The Royal Rumble: Yunus v. Compartamos

26 February 2010 at 08:00 13 comments

By Josh Weinstein, KF9 Philippines

“You’re unhappy. I’m unhappy too. Have you heard of Henry Clay? He was the Great Compromiser. A good compromise is when both parties are dissatisfied, and I think that’s what we have here.” – Larry David

Within the international development community, a debate for the heart of the movement came to the fore two years ago with the IPO of Compartamos, the largest microfinance institution in Mexico.  Divisive and controversial, Compartamos’ decision to sell shares and publicly list on an exchange is perhaps the clearest manifestation of where the two sides diverge.  One side, led by Muhammad Yunus, founder of the Grameen Bank and winner of the Nobel Peace Prize in 2005, contends that, at its core, the sole fundamental mission of microfinance is poverty alleviation.  The other side argues that the goal must be maximizing profit and, more specifically, ROE (return on equity) – extending services to a previously unbanked population and expanding via revenue growth.  Just about everyone has an opinion on the decision and, at the very least, it allows for a great philosophical and economic debate about the most effective way to assist the billions of people who live below the poverty line.

First, a brief background on microfinance for the unitiated.  Without going into too many specifics, microfinance describes the provision of financial services to individuals below the poverty line with no material collateral.  Microcredit, specifically, refers to the disbursal of small loans – generally between $50 and $1,000, depending on the sophistication of the institution and the industry in general (average loan with Compartamos is $623) – to individuals that cannot access credit via the traditional banking system.  Given their small size, the cost of servicing these loans, as a percentage of the total, is high.  Remember: it costs the same amount to service a $10,000 loan as it does a $100 loan (salaries, office materials, etc.), and these microfinance institutions often have to track down the borrowers on a weekly basis to collect the interest and principle.  In other words, interest on microfinance loans are higher than one might think appropriate.  In the United States, 50% for a loan may seem exorbitant.  But, when you look at it relative to the alternatives (up to 800% from loan sharks) and the fact that these loans are expensive to service, high interest rates are a necessity.  But at what level are interest rates exorbitant, even for an MFI?  This is the question at the heart of the Compartamos debate.

Interest rates have an inverse relationship with loan size.

For an MFI to be financially sustainable (in other words, rely on profits, rather than donations or grants), it needs to generate sufficient revenue from its loan portfolio to pay for its overhead.  For it to grow, it must make substantially more than that.  Muhammad Yunus would argue that all profits be reinvested in organization and put toward subsidizing interest rates, focusing on the singular mission of poverty alleviation.  Yunus’ organization, Grameen Bank, is actually owned by the borrowers, so profits that are not reinvested are distributed as dividends.  Compartamos, which has institutional and private investors, takes a different approach. In 2005, Compartamos had an average interest rate of over 88% – an exorbitant rate, even within the world of microfinance.  Yet, at the end of the day, Compartamos has been a model of success in the microfinance world.  It generated annual returns on equity of 53% between 2000 and 2006, attracted investment capital from around the world, and, in the process, expanded access to credit and financial services for millions of people without previous access.  So why is it controversial?

At its core, microfinance embodies the idea of the double bottom line – a dual commitment to financial profit and social responsibility.  By nature, the management of a publicly-traded entity is responsible to its shareholders, above all else.  Unless there is an agreement among shareholders to sacrifice profit for social impact, the tenets of publicly-traded organization are at odds with the concept of the double bottom line.  An MFI like Compartamos will target clients higher on poverty chain in an effort to reduce default rates, ceasing to serve the poorest – those most in need of microcredit.  So is this an acceptable model?  Muhammad Yunus would argue that the answer is simple: a microfinance organization cannot be a publicly-traded entity, because its goals are inconsistent with the mission.  Here Mr. Yunus vents his frustrations:

Yunus, 67, says he fears that his innovation has been twisted to benefit investors, rather than the poor. But he has particularly unforgiving words for microlender Compartamos. At one point during a conversation, Yunus objected to the mention of Compartamos and microfinance in the same sentence. “When you discuss microcredit, don’t bring Compartamos into it,” he instructed. “Microcredit was created to fight the money lender, not to become the money lender.”

Oh snap!  Yunus’ opponents and Compartamos supporters would argue that, without generating profits for investors, MFIs will never attract the capital necessary to achieve poverty alleviation on a scale large enough to reach all those that need microfinance services.  After all, in the eyes of potential investors, money that could be making more money is actually losing money.  But a highly profitable MFI, like Compartamos, will attract a lot of money, which, in turn, can be put to work by potential entrepreneurs in the developing world.  In response to M. Yunus’ scathing review, Compartamos released an 11-page statement defending itself:

We generate social value by providing access to financial services for as many people as we can in the least amount of time. We create economic value by building a profitable and strong company where private capital can participate, making this industry attractive for others to compete in providing better financial services for low income people. We also generate human value by believing in people, by giving credit to their word and their willingness to succeed and realize their capacities, and by encouraging them to be better persons. Not only do we believe these are not contradictory goals, but we are convinced the three reinforce each other.

Touche, Compartamos.  So, the other side would argue, Compartamos and profit-generating MFIs not only remain true to the fundamental mission of poverty alleviation, they actually serve to expand it well beyond the scale it could achieve in a more socially-oriented framework.

A myriad of other factors are critical to an informed discussion of this debate.  For example, how can Compartamos serve the poorest individuals with a higher risk of default when it is responsible for generating returns for its shareholders?  (The answer is that it doesn’t, nor does it claim to.)  Without that function, how then is it any different from the traditional banking system it was designed to circumvent?   These are questions for another post.  I’ll try my best to posit a solution, or at least a compromise that might satisfy both camps.

Microfinance can operate across the pyramid

It seems to me that these two models of microfinance – non-profit or borrower-owned vs. public for-profit – can coexist, serving different populations within the spectrum of poverty.  Currently, the microfinance industry serves ~10% of the estimated $250 billion of global demand.  Microfinance institutions, in theory, offer a broad suite of services to individuals with no access to the traditional banking system, yet the unbanked population (~4 billion people) is dramatically stratified.  At the very bottom are the destitute, those living in extreme poverty (less than $1 per day).  Here, microfinance is ineffective, and aid, in the form of food and healthcare, are necessary.  For the ~3 billion people that could benefit from these services, both the non-profit Yunus model and the public Compartamos model could each serve a valuable role.  For the vulnerable non-poor and those just below the poverty line (just above the poverty line) that are more reliable, Compartamos could offer high interest rates and still generate a positive return on equity, attracting large investments from institutional investors, rather than donor capital.  Compartamos is serving businesses with high inventory turnover (i.e. buy a dozen eggs for 100 pesos in the morning, and sell them for 120 pesos in the afternoon, for a 20% daily return).  Therefore, 88% annual interest is actually not as burdensome as it seems.  Also, success breeds replication, which helps serve the poor even more.  Compartamos has perhaps been a victim of its own success, as new competition by others replicating its model has driven interest rates down from ~88% in 2005 to 71% in 2008.

The MFIs in the Grameen camp, on the other hand, can still focus on those below this level with reasonable interest rates, remaining sustainable, but still functioning as non-profits.  The interest rates will continue to make these organizations appealing to clients, as will the provision of other non-financial services, like micro-insurance, energy programs, entrepreneurship training, and others.  These institutions could mandate specific thresholds for potential clients in order guarantee the social mission (The Progress out of Poverty Index comes to mind).  These socially-focused MFIs will continue to receive grant funding from international development organizations, like the World Bank and the IFC, and philanthropy groups, like the Gates Foundation and the Clinton Global Initiative. Investors can make decisions based on their own motivations.  Online P2P lending organizations like Kiva have proven that people are willing to accept 0% rates of return, provided funds are directed to borrowers of a specific profile.  In addition, institutional investors are crawling over themselves to give money to successful organizations with a social mission.  For them, the 10-12% returns on investment are satisfactory.

At the end of the day, the success of microfinance and microcredit depends on scalability and adherence to mission.  The Compartamos IPO highlights the divide among the development community.  I reject the premise that the two models are mutually exclusive.  I’d go so far as to argue that they are complementary.  Pursuit of profit is a good thing – it is what drives the capitalist engine, and microfinance is fundamentally a capitalist approach to development.  And, though the idea is controversial, I believe that it is OK not to have an committed social mission if an institution is still serving the unbanked, as this is a social mission in itself.   Again, Compartamos explicitly defines their role in microfinance:

Everybody agrees that MFIs are going through a period of deep and important change. There is no question that the debate will continue. This letter is merely a contribution to better understand our point of view in the debate. In the end, the ability to expand  the market and include large numbers of excluded low income people into the financial sector, will give us all a better perspective on the benefits of the commercialization of microfinance.

Let Compartamos target a lower risk, less impoverished clientele, and focus the Grameen segment on the still-unbanked poorer individuals.  True, this is a drastic oversimplification of a complex and nuanced topic, but at the end of the day, a large percentage of this market remains untapped.  It is premature to be arguing about which of these two proven models are best going forward.  After all, there is more than enough business for everyone.


Note: This is a modified and updated version of an article I wrote for a public policy journal, found here

Entry filed under: blogsherpa, KF10 (Kiva Fellows 10th Class), KF9 (Kiva Fellows 9th Class), NWTF (Negros Women for Tomorrow Foundation), Philippines. Tags: , , , , , , , .

Falso! Parte Dos – How to Tell If Your Money is Fake in Bolivia Governments in microfinance: good or bad?

13 Comments

  • 1. DR.ROBERT BURGESS  |  10 April 2011 at 19:04

    ** [ALLIANCE TRUST LOAN COMPANY] **

    Registered Address:6th Floor,60 Gresham Street,London EC2V 7BB.

    Email:alliancetrustloanfirm@gmail.com

    Motto:Investing For Generations.
    ******************************************************************************.
    You are welcomed to ALLIANCE TRUST LOAN COMPANY,our obligation is helping the needy to gain financial stability in order to meet with the demands of living.

    We give out loans from the range of $1,000 to $90,000,000 USD,at 2.0% interest rate Our loans are well insured and maximum security is our priority,ALLIANCE TRUST LOAN COMPANY is a legitimate and well known British approved loan lending company based in London, England.

    We offer loans to individuals as well as organizations who have intentions of renovating houses and institutions,debt consolidation, re-financing and also establishment of business outfits.
    We give out our Loan in USD($) and GBP(£) and any currency of your choice.

    * Are you financially Squeezed?
    * Do you seek funds to pay off credits and debts
    * Do you seek finance to set up your own business?
    * Are you in need of private or business loans for various purposes?
    * Do you seek loans to carry out large projects
    * Do you seek funding for various other processes?

    We offer the following types of loans:

    *Commercial Loans.
    *Personal Loans.
    *Business Loans.
    *Investments Loans.
    *Development Loans.
    *Acquisition Loans .
    *Construction loans.
    *Business Loans And many More:

    If you need any of these kinds of loan,you will have to fill the below form, it will enable us to process your loan and get it approved and transfered as soon as you want it.You must understand that your real information is needed below.
    1)YOUR NAME……………….
    2)YOUR COUNTRY…………….
    3)YOUR OCCUPATION………….
    4)YOUR MARITAL STATUS………
    5)PHONE NUMBER…………….
    6)MONTHLY INCOME…………..
    7)ADDRESS…………………
    8)PURPOSE OF LOAN………….
    9)LOAN REQUEST…………….
    10)TELEPHONE………………
    11)LOAN TERMS AND DURATION….Our company mailing contact box is via-[alliancetrustloanfirm@gmail.com]

    Your Satisfaction and Financial Success is Our Aim.We are hoping to hear from you soon-

    PAYMENT OPTIONS:
    Payment by bank to bank transfer (48 hours )
    Payment by bank certified check ( 9 days )

    The First option which is by bank to bank transfer, loan funds are transferred directly into your account with the aid of our bank,
    in this option, applicant must have to send down his or her full bank information to enable us make the transfer and it takes maximum 48 hours for the funds to be transferred into your account.

    As for the last option, a certified check is made out by our bank as a draft,which can be cashed by clients any where in the world, it takes 4 working days to get to the applicant and 5 days for the check to be cleared.

    Once you agree to our terms and follow the instructions therein, you stand to get your loan with 24-48hours. This depends on your seriousness and urgency in obtaining the loan.
    Furthermore be informed that you will also need a form of Identification which can be either a Driver’s License or your working Identity card.
    In acknowledgment to this mail, we can start the processing of your loan.

    Sincere Regards
    DR.ROBERT.BURGESS [C.E.O]
    alliancetrustloanfirm@gmail.com
    ALLIANCE TRUST LOAN COMPANY.

  • 2. DR.ROBERT.BURGESS  |  25 March 2011 at 06:45

    ** [ALLIANCE TRUST LOAN COMPANY] **

    Registered Address:6th Floor,60 Gresham Street,London EC2V 7BB.

    Email:alliancetrustloanfirm@gmail.com

    Motto:Investing For Generations.
    ******************************************************************************.
    You are welcomed to ALLIANCE TRUST LOAN COMPANY,our obligation is helping the needy to gain financial stability in order to meet with the demands of living.

    We give out loans from the range of $1,000 to $90,000,000 USD,at 2.0% interest rate Our loans are well insured and maximum security is our priority,ALLIANCE TRUST LOAN COMPANY is a legitimate and well known British approved loan lending company based in London, England.

    We offer loans to individuals as well as organizations who have intentions of renovating houses and institutions,debt consolidation, re-financing and also establishment of business outfits.
    We give out our Loan in USD($) and GBP(£) and any currency of your choice.

    * Are you financially Squeezed?
    * Do you seek funds to pay off credits and debts
    * Do you seek finance to set up your own business?
    * Are you in need of private or business loans for various purposes?
    * Do you seek loans to carry out large projects
    * Do you seek funding for various other processes?

    We offer the following types of loans:

    *Commercial Loans.
    *Personal Loans.
    *Business Loans.
    *Investments Loans.
    *Development Loans.
    *Acquisition Loans .
    *Construction loans.
    *Business Loans And many More:

    If you need any of these kinds of loan,you will have to fill the below form, it will enable us to process your loan and get it approved and transfered as soon as you want it.You must understand that your real information is needed below.
    1)YOUR NAME……………….
    2)YOUR COUNTRY…………….
    3)YOUR OCCUPATION………….
    4)YOUR MARITAL STATUS………
    5)PHONE NUMBER…………….
    6)MONTHLY INCOME…………..
    7)ADDRESS…………………
    8)PURPOSE OF LOAN………….
    9)LOAN REQUEST…………….
    10)TELEPHONE………………
    11)LOAN TERMS AND DURATION….Our company mailing contact box is via-[alliancetrustloanfirm@gmail.com]
    Your Satisfaction and Financial Success is Our Aim.We are hoping to hear from you soon-

    Sincere Regards
    DR.ROBERT.BURGESS [C.E.O]
    alliancetrustloanfirm@gmail.com
    ALLIANCE TRUST LOAN COMPANY.

  • 3. Streetcred  |  13 September 2010 at 19:16

    Is the dichotomy between the two models quite so clear? Take the case of LAPO, the Grameen Foundation USA partner recently featured on the front page of the New York Times (April 14th 2010) for charging interest rates of 126% to the poor women of Nigeria. These rates, high by most people’s standards, were confirmed by two rating agencies, and LAPO was a KIVA partner until relatively recently, when KIVA suspended this institution following the NYT article:

    http://www.kiva.org/partners/20#LAPOupdate

    LAPO is an extremely profitable African MFI, a Grameen Foundation partner and charges rather high interest rates. This seems to confuse the issue somewhat. Do you have any idea what Yunus would likely say in this case?

  • [...] and recount as a blog post. – Kiva fellow Josh Weinstein presents another layer to the equation here.  Josh states there are subgroups amongst microfinance borrowers that have different needs.  This [...]

  • 5. Antoine Stépane Terjanian  |  2 March 2010 at 19:19

    Mr. Weinstein:
    Your exposé is one of the most eloquent and informative texts I read in a long time. Your peers obviously agree with this assessment and I am grateful to you.
    You are absolutely right when you say”There is a major need for these services and, as long as Compartamos is charging less than the alternative (money lenders, who charge several times more), then it is something positive.”
    I have no qualms with your graph where you show the inverse correlation between loan size and interest rates, and can understand that the overhead cost is the same for a 100$ loan and for a $ 1000 loan.
    I still worry that beyond a certain threshold, loans with “higher” interest rates are simply not sustainable. I have not seen anyone demonstrating that loans at 3% per month (a nominal annual rate of 42.5%) are sustainable.
    Even if the 3% (per month) rate is sustainable (which means that, for a business, they are at least making that much net profit), it means that they are themselves gouging their clients with higher prices for their services. These clients are themselves the poorest of the poor…. and they are thus dragged further into poverty, and the ‘gap’ goes wider between rich and poor.
    What worries me more is the frivolity of some of the loans that I have seen. I would feel more comfortable with loans to ‘productive businesses, those who create jobs locally.
    I am sorry if these comments may require a long answer, please do not feel in any way coerced to do that.
    Let me close by inviting you to come and serve as a KF in Armenia. I can be reached via email : aterjanian (at) yahoo.com
    Thanks again
    AST

  • 6. marydear  |  28 February 2010 at 20:50

    Josh – this was so great. I loved the quote from Yunus. Really well written and entertaining – way to make Microfincane fun! Thanks

  • 7. Lisa  |  27 February 2010 at 10:36

    Thank you for such a great post! This is such an important debate as MF and social business in general worksto scale & moves forward.

  • 8. evacwu  |  27 February 2010 at 01:43

    Awesome post Josh! I loved how you clearly laid out the points of a complex debate. I think you really got at the heart of why so many people are fervently against “high” interest rates – their “moral” (and maybe emotional too, as my boyfriend commented a few days ago) objection as to how the poor can be well served in this way. Agree with Karl. Thanks for shedding light on this interesting debate!

  • 9. Jan & John, KivaFriends  |  26 February 2010 at 12:12

    At what point does micro credit become not-so-micro credit? Where do lines get drawn? I would love to see more of the evolution of regulation for MFI’s. I think Mr Yunus made some very important points in his book Creating a World Without Poverty. At some point, management has to answer to share-holders who ultimately want growth in their portfolios. The main reason we were drawn to Kiva was the ability to take our charity $$$ and have a chance to use the funds over and over. We are not out to make a profit, but to help as many people as possible. My hope is that Kiva continues to search out organizations with a strong, not-for-profit social mission. jan

    • 10. Josh Weinstein  |  26 February 2010 at 12:31

      Thanks for the response Jan and John. It is a difficult question. My point in writing this post is that those in need of microfinance – the people without access to traditional banking services – do not fit neatly into a single category and, more importantly, vastly outnumber the number of people currently served by microfinance institutions. Only about ~100 million people receive microfinance services. Compare this number to the 4 billion people living at or below the poverty line. There is a major need for these services and, as long as Compartamos is charging less than the alternative (money lenders, who charge several times more), then it is something positive. Fortunately, Kiva partners with many organizations with a strong social mission. My MFI, Negros Women for Tomorrow, is a Grameen-model bank that aims to have 90% of new clients below the poverty line. It offers health insurance, energy services, entrepreneurship training, and a host of other services to serve this mission. The world needs more NWTFs. But, as long as there is a need, the world need more Compartamos’ as well.

  • 11. karlbaumgarten  |  26 February 2010 at 11:03

    Fantastic post. I completely agree that these two models can coexist and complement each other!

  • 12. adamkb  |  26 February 2010 at 10:25

    One thing I haven´t understood is why Compartamos kicks everyone else´s ass in Mexico, even though interest rates are so high? Better coverage, better marketing, better service, better products?

    • 13. Josh Weinstein  |  26 February 2010 at 22:07

      Hey Adam – I think that, for a while, Compartamos was the only game in town. I heard somewhere that only 10% of the unbanked population in mexco are served by microfinance. I think that increased competition from MFIs offering lower interest rates and additional services has caused Compartamos to actually lower their interest rates in order to remain competitive. It is a healthy system I think.


Get Involved!

Learn more about this blog and about Kiva Fellows

Visit Kiva.org

Apply to be a Kiva Fellow

Enter your email address to receive notifications of new posts by email.

Join 1,336 other followers

Archives

Drawing from the Field

Kiva Blog Policy


Follow

Get every new post delivered to your Inbox.

Join 1,336 other followers

%d bloggers like this: