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Stanford Graduate School of Business 'News' Microfinanciers: Developing Paths to Self-Sufficiency
by Anne Field A loan of $50 in the developing world can raise a family out of abject poverty, but servicing small loans can be costly. Alums are working to improve the business model for microfinance institutions so they can expand their reach.
Mike Murray, MBA '81, remembers the day clearly. About 22 years ago as an Apple Computer employee, he was attending a national sales meeting in Acapulco and decided to take a walk on the beach. There he met a bedraggled boy dressed in rags, begging, holding the hand of his little sister, who was blind. Murray gave them money, but he was profoundly shaken by their plight. Afterward, he found himself thinking often about the encounter. Surely there must be a way to help these children - and millions of others - in a more constructive, long-lasting way. Murray now thinks he has found the answer. About four years ago, he launched an organization to help accelerate the growth of microfinance, an approach whereby local groups make small loans to destitute people to jumpstart businesses. He recalls the pride and hope exuded by a group of women in Bolivia who had received loans of $100 or so. "I saw a real miracle of emotional, intellectual, and spiritual empowerment," he says.
For Rachel Payne, MBA '04, the long-term impact of microfinance really hit home last year when she helped set up a loan program in Uganda. It was during a conversation with a village phone operator, a client who had taken out a loan to set up a business providing telephone service for the rest of the village. The woman recounted overhearing a mother urging her daughter to go to school so she could become a phone operator herself one day. In that moment, Payne explains, she saw the profound effect her work could have on the entire community. "These women were role models for the rest of the village, making it socially acceptable for girls to be literate," she says. "By breaking down the barriers people face, we are enabling them to use their own resources to change their lives." How best to address the problem of extreme poverty in developing nations? For a growing number of people, one approach - microfinance - is a tactic of breathtaking potential. "It's the most important solution I have found," says Vinod Khosla, MBA '80, a partner in Kleiner Perkins Caufield & Byers, the Menlo Park, Calif., venture capital firm. Khosla works closely with a number of microfinance institutions. Inspired by European and Indian credit cooperatives in the late 19th century, this microfinance model of lending small amounts to individuals and making their friends and neighbors responsible for defaults was pioneered in the mid-1970s by Grameen Bank in Bangladesh. There are now about 3,000 microfinance institutions - MFIs for short - in Asia, Africa, the Caribbean, and Latin America. They are financed both by donors looking for a way to tackle poverty and, more recently, by investors seeking profits. In most cases, borrowers don't have conventional collateral. Interest rates at 30 to 50 percent a year, while high by Western standards, are considerably less that those demanded by other local moneylenders, who charge from 10 percent a day to 50 percent a month. To ensure repayment, microfinance institutions often lend to groups of 3 to 30 borrowers, usually women, who take responsibility for seeing that their colleagues pay on time. Repayment rates range from 90 to 98 percent, according to a variety of experts. The microfinance approach has helped many people work their way out of abject poverty and send their children to schools they would not otherwise have been able to afford. It also has empowered women by providing them with more economic clout in their homes. But it is by no means yet a panacea for world poverty. MFIs still face substantial barriers, from a lack of standardized financial metrics that make it difficult to measure success to steep administrative costs and problems associated with serving dispersed rural populations. Indeed, while there are about 3 billion people, including children, living on less than $2 a day - the World Bank's definition of poverty - microfinance organizations have given loans to about 80 million adults. That, according to Murray, is just about 20 percent of the potential candidates for loans. "We have to get a lot larger to really help people living in poverty," he says. "At a macro level, it's when you have 10,000 or 20,000 families benefiting from these loans that the growth rate of an entire economy is raised. The tide lifts all ships." The good news is that most of these obstacles are far from insurmountable. Microfinance institutions and their advocates, including a number of Stanford Business School alumni/ae, are addressing problems head-on. Specifically, they are introducing new measurement systems, creating more efficient operating systems, developing ways to significantly boost growth, and installing technological innovations. The challenges start with the need for financial transparency. Until recently, there have been no standard methods of measurement. The lending institutions have produced a potpourri of metrics - and little clear evidence of their profitability, size, or societal impact. For example, some MFIs include donations in their revenue numbers; others don't. "There are lots of anecdotal accounts of success, but it would be nice to have more quantitative measures," says Business School Professor John McMillan, who co-directs the School's Center for Global Business and the Economy. The center has hosted several discussions and speakers on microfinance. "If you're going to reach more investors and donors, you need clear standards that are generally accepted," says Payne, who now works for Google, where she is helping to set up the Mountain View, Calif., company's philanthropic arm. The local nature of MFIs means many don't operate under regulatory supervision, says Blaine Stephens, director of analysis for Mix Market, a microfinance information clearinghouse in Washington, D.C. This makes it difficult to judge which of the nonprofit organizations, most of whom are dependent upon donors now, could in the future sustain themselves or greatly expand their reach. In fact, some studies suggest MFIs are still very dependent on donations. In a 2003 study of 125 of the largest MFIs, 66 were able to meet their costs without donations, according to the MicroBanking Bulletin, which is published by Mix Market. That means, of course, that about half were not financially sustainable. For those focusing on poorer clients, 37 percent were sustainable. The profitability of microloans, according to the limited data available, tends to vary with the lending institutions' clientele and loan types. So-called solidarity lenders serve groups of three to five people. Village banks work with populations up to 30. Lenders to individuals eschew the traditional group orientation of MFIs. Generally, "the larger the group, the poorer the people," says Monica Brand, MBA '97, vice president of marketing and product development for Accion International, which assists and invests in MFIs in Latin America, the Caribbean, and Africa.
Thus, the average loan size for village bank lenders is $149, compared to $1,220 for lenders to individuals, according to researcher Jonathan Morduch, associate professor of public policy and economics at New York University. In a recent study of 124 institutions, he found the average return on assets was minus 8 percent for lenders using the village banking model, minus 5 percent for solidarity loans, and plus 1 percent for loans to individuals. Consider one of the most successful MFIs, Bank Rakyat Indonesia (BRI). From 1999 to 2002, BRI's microfinance division had annual average profits of $147.1 million with a 6 percent return on assets. But its average loan size was $345. In contrast, institutions in Bangladesh and India generally made loans on the order of $50 to $150. The implication: BRI, along with other similarly successful MFIs, didn't generally serve the poorest of the poor. But as success stories spread, more funds have become available. Over the past several years, 60 to 100 funds have been started, investing about $1.2 billion in some 500 MFIs, according to Elizabeth Littlefield, director of Consultative Group to Assist the Poor, a Washington, D.C.-based consortium of 28 private and public agencies trying to increase access to financial resources for the poor in developing countries. Some of the funds are seeking a conventional return on investment, either to return to investors or to plow back into microfinance. BlueOrchard Microfinance Securities, started in 2001, has $40 million invested, with an anticipated annualized return of 5 percent to 9 percent, according to Morduch. Accion Investments, launched in 2003, has $19.6 million in assets with a 7 percent to 8 percent return. The funds are a significant source of capital, but "they're not investing in the MFIs reaching the most poor," Morduch says. Others point to a potential downside for the microlenders financed by these funds: the exchange rate risk. That's because the investments are made in dollars. As a result, the risk is held by the recipient institutions, not investors. Furthermore, it's clear that there aren't a great many institutions in strong enough financial shape to accept investments from these funds. Result: "It suggests there will be consolidation," Littlefield says. "There are too many funds and not enough institutions ready for investment." Microfinance institutions also have had trouble making inroads in rural areas with dispersed populations. Indeed, the most successful are located where it's easier to serve large numbers of clients with small staffs. Agricultural economies pose another problem: When they're hit by seasonal calamities, such as exceptional rainfall, most or all of a lending institution's clients are hurt at the same time. "It's difficult for portfolio management purposes to have all our clients' risks so connected," Littlefield says. Still, while MFIs face steep challenges, many advocates say they've also begun to turn the corner. "We're at a turning point. Awareness [of more sophisticated metrics] has started to increase. Investment has started to increase" says Payne. "We're reaching a tipping point for microfinance in our ability to reach more people." Over the past five years, there's been a small but significant upswing in the number that is self-sufficient. Average total revenue over average total cost ranges from 0.95 for solidarity lenders to 1.11 for MFIs loaning to individuals. That compares to 0.89 for solidarity loans and 1.02 for individual loans in 1998, according to Morduch. Also, newer organizations - those started after 1995 - have become financially sustainable more quickly than those started previously, according to MicroBanking Bulletin. Several major banks recently have entered into microfinance lending, further evidence of its increasing viability, according to advocates. One pioneer, Deutsche Bank, for example, introduced its own private nonprofit fund about seven years ago. Its approach was to make loans to local banks, which would use the money as collateral when lending to MFIs. "Our mission is to create an indigenous system of financial support for the portfolio by linking local banks that are the source of capital to MFIs," Christina Juhasz, MBA '95, says about the bank's foundation, where she is the volunteer director of the microfinance group in the United States. Earlier this year, however, the bank took its commitment to another level with the launch of a $75 million commercial fund accepting outside investments. (The bank does not anticipate making a profit from the fund, which is part of the foundation, but does expect investors to do so.) "We saw that, my goodness, there's money in this," says Juhasz, who is also a Deutsche Bank fixed-income director. "And we could encourage others to invest with us for a profit." Then there's the issue of standardization of financial metrics. Recently, various organizations have made significant progress. This fall, Consultative Group was scheduled to come out with a standardization guide for microfinance institutions. Already, groups like Mix Market have developed metrics that about 450 MFIs follow. The most profitable institutions have established cost control models for the industry. While MFIs have generally charged high interest rates to cover the high administrative costs of small loans, at some of the most successful institutions costs are down to about 4 cents on the dollar, according to Littlefield. Some advocates say the most profitable MFIs do not all focus on less-poor clients either. A study of 17 institutions that became self-sustaining between 1999 and 2002 found that their loan balances were lower on average and retained more of a focus on poorer clients than others, according to MicroBanking Bulletin. Accion's Brand points to Compartamos, a successful MFI in Mexico that uses a village banking approach and "reaches some of the lowest segments of the poor," she says, thanks to its highly efficient operations. And, according to Murray, the larger average loan size made by some MFIs doesn't mean they're working with less poor clients; it means that their borrowers are on their second and third loans, which tend to be larger than their earlier ones.
The fact that the more sustainable MFIs tend to reach more clients is one reason that Murray launched an organization in 2001 to help MFIs dramatically increase the number of people served. He founded Unitus, what he calls a microfinance accelerator, to provide training and other assistance to promising MFIs with the goal of reaching 10 million borrowers by 2015. Murray and his colleagues, based in Redmond, Wash., pinpointed 60 financial, political, and management metrics to identify the microlenders who were most likely to be successful. (They had to have been making loans for two to five years with a 98 percent or greater repayment rate, for example.) During five- to seven-year partnerships with the chosen organizations, Unitus intends to help them move from nonprofit status to official banks for the poor. The institutions can then be deemed eligible for equity investments, allowing them to grow their operations significantly. With this approach, "you're going to make a real dent in entire communities," says Murray, who expects each of the seven MFIs he is working with now to serve at least 250,000 clients in five years. One such institution, SKS, located in Hyderabad, India, was serving about 13,000 women three years ago. Unitus consultants helped rewrite the organization's business plan and train its managers. Now, it reaches about 100,000 clients and has applied for a license to become a bank. Its return on assets is 2.5 percent. Advocates also point to a big push to promote savings among MFIs. More than 10 percent of institutions from 1999 to 2002 went from having no deposit services to holding savings of more than 20 percent of their total asset base, according to Mix Market. That's important because institutions able to take deposits are likely to have a lower cost of capital and the ability to make more loans. They point to the success of BRI, which was launched in the 1980s as a bank for the poor. In the 1997 financial crisis, the bank not only survived but took in more deposits because it was viewed as being so safe, Morduch reports. Still, while there has been progress, it's a tough road. In order to register officially as a bank serving the poor, MFIs in many countries must jump significant regulatory hurdles. The result: In some countries, regulatory reform will be necessary first. Perhaps the biggest boost for microfinance will come from new technology. Some MFIs have experimented with the use of handhelds. Loan officers using their PDAs can make financial decisions in the field so that clients don't have to make a time-consuming trip to the branch. Payne recently participated in a one-year pilot project led by Hewlett Packard and funded by the U.S. Agency for International Development in which clients of three MFIs in rural areas of Uganda made loan payments by swiping a smart card into point-of-service machines hooked up to a branch over a wireless network. If successful, such technology could erase most of the problems faced by MFIs serving dispersed, rural populations. "If they cover the cost for tiny transactions without having the human capital and variable costs of the past," Littlefield observes, "there's almost no limit to how many of the poor can be reached." Alternative Approaches to Reducing Global PovertyMicrofinance is just one of many approaches to helping the poor in developing
countries improve their lives and become self-sufficient. Here are a few other
organizations in which Business School alumni/ae have been involved and their
models: VILLAGE ENTERPRISE FUND ACUMEN FUND KICKSTART By giving the manufacturer of, say, irrigation pumps a line of credit, a chain reaction is set in motion, ultimately allowing the farmer to buy on credit an $80 to $90 pump he would never have been able to afford otherwise. "We're looking for something that can create a major large-scale change, not incremental improvement," Slettehaugh says. Food vendors are among the small business people who benefit from micro loans in developing countries. From left to right, a businesswoman client of a microfinance institution in Hyderabad, India; another in Tula, Mexico; and others in Nairobi, Kenya. The institutions that make the loans are partners of Unitus, an organization headed by Mike Murray, MBA '81, who is trying to expand the reach of microfinancing. About 2,000 Ugandan phone operators, such as Naluwata Proscova, right in left photo, have taken out 12-month loans to buy booster antennas, wireless handsets, and solar panels or car batteries to run phone service in remote villages, many without electricity. At right, Richard Mwami, manager for the company MTN villagePhone trains more potential phone franchise operators at a session in Kampala. Nine microfinance organizations are involved in making the equipment loans. From top, photos courtesy of Robert King, Jacqueline Novogratz, KickStart.
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