The concept of social investment has received growing attention over the last decade. The core idea is simple: investing in organizations that produce a substantial positive soal outcome -- and at least some financial return. Advocates for social investment frequently use the phrase “doing well while doing good.”
While there has been much discussion of social investment, there has been relatively little actual investment. The one area where substantial flows of capital have emerged under the social investment umbrella is microfinance. Thus, there are important lessons and insights for social investment as a whole to be gained by examining the experience of the microfinance industry in trying to marry profit and social returns.
Over the last two decades, microfinance has grown from a promising experiment to a burgeoning industry that serves over 200 million people worldwide. The early hope was that microfinance would drive toward full sustainability, earning all the necessary funds for their operations and growth. Microfinance banks would earn solid profits and wouldn’t need subsidies after the banks were fully established to keep going. Muhammad Yunus himself has voiced support for the concept of “social businesses” – businesses designed to produce some financial return (which gets re-invested in the business) while delivering social returns. But it has turned out that social investors (and the subsidies they bring) remain critical if social goals are to be achieved.
The following selection of FAI papers discusses the challenges and complexities of uniting profitability with positive social outcomes in microfinance. The papers cover a range of topics – including profitability, competition, regulation and subsidies – that have an impact on the supply-side of microfinance. The following sampling of papers is not exhaustive, but rather presents a brief glimpse into the intricacies of social investment in the field of microfinance.
Microfinance Meets the Market, Robert Cull, Asli Demirgüç-Kunt and Jonathan Morduch provide a comprehensive look at the challenges of providing reliable banking services to the poorest customers in a commercially viable way. They re-run the Mix Market data to show hidden subsidies, and argue that profitability is associated most strongly with lenders making larger loans to less poor customers. Institutions serving the poorest customers—those at the heart of the early microcredit narrative—are more likely to lean on subsidies. The overview was published in the Journal of Economic Perspectives.
Using two sets of data, the same three authors examine whether the presence of traditional commercial banks affects the profitability and outreach of microfinance institutions. They present their findings in Banks and Microbanks. The short answer is that competition really matters. More competition from commercial banks tends to push microlenders toward poorer, less banked markets.
In Microfinance & Social Investment, Jonathan Morduch and Jonathan Conning step back to look at theory and evidence. Written for the Annual Review of Financial Economics, they frame social investment both in terms of its pluses and its risks (as seen most dramatically by microfinance problems in South India). They create a bridge from the modern theory of corporate finance to re-cast microfinance, building from the challenges that investors face in ensuring that their investments are safe.
The authors of Financial Performance and Outreach: A Global Analysis of Leading Microbanks explore the determinants of profitability, loan repayment and cost reduction for a variety of microfinance institutions. Social investment is often predicated on market failure, and that’s often tied to information problems between investors, lenders, and borrowers. To make profits, institutions need to raise interest rates. But information problems mean that raising interest rates can exacerbate loan default rates. Cross-country data confirm the prediction for microlenders who do not use group-lending methods. Those lenders end up having to put more money into staff time to compensate. As predicted by theory, group-based lenders are much less affected by loan default rates when they raise interest rates. Published in the Economic Journal.
In Microfinance Tradeoffs: Regulation, Competition, and Financing, Cull, Demirgüç-Kunt, and Morduch summarize their work through 2009. They describe important trade-offs that microfinance practitioners, donors, and regulators face. Published in the expensive but interesting Handbook of Microfinance.
Does Microfinance Regulation Curtail Profitability and Outreach? analyzes the financial data of 245 microfinance institutions to examine the effect of regulation on the profitability and outreach of these institutions. Banks that take savings need regulation. But conforming to regulation is costly. How do microlenders respond? Cross-country data show that non-profits absorb the loss and stick with their mission, but sacrifice reach, while profit-driven microlenders move up-market to cut costs. By Cull, Demirgüç-Kunt, and Morduch, and published in World Development.
Smart Subsidy for Sustainable Microfinance explains the notion of “smart subsidies” and makes a case for their application to increase the scale of microfinance, access to commercial funds and outreach.
In The Role of Subsidies in Microfinance: Evidence from the Grameen Bank, Jonathan Morduch shows the major role of subsidies in the development of the Grameen Bank. Grameen Bank has long reported being profitable, but Morduch shows that the reports hide substantial subsidies. The study looks at Grameen in the mid-1990s, during a major growth spurt. Published in the Journal of Development Economics.