Not For Profit = No Profits?

August 27, 2008, Christoph Kneiding

Profit margins of MFIs that function as non-profit organizations have exceeded those of for-profit MFIs in 2005 and 2006 (see Figure). This seems to be counter-intuitive as one generally thinks of for-profits as more prone to maximize their profitability than their non-profit counterparts. Of course, we have to remind ourselves that non-profit is a legal form, and not a mission statement. There are two important factors that can help to explain the phenomenon we observe.

First, for-profits face higher costs than non-profits, for various reasons. Funds come increasingly from commercial lenders who want a higher return on their invested capital than is the case for donors. MBB data shows that in 2006, more than 90 percent of the average for-profit MFI portfolio (versus 57 percent for non-profits) was commercially funded, which incurs a higher financial cost. For-profits (which are generally incorporated as banks) also face higher regulatory costs, as financial supervisory bodies pose extensive requirements with regard to reporting and internal processes of these institutions. Lastly, for-profits do not enjoy tax-exemption of their profits, as is the case for non-profits. After-tax margins of for-profit MFIs are therefore even lower as the figures shown in the graph are calculated on a pre-tax basis.

But that’s just part of the story. For-profit MFIs tend to operate in more mature markets, which are characterized by higher levels of competition. In general, this leads to a drop in interest rates, which puts downward pressure on profit margins. Bolivia is a very good example for this phenomenon: from the early nineties until now, interest rates have dropped from 60 to 17 percent, mainly driven by the arrival of new players in the Bolivian market. It is reasonable to assume that profit-driven MFIs will continue to focus on more developed markets, where they increasingly will encounter competing institutions. Further pressure on profit margins can be expected.