet vast untapped demand inMexico. Its

borrowers have risen in number from 60,000 to around 900,000 in the past eight years. This is hardly anindication of exploited customers.Moreover, it is targeting potential borrowers just outside themainstream, not the very poorestMexicans.A big win like the Compartamos IPO was needed to attract lots more capital into the microfinanceindustry, says lvaro Rodrguez Arregui, the chairman of ACCION International, a charity that has beenhelping to spread microfinance since the 1970s. He expects interest rates to fall sharply as the rush ofcapital that followed the IPO expands supply and intensifies competitionjust as it has done in Bolivia,which boasts the first for-profit, but not listed, microfinance institution, BancoSol. For-profit


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microfinance has been growing fast, including in India where SKS, a lender created by Vikram Akula, aformerMcKinsey partner, is backed by Sequoia, a leading Silicon Valley venture-capital firm.ACCION was an early investor in Compartamos, and banked $140m in the IPO (and retains a 9% stake).This infuriates critics such asMr Waterfield, especially as ACCION has received funding from theAmerican taxpayer via USAID, the development agency. ACCION is reinvesting the money in newmicrofinance schemes, however.Mr Rodrguez Arregui fears the public fight over profits may scare awayinvestors. Perhaps the best way to help the poor is to acknowledge that charitable and commercialmicrofinance can co-exist.from the print edition | Finance and Economics

Apparently, microfinance in South Korea has failed. The Korea Times, a South Korean daily

newspaper, attributes this failure to lack of private donations and government support.

The South Korean government established the Social Solidarity Bank (SSB), the nations

first non-governmental microfinance institution, in 2002. Since its inception, SSB attracted

corporate donations of3 billion won (USD $3.15 million), in large part from conglomerate

Samsung Group and Kookmin Bank. However, The Korea Times believes this was a

miniscule amount of money and not enough to allow the bank to operate as a financial

institution.Lim Eun-eui, a SSB public relations officer, blames the banks failure on the lack of support

from the government and private sector: We have not been able to live up to our

objectives in terms of helping people in need, as there is only so much we can do in the face

of the indifference of private companies.Contrary to these accusations, the government has been hard at work, devising new plans

to strengthen the microfinance sector. Earlier this year, the Justice Ministry introduced a

plan to set an interest rate cap of40%, in order to prevent credit defaults and the extensionof risky loans. However, the plan met resistance from policymakers and the finance

industry. The Ministry of Finance and Economy also toyed with the idea of seizing funds

from inactive accounts at local banks, an estimated 722.4 billion won (USD $753.6 million)

accumulated over the past 5 years. These plans, too, were felled by the self-serving finance

industry which balked at the proposed forced donation.The Korea Times and the SSB may seek to lay the blame elsewhere, but the failure of a

state bank is the oldest story in the book.Additional Resources1) The Korea Times: Micro-Credit Provides Little Help for Poor2) Bloomberg Currency CalculatorHeadnote]THE VOLATILE COMBINATION OF PROFIT-SEEKING MICROFINANCE COMPANIES, MINIMAL COMPETITION,AND VULNERABLE BORROWERS HAS OPENED UP DANGEROUS POTENTIAL FOR EXPLOITING THE POOR.THE MICROCREDIT INDUSTRY NEEDS TO BE REGULATED-THROUGH POLICIES THAT ADDRESS


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TRANSPARENCY, HIGH INTEREST RATES, AND ABUSIVE LOAN RECOVERY PRACTICES.SINGE MUHAMMAD YUNUS pioneered the concept of microcredit in 1976 and founded the GrameenBank in Bangladesh, microcredit has become a major movement. Worldwide, 3,552 microcreditinstitutions provided loans to 155 million clients, finds the State of the Microcredit Summit CampaignReport 2009. Grameen Bank alone disbursed more than $5 billion in microloans over the last 10 years,and it now has 7.7 million borrowers. According to the Grameen Bank website, microcredit is "offered forcreating self-employment for incomegenerating activities and for housing for the poor, as opposed toconsumption." The poor are expected to invest the microloans to start up or grow a microbusiness andthus climb out of poverty. Microcredit is the latest silver bullet for alleviating poverty.In his popular 2005 book Fortune at the Bottom of the Pyramid, CK. Prahalad argued that there is muchuntapped purchasing power at the bottom of the pyramid (BOP), and that private companies can makesignificant profits by selling to the poor, while simultaneously bringing them prosperity. Focusing onefficiency and low default rates, Prahalad cites microcredit as a good example of the BOP proposition.And indeed, in the past few years hundreds of for-profit companies have begun financing and marketingloans to the poor in developing countries. But, in an ironic twist, private companies are making a fortunein microcredit by doing exactly what microcredit was designed not to do: exploit the poor. "Now poorpeople are turning into one of the world's least likely sources of untapped profit, primarily because theywill pay interest rates most Americans would consider outrageous, if not usurious," wrote BusinessWeek

journalists Keith Epstein and Geri Smith in a December 2007 article. MFTransparency, a selfmonitoringmicrofinance industry association, finds that private companies have been attracted to microcredit "bynear-monopoly lending environments and misleading pricing systems compounded by borrowers'frequent lack of understanding of the financial details of credit transactions."1

Whether fair or not, a few recent high-profile events have galvanized criticism of microfinance institutions(MFIs). When Banco Compartamos in Mexico went public in April 2007, the- initial investors' stake of $6million was valued at $1.5 billion - a return of roughly 100 percent a year compounded over eight years.This profitability is due to the fact that Compartamos charges interest rates that exceed 100 percentannually on their loans to the poor. Yunus was particularly critical of Compartamos, telling BusinessWeek,"Microcredit was created to fight the moneylender, not to become the moneylender."

In the Indian state of Andhra Pradesh more than 200 people committed suicide, allegedly because ofintimidation by MFIs. Government authorities closed down 50 branches of two major MFIs in 2006 andcharged them with exploiting the poor with usurious interest rates and intimidating the borrowers withforced loan recovery practices. Y.S. Rajasekhara Reddy, chief minister of Andhra Pradesh, was quoted inThe Times of India as saying, "MFIs were turning out to be worse than moneylenders by charging interestrates in excess of 2 o percent."2 And over the past few years, there has been growing criticism of MF I sby government officials and politicians in Bangladesh, Cambodia, India, Pakistan, and Sri Lanka.

I argued in an earlier article in this magazine that microcredit does not significantly alleviate poverty (see"Microfinance Misses Its Mark" in the summer 2007 issue of the Stanford Social Innovation Review). Thevast majority of microcredit clients are caught in subsistence activities and compete in overcrowdedmarkets. They usually have no specialized skills, hire no paid staff, own few assets, and operate on toosmall a scale to achieve efficiencies, and so they do not earn enough to rise out of poverty. In March 2009 the World Bank published Moving Out of Poverty, one of the most thorough field studies of thedynamics of poverty based on narratives from 60,000 poor or formerly poor people in 15 countries ofAsia, Africa, and Latin America. The study notes an "important insight" that "the tiny loans usuallyprovided under microcredit schemes do not seem to lift large numbers of people out of poverty."

Regardless of this debate, microcredit has grown dramatically in the last 30 years and becomeincreasingly commercialized. The volatile combination of profit-seeking companie s, minimal competition,and vulnerable, ill-informed, and ill-educated borrowers has opened up dangerous potential for exploitingthe poor. There is a dire and immediate need to regulate microcredit to protect poor borrowers.


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DENY THE PROBLEM

One response of the microcredit industry to mounting criticism has been to deny the problem. In a June2008 open letter to critics, Carlos Danel and Carlos Labarthe, the co-founders of Compartamos, write, "Inan open and free market, we are convinced our clients are in the best position to make the right choicesfor themselves and their families." 3 The first problem with this assumption is that the microcredit

organizations do not operate in free and competitive markets. They are actually often quasi-monopolies.The Consultative Group to Assist the Poor (CGAP), a consortium of development agencies and privatefoundations dedicated to promoting microcredit, states, "In most countries, the microcredit market is stillimmature, with low penetration of the potential clientele by MFIs and little competition so far." 4 NimalFernando, a microfinance specialist working for the Asian Development Bank, concurs: "In manycountries in the region [Asia], the majority of microcredit is provided by a few leading institutions, andcompetition among them is mostly on non-price terms."5

Later in their open letter, Danel and Labarthe concede that microcredit is not a competitive market. Theyjustify their bank's high interest rates and high profitability on the grounds that they "wanted to build anindustry ... to draw in investors and competition." The promise is that "competition will make for more andbetter products at better prices in the future." This is a rather disingenuous defense of exploiting the poor.Let's follow the argument: Exploitation today will enable future competition that will then reduce

exploitation, (So the monopolists exploiting the poor today are doing a service for tomorrow's consumers.) By this logic, we should be grateful to the loan sharks of past centuries for charging usurious interest rates that have attracted microcredit firms to the market.

The second and bigger problem with the free market argument is the assumption that microcredit clientsare rational economic actors. Even in a rich country like the United States, there are laws to protectfinancial services customers. Since the 2008 economic crisis, there has been a strong push by theObama administration to increase consumer protection with, for example, the Credit Card AccountabilityResponsibility and Disclosure Act of 2009. The Obama administration in July 2010 created anindependent agency, the Consumer Financial Protection Bureau, with broad authority to protectconsumers of financial services from abusive, deceptive, and unfair practices. The administration justifiedregulatory reform on the grounds that "financial products are complex, and it is often difficult for even themost financially astute consumers to recognize the risks financial products can present." 6 If financial

literacy is a problem in the United States, it is a much bigger problem for microcredit clients in poorcountries. In fact, poor people are often illiterate and innumerate. The adult illiteracy rate in India is 39percent, and clearly much higher among the poor. This problem is exacerbated for microcredit clients whoare overwhelmingly female and have an even higher illiteracy rate.

There are very few empirical studies on financial literacy, especially in developing countne s. A survey ofclients of two micronnance organizations in India found, not surprisingly, very low levels of financialliteracy.7 The great majority of the respondents could not identify the interest rates on their loans (due inpart to a lack of transparency, which I will discuss below) . The survey also found that only 17 percent ofthe respondents were able to solve the arithmetic problem "divide 8,0 00 by 10," and only 3 percent ofrespondents could solve the problem "multiply 4,500 by 18." Given such low levels of numeracy, it isdifficult to see how microcredit clients can make good financial choices, such as comparing two loans withdifferent terms.

The microcredit industry has tried to downplay the problem of consumer exploitation. In a February 2009paper CGAP argues, "It is a mistake to assume that Compartamos' interest rates are typical of theindustry, or even a substantial part of the industry." 8 But should we wait until exploitation has becomepervasive before implementing consumer protection regulation? There are laws against stealing, eventhough most people are not thieves. In developed countries there are laws resulating loan recoveryprocess, even though abusive practices are not widespread. Moreover, high interest rates are not asrare as CGAP implies . By their own analysis, 5 percent ofmicrocredit loans worldwide are at interestrateshigher than 50 percent per year; and this does not take into account fees and compulsory savingsthat significantly increase the effective interest rates. Lack of transparency is almost universal. Chuck


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Waterfield, microfinance expert and founder of MFTransparency, argues that the true priceofmicrocredit loans has "never been accurately measured nor reported. . . . This is hard to imagine andeven harder to explain." 9 Regulation of the microcredit industry must focus on three issues: lack oftransparency, high interest rates, and abusive loan recovery practices.

LACK OF TRANSPARENCY

At a Microcredit Summit Campaign conference in July 2008, MF-Transparency was launched as theindustry's policeman. Since then, 183 industry leaders have endorsed the organization. On its website, MF Transparency states its reason for forming: "Due to complications of market conditions and lack ofregulation, the true price of loan products has never been accurately measured or reported." MFTransparency's phrase "complications of market conditions," however, seems to be a euphemism formarket failure.

The effective interest rate that a borrower pays for microcredit is very different from the stated interestrate of the loan. Microcerdit organizations routinely hide the actual interest cost by using "creative"practice s, such as charging interest on the original value of the loan rather than on the declining balance;up-front fees; collection of a security deposit (deducted from the loan amount); compulsory savings(collected with loan installments); and charging an insurance premium. With such hidden charges it is

common for the effective annual interest rate to be more than 100 percent, when the stated interest rateis only 15 percent.

Subrata Mitra, finance professor at the Indian Institute of Management Calcutta, describes a typical IndianMFI loan of 1,000 rupees (Rs) with an annual interest rate of 17.5 percent due in 47 weekly installments .The total repayment would be 1,175 Rs at 25 Rs per week. But there would also be a security deposit of10 percent of the loan deducted up front and refunded with 5 percent interest at the end of the year, aswell as an insurance premium of 2 percent deducted up front. The borrower would also be required tosave 10 Rs per week for one year at 5 percent interest rate.10 With these terms, the effective annualizedinterest rate is 121 percent compared to the stated interest rate of 17.5 percent. Given the low levels ofnumeracy and literacy, let alone financial literacy, it is impossible for microcredit clients to compare twoloan products with a plethora of confusing terms.

The 2009 book Portfolios of the Poor applauds MFIs for charging up -front fees as a good way to reducerisk. In fact, up -front fees and the other complicated terms serve only to reduce the effective amount ofthe loan and to increase the effective interest rate charged, which increases the MFI's profits but does nogood for the poor. It is ironic that the savings feature of microcredit loans is touted as serving the poor'ssavings needs. The poor clearly need savings facilities, but bundling together savings with microcredit ina non-transparent manner is ineffective and unethical. If the security deposit is increased to 20 percent inthe loan example above, the effective interest rate jumps to 194 percent per year.

An essential condition for an open and free market is the ability to compare competing products, whichrequires pricing transparency. Regulation is needed that mandates microcredit organizations to explicitlystate the effective interest rate calculated using a standard and prescribed approach, and to describe allthe loan terms simply.

HIGH INTEREST RATES

Criticism of the microcredit industry for charging high interest rate s has intensified in recent year s,especially with the growth of for-profit MF Is. A paper published by CGAP argues, "It is fair to criticize anMF Fs interest rates as unreasonable only if its profits or some controllable element of its costs isunreasonable."11 This is happening: Interest rates, profits, and controllable costs areunreasonably high for a significant part of the microcredit industry - and the need to regulate an interestrate cap formicrocredit is imperative.


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Based on data from 555 sustainable MFIs in 2006, the above CGAP paper shows that themedian interest rate is 2 8 percent per year. Even this number is understated because it does notinclude the impact of compulsory savings, which increases the effective cost of the loan to the borrower.Yunus argued in 2009 that if the microcredit interest rate is more than 15 percent above the cost offunds, then it is "too high. ... You are moving into the loan shark zone." Generously allowing 10 percentfor cost of funds implies that more than half of MFIs charge interest rates that Yunus would considertoo high. In SubSaharan Africa and Latin America, 5 percent of MF Is charge interest rates above 70percent; around the world, 5 percent of MFIs charge interest rates above 50 percent per year. AlthoughCompartamos' interest rates exceeding 100 percent might be exceptional, interest rates exceeding 50percent are certainly not rare.

Many MFIs are very profitable. In the C GAP study, MFIs earned 2.1 percent return on assets annually,which is well above the 1.4 percent earned by banks in the same countries . MFIs are usually not ashighly leveraged as banks, thus lowering their return on equity. In spite of this, 10 percent of worldwidemicrocredit loans earned return on equity above 35 percent in 20 o 6. These are high profits by anybusiness criteria. The CGAP study concludes that MFI profits are high because "the microcredit market isstill immature, with low penetration of the potential clientele by M F Is and little competition so far."Monopoly rents and vulnerable consumers are the cause of high prices and profits in microcredit.

The industry response is that the high interest rates are due not to high profits but to high costs. Becauseof fixed costs in servicing a loan, it is proportionally more expensive to service a microloan than a largerloan. Moreover, the poor infrastructure in developing countries leads to high costs. But this argument isnot consistent with empirical evidence. In a July 2009 analysis of 22 MFIs in Mexico, Waterfield shows avery wide range of loan prices - from 38 percent to 90 percent - within similarly sized loans.12 Analysis of48 MFIs in the Philippines and 31 MFIs in Ecuador yields similar results. As Waterfield's analysis holdsthe loan size and environment constant, the price differential is likely due to local monopoly power, whichleads to high profits. Costs measured by operating expenses as a percentage of loan portfolio also varywidely - ranging from 25 percent to 55 percent - for Philippine MFIs with similarly sized loan products.Once again, since this analysis controls for loan size and the environment, the cost differential is likelydue to some MFIs having unreasonably high controllable costs. In Bangladesh in 2006, the state-backedwholesale funder of microfinance publicly voiced concerns about poor borrowers having to pay highinterest rates because of inefficient MFI operations. In a competitive industry, such wide differentials incosts and prices would not persist, and firms with inefficient operations and high prices would bepenalized. This is further evidence that microcredit is a monopolistic industry, and regulated interestrate caps are needed urgently.

Fernando argues that interest rate ceilings will reduce the availability of microcredit.13 A CGAP paper byBrigit Helms and Xavier Reihe concurs that interest rate ceilings "often hurt rather than protect the mostvulnerable by shrinking poor people's access to financial services." 14 The flaw in this argument is theassumption that microcredit is a competitive industry. Price controls in a competitive industry will lead toreducing supply; but that is not true in a monopolistic industry. Setting an appropriate interest rate ceilingwill actually expand the availability of microcredit, given the monopolistic nature of the industry. Thisshould not be difficult, since the gap between the competitive and monopoly price today is so big.

ABUSIVE LOAN RECOVERY

Microcredit is also coming under increasing criticism for its debt collection practices. Although there is nosystematic evidence, there is anecdotal evidence that some MFIs use coercion to enforce loanrepayment. In Kalihati, one of the first Bangladeshi villages to benefit from Grameen's low-interest creditscheme, the villagers who have taken out a loan are unable to reimburse their credit and claim to beharassed by Grameen Bank representatives. Korshed Alom, a former debt collector, was put into earlyretirement for questioning Grameen's methods. "Their technique is to scare borrowers and insult them,"he told France 24 in a June 4, 2008, report on microfinance. ' We tell them to sell their clothes, that theyhave no other choice. Fm not proud of myself, but several times I had even been obliged to say, 'Sell yourchildren.'"15


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Some MFIs in Andhra Pradesh were charged with intimidating borrowers with forced loan recoverypractices. According to a Jan. 8, 2008, Wall Street Journal article, one delinquent borrower was violentlybeaten by a thug working for a collection agency that was hired by ICICI Bank. The Delhi ConsumerCommission fined ICICI for what the judge called "the grossest kind of deficiency in service and unfairtrade practice." In Mexico, clients of Azteca who slipped behind on repayment received frequent visitsfrom motorcycle-riding collection agents, according to a Dec. 13, 2007, BusinessWeek article. Muchmicrocredit relies on group liability. Sometimes the coercive practices are undertaken not by the MFI butby the group members.

Exploitation can occur even without an MFI using coercive loan recovery practices. All that is needed isfor the borrower to believe coercion will be used. A survey of clients of two microfinance organizations inIndia finds that 53 percent of respondents believed "it is all right" for an MFI to confiscate assets such ascows, house, land, and machinery if the borrower is unable to repay the loan.16 This is particularlydisturbing because the crux of microfinance is uncollateralized lending. The survey results do not implythat assets are in fact confiscated by the MFI in the event of default, but the perceived threat ofconfiscation (or any other threat) is in itself intimidating and abusive.

ALTERNATIVES TO REGULATION: TOO LITTLE, TOO LATE

The potential for consumer exploitation in the case ofmicrocredit is a direct result of market failure. Thisfailure is due to two underlying causes: first, too little competition; many MFIs exercise significant marketpower that results in very high interest rates. Second, the consumers ofmicrocredit are ill informed,which allows MFIs to be non-transparent in loan terms and engage in abusive recovery practices. Whenthe profit-maximizing behavior of firms in a free market results in negative consequences to publicwelfare, constraints need to be imposed. Constraints can be achieved through four approaches:corporate social responsibility, self-regulation by the industry, activism by civil society, and governmentregulation.

Many MFI proponents do acknowledge the problems of consumer exploitation but do not like the solutionof regulation. They plead with microcredit organizations to act more ethically, or argue that the industryshould regulate itself. These responses are at best naively optimistic and will not work.

Commercial organizations given opportunities for increasing profits usually act in their self-interest. In aJan. 20, 2005, survey on corporate social responsibility (CSR), The Economist magazine concluded thatfor most public companies, "CSR is little more than a cosmetic treatment." Appeals for self-restraint onthe grounds of ethics and values have not been effective in the business world, and there is no reason tobelieve commercial microcredit organizations will be any different.

An appeal on ethical grounds is complicated by the fact that industry participants do not agree on acommon set of values. A group of leader s in microfinance signed the Pocantico Declaration in Apr il 2008in an attempt to develop common ground and a set of principles. Unfortunately, the declaration is full ofvague statements and platitudes, and no consensus on specific issues. In fact, it indicates explicit dissentwhen it states,


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On a larger scale, the American experiment with deregulation of the financial services industry has beena failure, and the United States is now on a path toward greater government regulation. There is littlereason to believe that the microcredit industry in developing countries will succeed in self-regulating whilefacing much less competition, less scrutiny, and more vulnerable consumers. In 2005, South Africaswitched from relying on the Micro Finance Regulatory Council, which used a self-regulatory approach, toestablishing the National Credit Regulator, which is a classic public sector regulator.

Another potential source of constraints is citizen activism. In developed countries, citizen activism hassucceeded even when there are no governmental regulations. Witness the recent pressure onMcDonald's to introduce healthier menu options. But activism is inadequate in most developing countries,because so many citizens lack the resources, awareness, and traditions necessary for suchempowerment. There are few activist movements exerting pressure on MFIs to reduce or preventexploitation ofmicrocredit consumers. One is the popular debtors' rebellion in Nicaragua - the "No Pago"(I Won't Pay) movement - that has spurred mass demonstrations protesting high interest rates anddemanding a legal ceiling on them.

It is doubtful that C SR is an effective constraint on firm behavior even in developed countries, let alone inless developed countries. Institutional maturity and public supportare needed for effective action by civilsociety and for self-regulation by industry. As countries develop economically, politically, and socially,

these mechanisms for constraining markets will improve. But we should not tolerate exploitation of thepoor today while we wait - probably a long time - for such changes to occur. For now, governmentregulation is the best way to protect microcredit clients.

THE PATH TO REGULATION

The best place to start the regulation of the microcredit industiy is to require transparency on loan terms.The U.S. Truth in Lending Act of 1968 requires all financial firms to disclose the annual percentage rate(APR), using a standardized formula that takes into account the various loan terms and fees. TheEuropean Union and the United Kingdom have similar regulation, although they use a different formula.The key is to mandate a standard formula that facilitates comparisons across loan providers.Implementing transparency regulation for microcredit should be fairly easy, since such regulation doesnot require many government resources and is unlikely to be controversial.

Developed countries have laws regulating recovery of personal loans. In the United States, the Fair DebtCollection Practices Act of 1978 prohibits debt collectors from using abusive, unfair, or deceptivepractices to collect personal debts. Collectors are even prohibited from repeatedly telephoning debtors.Enforcing such laws, if they existed in developing countries, might be difficult, especially in rural areas.But difficulty is not a good reason to avoid implementation. Governments should regulate microcredit loanrecovery practices and attempt to enforce the regulation. In addition, governments and civil societyorganizations should better educate microcredit borrowers about their rights. This is clearly an uphillbattle - all the more reason to get started soon.

Today, 40 developing countries impose ceilings on interest rates. Many developing countriesliberalized interest rates and removed limits during the 1980s as part of financial sector reform. This wasappropriate, since there was enough competition among financial service firms catering to middle-class

and affluent people in developing countries. But the same is not true formicrocredit targeted at the poor.As Yunus pointed out in 2007, "The existing regulations are designed with commercial banking in mind,but microfinance requires a dedicated regulator and a relevant set of rules." 18 In Bangladesh in 2004,when there were no laws limiting interest rates, the state-backed wholesale funder of microfinancecapped the on-lendingrate of all its clients at 24 percent annual effective rate. More recently in 2009,the Microcredit Regulatory Agency in Bangladesh announced that MFIs must limit the interest rate to 30percent. A 2004 presidential decree in Bolivia also imposed interest rate ceilings on small loans. Eachcountry's government needs to determine the appropriate interest rate ceiling formicrocredit, so that itis high enough to cover operating costs and reasonable profits and not so low as to stifle thedevelopment of the industiy - nor so high as to be exploitative of the poor.


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Although I believe governments should be the primary force in regulating microcredit, there still is a rolefor other organizations to constrain the behavior of MFIs. Industry self-regulation can be a usefulsupplement to legal regulation. International donor organizations, such as the World Bank and U.S.Agency for International Development, can put pressure on their MFI clients to reduce or preventexploitation of the poor and to help governments draft appropriate regulations and transfer knowledge ofbest practices. Large commercial banks that are wholesale lenders to MFIs should exercise their socialresponsibility and press their MFI clients to behave responsibly. And civil society organizations can play alarge role in shining the light on MFIs that behave inappropriately and in educating poor borrowers abouttheir rights. But none of these approaches can be sufficiently effective without government regulation.

[Footnote]Notes1 Gde Anugrah Arka, "Microcredit Lenders Urged to Improve Transparency," Reuters, July 28, 2008.2 Sudhire ndar Sharma, "D e ath by Microcredit ," Th e Times of In dia, Sept. 16,2006.3 Carlos Danel and Carlos Labarthe, "A Letter to Our Peers," June 2008 . Available at http://www.compartamos.com.4 Richard Rosenberg, Adrian Gonzalez, and Sushma Narain, "The New Moneylenders: Are the Poor Being Exploitedby High Microcredit Interest Rates?" Occasional Paper 15, Washington, D.C: Consultative Group to Assist thePoor, February 2009.5 Nimal Fernando, "Understanding and Dealing with High Interest Rates on Microcredit," Manila: AsianDevelopment Bank, May 2006.6 "Strengthen ing Consumer Protection." Available at http://financialst ability.gov/ docs/regulatoryreform/strengthen

ing_consumer_protection.pdf.7 Akhand Tiwari, Anvesha Khandelwal, and Minakshi Ramji, "How Do Microfinance Clients Understand TheirLoans?" Chennai, India: Centre for Micro Finance/ Institute for Financial Management and Research, October 2008.8 Rosenberg, Gonzalez, and Narain, "The New Moneylenders: Are the Poor Being Exploited by High MicrocreditInterest Rates?"9 Chuck Waterfield, "Implementing Pricing Transparency in Microfinance," MF Transparency Newsletter, 2009 .10 Subrata Kumar Mitra, "Exploitative Microfinance Interest Rates," Asian Social Science, 5(5), May 2009: 87-93.11 "The New Moneylenders: Are the Poor Being Exploited by High Microcredit Interest Rates?"12 Waterfield, "Implementing Pricing Transparency in Microfinance."13 Fernando, "Understanding and Dealing With High Interest Rates on Microcredit."14 Brigit Helms and Xavier Reille, "Interest Rate Ceilings and Microfinance: The Story So Far," Occasional Paper 9,Washington, D.C: Consultative Group to Assist the Poor, September 2004.15 "The Crushing Burden of Microcredit," France 24, April 4, 2008. Available at http://www.france24.com/en/20080404-bangladesh-burden-microcredit-caring-grameen-bank-mohammed-yunnus.16 Tiwari, Khandelwal, and Ramji, "How Do Microfinance Clients Understand Their Loans?"17 The Pocantico Declaration is available at http://www.accion.org/Document.Doc?id=442.18 Muhammad Yunus, "Lifting People Worldwide Out of Poverty," Knowledge@ Wharton, May 27, 2009.

Karnani, A.. "MICROFINANCE NEEDS REGULATION. " StanfordSocial Innovation Review1 Jan. 2011: ABI/INFORM Global, ProQuest. Web. 22 Feb. 2011.Bangladesh, Dec. 11 -- In 1976, Professor Muhammad Yunus introduced microcredit in Bangladesh.Within a decade many countries replicated his programme. By the time the first Microcredit Summit washeld in Washington D.

C. in 1997, microcredit has already become a household name.

How many poor families, over the decades, are lifted out of poverty is yet to be confirmed. But it is wellrecognized that microcredit serves the poor who never had access to cash money, and, at the same timeit even benefits the richest with tremendous investment opportunities.

The United Nations declared the year 2005 as "The Year of Microcredit". Microrcedit received worldrecognition as an effective tool to eradicate poverty. Eventually, Professor Muhammad Yunus gained trustand friendship of many statesmen, kings and the queens.


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As hundreds of micro finance institutions (MFI) mushroomed around the world, questions were raisedabout loan size, loan disbursement and repayment methods, the long term socio-political impact onbeneficiaries, accountability and transparency of MFIs, and so on. The high rate ofinterest charged onmicro loans is the most criticized and debated issue all along. The fact is, a whole lotofmicrocredit borrowers suffer from the exorbitant rates ofinterest.

In 2006, the Norwegian Nobel Committee crowned Professor Muhammad Yunus and Grameen Bank withthe Nobel Peace Prize. It was in recognition of his fight against poverty, not a declaration that he sentpoverty to the museum.

And with Nobel Peace Prize, Grameen Bank and Professor Muhammad Yunus again came under fierceattack for their performance in lifting poor families out of poverty. No one, however, accused him ofmalpractice.

But Norway's national TV NRK has done exactly that very recently. NRK aired a documentary onNovember 30 which claims that the Nobel laureate diverted about $100 million aid money for the poorborrowers of Grameen Bank to another of his company back in 1996. An online newspaper headlinesays, "Yunus 'siphoned Tk 7.0bn aid for poor'".

"I got most of the documents from the archives of Norad, the Norwegian aid agency in Oslo," thedocumentary maker said. Documents surfaced on internet and print media suggest that the fund divertedby Grameen was no secret. The fund, in fact, came from Germany, Norway, Sweden, and theNetherlands. And donors knew the transfer was made to Grameen Kalyan, a sister concern of GrameenBank.

Since NRK aired the controversial documentary, a wave of comments, both for and against GrameenBank, stormed the media. While the finance minister in Bangladesh said, "No fault if there wasunderstanding," but Prime minister Sheikh Hasina, warned Yunus of consequences if he were foundguilty. The Nobel Laureate welcomed a probe.

One BBC report reads: "Norway says it is examining reports that Nobel Peace Laureate MuhammadYunus allegedly diverted millions of dollars of aid money from a bank." It adds: "International

Development Minister Erik Solheim said that it was 'totally unacceptable that aid is used for otherpurposes than intended'."

Media reports, however, mention nothing about the three other countries involved; Germany, Sweden andthe Netherlands.

It appears that the Norwegians are staging a drama they have written over more than a decade.Whichever pattern they follow to play next episodes, we guess, the show is going to end in a funny way.

One good thing is that the controversy provides us an opportunity to have a better insight into Grameen.We hope the government of Bangladesh will conduct a fair investigation and bring Grameen Bank and itssister concerns under microscope. Time will tell whether Yunus is guilty or not. Meantime, we I would like

to congratulate him for defying the donors and do what he deemed best for Grameen.

After all, one of the causes that foster poverty in our world, especially the chronic one in the developingcountries, is donor's policy. Isn't i t!

Published by HT Syndication with permission from The Financial Express.

For any query with respect to this article or any other content requireme


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"Microcredit: Looking at the brighter side. " The FinancialExpress 11 Dec. 2010,ABI/INFORMGlobal, ProQuest. Web. 22 Feb. 2011.

Mission impossible: diffusion and drift in the microfinance industryMarc J. Epstein, Kristi Yuthas. Sustainability Accounting, Management and PolicyJournal. Bingley: 2010. Vol. 1, Iss. 2; pg. 201

Abstract (Summary)The purpose of this paper is to thoroughly examine sources of mission diffusion and mission drift in themicrofinance industry and to identify consequences of and remedies to these problems. Extensive fieldexperience relating to individual microfinance institutions (MFIs) and industry trends provides thegrounding for a review of the trade and academic literatures in microfinance and social enterprisemanagement. Mission diffusion arises from pursuing diverse approaches to poverty alleviation andaddressing disparate and changing stakeholder interests. Mission drift arises from commercialization and

conversion activities aimed toward enhancing ratings and achieving scale. Mission clarity can be regainedthrough clarification of the mission along with more effective corporate governance and performancemanagement systems. The tension between financial and social performance is not merely ideological -economic realities make it almost impossible to stay on mission. Understanding these realities can helpMFIs maintain and regain clarity of mission. The paper sheds new light on reasons the microfinanceindustry has not been able to deliver on promises of poverty alleviation during a period of heavy demandrapid scaling.

Full Text(10383 words)CopyrightEmerald Group Publishing Limited 2010

Regeneration

Edited by Jesse Dillard and Madeleine E. Pullman

Introduction

Microfinance institutions (MFIs) provide financial services to poor clients who are otherwise excluded fromformal financial systems. The majority of microfinance firms concentrate on providing credit tomicroentrepreneurs who need financial capital to fund business investment and fuel economic growth.Traditionally, MFIs have operated as non-governmental organizations (NGOs), receiving funding from abroad variety of sources that include philanthropy and government grants along with client fees. Likeother social enterprises, dependence on funding can push MFIs to become more innovative and

entrepreneurial ([49] Mort et al. , 2003), or it can make them behave more like market-driven corporations([29] Eikenberry and Kluver, 2004). As the microfinance industry matures, funders are becoming moredemanding in their expectations for effective investment of these funds and for clear demonstrations ofsocial impact. Such institutional changes have pushed nonprofits toward a corporate approach ([11]Bruck, 2006).

Through their commercialization efforts, organizations can change in ways that compromise theirmissions ([27] Dolnicaret al. , 2008). Regardless of their structure, social enterprises position themselvesphilosophically along a spectrum between philanthropic and commercial paradigms ([65] Dees, 1996).Where the philanthropic model is built upon values such as stewardship and stakeholder participation, the


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corporate model emphasizes strategic positioning and risk taking ([29] Eikenberry and Kluver, 2004). Asthe number of MFIs increases rapidly, demand for funding intensifies. Such demand can result in intensecompetition among organizations ([22] Dees, 1998; [53] Parker, 1998), as has occurred in recent years inthe microfinance industry. In response, MFIs have developed professional staff or departments tomanage the rigors of interacting with funding agencies, preparing funding applications, and managing theaccounting and reporting requirements associated with the funds.

The combination of greater demands from funders and more competition for funds often results infragmentation of the mission, as MFIs broaden their reach to increase funding eligibility. Like other donor-dependent enterprises, most MFIs find it challenging to maintain commitment to the original mission whenthat means forgoing critically important funding opportunities. Through this fund-seeking process, themission can be diffused, as the MFI attempts to satisfy a diverse range of expectations and commitments.

Availability of traditional donations and grants is tightly limited, and the demand for microfinance servicesis huge - current estimates suggest that MFIs currently satisfy only about 10 per cent of the existingmarket demand ([26] Dieckmann, 2007). Many microfinance organizations therefore seek to scale uprapidly to better address the vast need for their services. Concurrently, there have been rapid increases infunding opportunities in the microfinance space. But these opportunities are currently only available tolarge, well-established MFIs that can demonstrate high levels of professionalism and fiduciary

competence similar to those required of the commercial financial sector.

The ability to grow need not be limited by access to donations and grants. For large, commerciallyoriented MFIs operating in stable countries, the "floodgates" have opened, and the availability of fundshas increased radically in the past ten years, as funders with a "private sector ethos" have rapidly enteredthe microfinance space ([41] Latortue et al. , 2006).

Funding for these MFIs increasingly comes in the form of loans from both donors and investors - anestimated 63 per cent in 2008 (Consultative Group to Assist the Poor ([14] CGAP, 2008)). The loans havestructures similar to commercial loans, although they may have lower-than-market interest rates. Theinvestment capital available to MFIs has also grown tremendously in recent years, and was estimated tobe more than $10 billion at the end of 2008 ([66] CGAP, 2009).

[56] Reille and Forster (2008) provide a comprehensive overview of the types of foreign capitalinvestment currently used in the microfinance industry. They report that in the past, investment capitalcame primarily from development finance institutions, the private investment arms of governmentaldevelopment institutions. Currently, the trend is shifting toward private investment funds; it is estimatedthat there are more than 40 of these existing funds. These microfinance investment vehicles areincreasingly available to second-tier MFIs that were previously donor dependent. As the market matures,options like structured finance arrangements in which loan assets are repackaged as securities are alsobeing developed. While the bulk of these current investment vehicles have a social responsibilitycomponent to their missions, mainstream investors are also seeking returns from microfinanceinvestments ([56] Reille and Forster, 2008).

Accessing available funding requires MFIs to become more professional in their governance andoperations, and function more like commercial financial institutions ([3] Arena, 2008). As a result, there is

a rapid movement in the industry known as the "commercialization of microfinance". Throughcommercialization, many MFIs have changed from charities to profit-seeking businesses, and a growingnumber are converting from NGO status to regulated commercial financial institutions. A few, such as thenow-famous Comportamos, have even become publicly owned corporations through initial publicofferings. Comportamos evolved from a small NGO to a public company with market capitalization of over$1 billion. Although the company has been heavily criticized for making "too much" profit while charginghigh interest rates to the poor, profitable microfinance organizations have been highly sought after byventure capital firms and private equity groups.


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While professional management and commercialization can vastly increase funding available for MFIs,they can place great stress on the MFI's original mission. And the consequences that result when amicrofinance organization loses clarity of mission can be dire. Diffusion can result in such problems asineffective delivery of services, and financial distress or failure of the MFI. Drift can result in such actionsas cutting services, increasing interest rates, or shifting attention away from the poor toward wealthierclients. Thus, as funding and commercialization pressures intensify, firms must take reasoned actions toretain and sharpen focus on poverty alleviation.

This paper identifies and discusses a number of industry and firm-level factors that can lead to missiondiffusion and drift in the microfinance industry. The paper concludes with a brief discussion of theconsequences of shifting away from mission, and steps MFIs can take to retain focus on effectives inalleviation of poverty.

Microfinance

The microfinance industry provides financial services in small denominations to the poor. These servicesinclude lending, savings, insurance, and remittances designed for poor clients that do not have access tofinancial services from mainstream financial institutions. Microfinance is thought to be one to the mostpromising tools for economic development and alleviation of global poverty ([4] Armendariz de Aghion

and Morduch, 2000) and empirical evidence suggests that microfinance can have a significant impact onpoverty reduction ([12] Burgess and Pande, 2005; [40] Khandker, 2003). Other impacts of microfinanceinclude a broad range-related social benefits such as female empowerment and vulnerability reduction([33] Goetz and Sengupta, 1996; [16] Cohen and Sebstad, 2000), food security ([64] Zelleret al. , 1997),in addition to business impacts such as improvements in productivity, technology and employment ([37]Hulme and Mosley, 1996) and profitability ([39] Karlan and Vladivia, 2006).

Since it is possible for MFIs to operate in a financially sustainable manner, they possess the ability toprovide these benefits on a long-term basis without ongoing need for donor support. Microfinancetherefore offers a market-based mechanism for supporting economic growth in regions where it isemployed.

The most common form of microfinance is microcredit - small loans used by microentrepreneurs to start

or expand small businesses. Through its direct impact on business growth, microcredit currently has thegreatest potential impact on economic growth and poverty alleviation. MFIs typically offer two basic typesof business loans: individual loans and group loans. Individual loans normally range from $1,000 to 5,000.These loans are often granted to individuals who have evidence of strong business performance, andoften require collateral. Repayment period for these loans generally ranges from six months to two years.

Group loans are much smaller, and are designed for very poor clients newly entering economic andfinancial systems. The typical size of these loans is from $100 to 1,000 per group member, and therepayment period is typically four to six months. These loans are generally awarded to groups of five to50 clients, who co-guarantee each others' loans. Group guarantees have been very effective mechanismsfor screening clients and enforcing payment; repayment rates on these loans are generally 95 per cent orhigher. Both kinds of loans may also require clients to maintain a mandatory saving account with abalance of 10-15 per cent of the loan amount to provide further security for the loan.

Both individual and group loans are designed to alleviate poverty by allowing poor clients opportunities forself-employment projects that allow them to generate income and build wealth. The resulting financialcapital provides the means for clients to better provide for household food, shelter, healthcare, andeducational needs. It can also help clients smooth consumption and more effectively deal with economicshocks.

Although the microfinance industry is united in its mission of poverty alleviation, MFIs can be divided intotwo camps based on the strategy they pursue to achieve this mission: the "welfare" camp and the


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"institutionist" camp ([67] Morduch, 1998). Those in the welfare camp tent to focus directly on povertyalleviation, often serving the poorest of the economically active poor - those living below 50 per cent ofthe poverty line. In addition to financial services, these MFIs may offer or link clients to other private orgovernmental poverty-related services, such as literacy or AIDS training.

MFIs in the institutionist camp tend to focus on outreach, serving as many poor clients as possible

through high-quality financial services alone. They believe this can best be accomplished by institutionsthat are financially self-sufficient and can grow without continuous injection of donor funding ([62] Wollerand Dunford, 1999). Although their approaches may differ, both camps ultimately seek to help the poorbuild their businesses, accumulate productive assets, and stabilize consumption.

Diffusion and drift

Increasingly, MFIs find it difficult to mange the growing tension between maintaining focus on povertyalleviation and accommodating the demands of funders and markets. We divide our discussion along thelines of two basic problems: mission diffusion, which occurs when organizations in the industry attempt toaccomplish multiple objectives that may be incompatible with the primary mission, and mission drift, whichoccurs when organizations drift away from their focus on poverty towards achievement of financial goals.

Mission diffusion

When MFIs pursue multiple, competing objectives, they often find that their focus on mission is diffused.While the industry is ostensibly focused on poverty alleviation through financial services, the actualactivities of microfinance organizations often extend far beyond traditional services offered by the otherorganizations in the financial services sector. These services can include training, value chain support,and access to social services such as healthcare, housing, and literacy programs. MFIs also commonlyengage in advocacy, working to improve regulatory regimes on behalf of their clients, who lack publicvoice ([58] Sievers and Vandenberg, 2007).

Taking a multifaceted approach toward a complex social issue is not a problem on its own. Diffusion onlybecomes problematic when the MFI lacks a comprehensive system for effectively managing a set ofdiverse activities. When an organization expands beyond its original mission intentionally, and develops

proper processes for managing the expansion, it can be considered to have effectively broadened itsmission. For the purposes of this paper, we use the term diffusion to refer to activities that are not wellintegrated into the overall strategy of the MFI or have unintentionally shifted resources and managerialattention away from priority objectives.

The most common non-financial service provided by MFIs is training. Most MFIs provide some training totheir clients before granting loans or providing other services. Since many borrowers are first-timeborrowers and unfamiliar with practices necessary to manage credit, MFIs offer orientation orsensitization meetings designed to make clients aware of which microfinance services are available in theregion, and how these services might be beneficial to microentrepreneurs and other clients that interactwith the service offerings of the MFI. In addition, they typically offer training in the use and managementof credit - including topics such as the importance of selecting a payment and loan size that meets withinthe client's cash flow capacity, and the importance of carefully managing funds, through activities such as

setting aside cash on a daily basis, so that the loan can be repaid on time ([58] Sievers and Vandenberg,2007).

In general, these training activities directly support achievement of the mission. They tend to servemarketing purposes such as increasing product awareness, enhancing repayment of microloans, andprotecting the lender from default. Many MFIs, however, go well beyond basic training, pursuing a holisticstrategy based on market subsectors, or "value chains". The value chain approach, supported byDepartment For International Development, Swedish International Development Cooperation Agency,and others, involves identifying trade barriers within an industry and helps companies overcome them.


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MFIs seeking to develop the value chain engage in activities such as researching markets, identifyinghow rents accrue through the value chain, and designing interventions such as information sharing or thedevelopment of trade associations ([47] Mitchell et al. , 2009).

Both socially and commercially oriented MFIs engage in these training activities. However, for a variety ofreasons discussed below, many MFIs engage in activities that extend far beyond the original scope

outlined in their missions, which can lead to diffusion. The first, and most important of these, is the natureof the problem these social enterprises seek to address.

Complexity of social problems

The basic financial training described above tends to directly support achievement of MFI objectives, as itimproves clients' abilities to use financial services in a manner that enhances their income level orstability and thereby directly impacts poverty. Poverty, however, is a complex, multifaceted problem, andthe immediate needs of impoverished clients often extend far beyond the reach of financial services ([1]Ahmed and Rafi, 1999). Clients commonly lack access to clean water, adequate nutrition, safe shelter, orbasic education. Such problems impede their ability to effectively manage their businesses and renderthe financial capital and other services they receive ineffective. For example, it is estimated that healthproblems are among the primary causes for microbusiness interruption and failure ([4] Armendariz de

Aghion and Morduch, 2000). Thus, MFIs dedicated to helping the poor often seek out means to improveclient health, such as through nutrition or HIV/AIDS education, or by securing client discounts to clinicalservices or health insurance.

Defaulting on loans commonly occurs during periods of family illness, when clients redirect businessfunds toward personal use ([10] Brett, 2006). Thus, programs to improve health can have direct impact onthe financial success of the client, and support poverty alleviation. However, the knowledge and expertiserequired to manage these programs and services are often well beyond the capabilities of MFImanagement and staff. Some MFIs address needs like healthcare by developing in-house expertise,structures, and processes that allow them to provide these services on their own. Others provide clientsaccess to these services by forming partnerships with NGOs or governmental organizations that workdirectly in these areas and already possess the necessary expertise ([58] Sievers and Vandenberg,2007). Although the latter route is less resource-intensive for the MFI, it nonetheless must engage staff

and other resources in planning and managing these partnerships. If not carefully managed and wellintegrated with other activities, healthcare initiatives can draw resources and attention away from theprimary mission of providing impact through financial services rather than promoting that mission.

Nonetheless, needs of the impoverished are so great, and the promise of poverty alleviation so strongthat many MFIs find themselves adding more and more services until microfinance represents only one ofthe many services offered to the poor. Some organizations have been successful in pursuing a multi-faceted poverty-alleviation strategy. Bangladesh Rural Advancement Committee (BRAC) in Bangladesh,for example, has been exceptionally successful in addressing needs of the poor through services asdiverse as supporting human rights, providing legal services, marketing seeds, running fish hatcheries,and delivering health interventions ([38] Jonker, 2009). Managing such a range of activities, however,requires a broad variety of skills and expertise that extend far beyond the capabilities of most MFIs.

Even with the requisite capabilities, BRAC has experienced failures in some of its social enterpriseefforts. Its attempt to enter the irrigation pump businesses by providing financing to pump salespersonsfailed when weather and food prices beyond the organization's control made operations unprofitable. Itsfounder argues that gaining an adequate understanding of social needs and enterprise opportunities in anarea requires many years of direct experience ([38] Jonker, 2009).

Competing interests


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At the same time, microfinance organizations struggle with competing facets of the poverty problem, theyalso suffer from competing beliefs and interests among stakeholders about the best way to address theproblem. Relative to stakeholders of mainstream financial institutions, microfinance stakeholders are likelyto hold strong and divergent beliefs about the appropriate direction for the MFI. These stakeholders,which include board members, funders, and employees are often drawn to the industry by their belief inthe mission and desire to alleviate poverty. Board members, employees, and investors often accept lowercompensation for their efforts because they have a strong belief in the social value their work cancontribute.

MFIs often have difficulty making trade-offs among the competing priorities of these stakeholders,because a