Commercialization 101: What is the significance?

If you're interested in microfinance, but don't necessarily want to learn about graphs, differential equations and statistical techniques then you have come to the right place. We will regularly be posting 101 blogs that explain the core principles of microfinance. Check out our first post on Microfinance 101.

This week's blog is a basic introduction to commercialization.

Recently there has been a lot of talk within the industry about the commercialization of microfinance institutions. In 2008 the wildly successful IPO of Mexico’s Banco Compartamosdemonstrated that the microfinance industry can yield massive profits and is worthy of private investment. But it also raised questions about whether such financial success is reason for concern, whether microfinance is in danger of mission drift, and if operating on a for-profit basis is in the best interest of the poor households microfinance claims to help.

To understand the implications and concerns regarding commercialization, it is essential to first appreciate the different types of microfinance providers: banks, for-profit NGOs, and non-profit, NGOs. From an economic standpoint the most significant difference among the various providers, is that commercialized entities (banks and for-profit MFIs) are able to distribute profits as they like after taxes. Non-commercialized MFIs (non-profit MFIs), must reinvest profits back into their organization. The MFIs also differ in regard to mission, clientele, services offered and regulation requirements they must meet. Banks are subject to stricter regulations and make loans that on average are about four times larger than loans from NGOs.  Since poorer customers generally demand smaller loans, average loan size is a rough proxy for the poverty level of customers.  On average, microfinance banks thus tend to serve a substantially better-off group of borrowers than do NGOs.  Banks also serve fewer women as a share of their customers. For-profit NGOs have a very similar profile to banks, but are not subject to the same rigorous regulation and tend to be less profitable.

Non-profit NGOs target a population group that is much poorer, less accessible and comprised of more women. Poorer customers generally demand smaller loans, which are relatively more expensive for the NGOs to service, and so they typically charge higher interest rates than microfinance banks in order to break even. It is important to note that profitability for non-profits is in an accounting sense; profits are not distributed to investors as is done in commercialized MFIs.

So which path is right for microfinance? Should we outlaw or embrace commercialization? The data shows that it is not an “either – or” situation. The fact is that commercial microfinance banks and non-profit MFIs actually complement each other. 

The demand for reliable financial services is huge and will take all kinds of institutions to address it. The challenge is to embrace the opportunities of the market while recognizing the potential trade-offs. A single approach – commercial or non-profit – places limitations on the populations reached by MFIs, and considering that over half-the world’s population is unbanked, such limitations should be avoided.