Microfinance practices face challenges

by Catherine Glenn Foster, 1L
Law Weekly
April 1, 2009

On Tuesday, March 24, Richard M. Greenberg, Senior Manager of Micro and SME Finance at Overseas Private Investment Corporation (OPIC), came to Georgetown Law to speak on “Current Developments in Microfinance and OPIC’s Role.” After providing an overview of microfinance, Greenberg moved on to address the state of the industry, the impact of the current global economic crisis on microfinance, and OPIC’s contributions to microfinance.

According to Greenberg, microfinance is the provision of financial services to poor and low-income clients with the basic aim of helping to lift the poor out of poverty. Robert Peck Christen, Richard Rosenberg, and Veena Jayadeva’s July 2004 paper “Financial Institutions with a Double Bottom Line: Implications for the Future of Microfinance” adds that microfinance is a movement that envisions “a world in which as many poor and near-poor households as possible have permanent access to an appropriate range of high quality financial services, including not just credit but also savings, insurance, and fund transfers.”Many different types of organizations, called microfinance institutions or MFIs, provide these services using capital from a wide variety of sources.

Greenberg reports that the industry continues to experience strong growth in global demand, with the poorest groups in many countries not yet reached. The use of technology such as cell phones, however, is building inroads to these people, creating new, efficient delivery options for mobile banking and other services, and further building demand.

Thus far, tools to measure the impact of microfinance have been inadequate, often relying more on anecdotal observation than systemic study, and increased scrutiny has unveiled occasional instances of improper lending practices. However, key industry players are developing tools to better measure impact and communicate their findings to the global community. According to Greenberg, the vast majority of practitioners are responsible and seek to generate positive impacts on communities. On the investor side, increasingly proven returns meant growing interest from investors, resulting in the rapid growth of capital until early 2008.

The global economic climate has taken a toll on microfinance. With increased risk and a decrease in available capital, there is much less investment by mainstream, commercially-oriented investors that were becoming an important source of capital prior to the crisis. However, Greenberg believes that MFIs that focus on short-term microenterprise lending for productive purposes should be less vulnerable. In fact, MFIs in general could be less prone to difficulties than other financial institutions due to their relative lack of leverage, their practice of borrowing long and lending short. Moreover, their loans that are used by borrowers to provide basic goods and services continue to be in demand despite the downturn. Small and medium enterprises, on the other hand, will likely be much more affected.

Even prior to the current global financial crisis, however, there were constraints on capital flows to MFIs, such as limits on the availability of local currency financing, dependence on foreign sources of funding, and limited access to capital from mainstream investors given the relatively low rates of return. Greenberg believes that one potential positive outcome from the current economic climate is that with much slower growth, MFIs are being forced to self-evaluate, addressing certain areas that may have been neglected, such as relatively weak corporate governance, internal controls, and information systems. This could help the industry refocus on managing resources more effectively when growth resumes.

According to Greenberg, OPIC was established in 1971 as an agency of the U.S. government, an outgrowth of USAID ideals. Greenberg refers to OPIC as a "government-owned corporation with a public-private sector board and a self-sustaining operation," created to "promote development through U.S. private investment" in new and emerging markets. It works by facilitating the investment of U.S. private capital and skills in the economic and social development of less developed countries and areas, and countries in transition from non-market to market economies.

Greenberg said that OPIC complements the private sector in managing risks associated with foreign direct investment, and he furthermore asserts that it supports U.S. foreign policy and best practices by requiring projects to adhere to international standards on the environment and human rights. Its three principal lines of business are financing/guaranties, political risk insurance (against inconvertibility of currency, for example), and investment funds. Currently, OPIC services are available for new and expanding business enterprises in more than 150 countries worldwide.

The world of mircofinance is awash in debates over topics such as profit/commercialization versus social justice, public- versus private-sector solutions, regulation, appropriate interest rates for inclusive financial systems, and the incorporation of Islamic Sharia law. There are also questions about whether most microfinance lending should be aimed at women, and the ability and need to reach those populations in the developed world who have little or no access to financial services.

Muhammad Yunus, the Bangladeshi banker and economist who developed the concept of microcredit and won the 2006 Nobel Peace Prize, has argued that profit motives could compromise traditional microfinance objectives. Greenberg believes there is a need for both nonprofit and profit-driven microfinance business models in order to reach as many segments of the poor and working poor as possible.

Greenberg remains optimistic about the future of microfinance.

"The dust will settle; markets will stabilize. Demand for microfinance should continue to grow--hundreds of millions of people need it," says Greenberg. "Microfinance institutions in many parts of the world have established a track record of good financial performance and earnings that will attract increased investment from a growing pool of interested investors."