eight

Development as Industry Building

Are not all these distinctly useful services? Is not the country the richer, the happier, the better endowed with producing power for them? Unquestionably banks of this class, which will neither give nor take anything for nothing, which scrutinise their member-customers with a keen, selfish, discerning eye, which think nothing of educating, of elevating the poor, which apply only the hard, cold principle of purely economic co-operation, have rendered perfectly inestimable services to the small trading classes, the agriculturists, the working population of their countries, and have strengthened the social fabric of their nations just where strength was most needed and tells to best effect.

—HENRY WOLFF, 18961

It is impossible for the large capitalist to come into direct contact with the small cultivator. The capitalist has no local knowledge of the individual, he has no agency for collecting small loans, and he could not keep millions of small accounts. There must be some intermediate organisations.

—WILLIAM GOURLAY, 1906²

It is far better to build the capacity of the financial system than to provide a substitute for its inadequacies.

—ELISABETH RHYNE, 1994³

When I think of vaccination in developing countries, I see a baby getting a shot. I hardly see the nurse who gives the shot, much less the health ministry she works for. When I think of the provision of clean water, I see a mother working a hand pump to fill a bucket. I do not see the nonprofit that drilled the well.

When I think of the delivery of financial services to poor people, I see a cluster of women in colorful saris seated on the ground, gathered to do their weekly financial business. But I also see a young man, the loan officer in Western clothes who is the nucleus of the gathering. And I wonder whom he works for: perhaps the Grameen Bank in Bangladesh? CASHPOR in India? The institution enters the image.

There is no Grameen Bank of vaccination. One does not hear of organizations sprouting like sunflowers in the world of clean water supply, hiring thousands and serving millions, turning a profit and wooing investors. Yet one does in microfinance. Stuart Rutherford observed that “most poor Bangladeshis now have routine access to a basic banking service that is often more reliable than the educational and health services that they commonly encounter. Nowhere else in the world has this yet happened.”4

More than any other domain of support for the global poor, microfinance comprises spectacular indigenous institutions. At the end of 2009, thirteen microfinance institutions (MFIs) belonged to the million-borrower club and eight had a million or more voluntary savings accounts. And though self-sufficient today, many once relied on outside support. Money now flows into MFIs through a variety of channels: dedicated investment funds, commercial bank loans, issuances of bonds and securitized microcredit loans, and initial public offerings (IPOs) of stock. The majority of the flows are public money, but the private share has risen steadily.

So distinctive is microfinance's transition from charity to industry that some observers have argued that success in microfinance should be defined as success in building organizations and industries.⁵ They are not purists: they do not argue that this is all that matters. The perspectives in the previous two chapters, which center on reducing poverty and expanding freedom, matter too. But as we have seen, those measuring sticks are deceptively hard to apply to microfinance and so far have produced fragmentary, ambiguous, and muted results. Meanwhile, it seems inherently good to cultivate self-sufficient, customer-oriented, domestically owned organizations serving poor people. So often foreign aid fails precisely because local people do not take ownership of whatever intervention is tried. Absent decisive evidence that microfinance is harming its clients on average, microfinance supporters should aim for and judge themselves against the goal of birthing MFIs that thrive independent of aid.

This point of view can be rooted in ideas as established as Amartya Sen's definition of development as freedom. Joseph Schumpeter was an Austrian-born economist who moved to the United States in 1932 to escape Nazism, then taught at Harvard for his last 18 years. In 1911, in his late twenties, Schumpeter published his Theorie der wirtschaftlichen Entwicklung. When translated into English in 1934, it gained the title The Theory of Economic Development.6 Entwicklung might better have been translated as “evolution” instead of “development” to convey the original German sense of continual, internally driven change.⁷ For Schumpeter, who lived in a time of accelerating industrialization, the interesting question in economics was not why prices settle at levels that balance supply and demand, but why the economic balance was constantly disrupted by new technologies, firms, and trade patterns. The ambient metaphor for the paradigm of equilibration, the farmers' market, was a terrible model for the economic churning he witnessed. Schumpeter concluded that the heroes of economic evolution and the objects of greatest scientific interest were entrepreneurs. They were agents of creative destruction, finding new ways to make valuable things: people like Henry Ford—and Muhammad Yunus.

In fact, for Schumpeter, entrepreneurs did not need to be individuals. Organizations, too, were entrepreneurial if they developed and spread “new combinations of the means of production.”⁸ In the Schumpeterian view, then, the arrival of self-sufficient MFIs, such as BancoSol in Bolivia, Equity Bank in Kenya, and Bank Rakyat Indonesia (BRI), is economic development, full stop.

The success of the microfinance movement in building dynamic institutions and industries is the brightest spot in this book's assessment. Accepting this success, the practical question, just as with conventional finance, is how to limit the damaging side of microfinance and help it realize its potential to deliver freedom-enhancing services to billions of people. Like most financial industries, microfinance is prone to mania. But just as it would be a step backward to ban the mortgage industry on account of its faults, so would it be to shut down microfinance. How can we assure that creative destruction is more creative than destructive? Metaphors from ecology inspire some broad answers. A species enriches its ecosystem when its natural growth is roughly checked by constraints and its linkages to other species are multiple: predation, competition for food, symbiosis, and so on. Likewise, MFIs enrich the economic fabric most when their growth is checked within certain rough limits and they provide multiple services, for example taking savings as well as making loans. But pouring millions into microfinance can cause micro-credit disbursements to grow dangerously fast and discourage lenders from taking savings. Mythologizing microfinance, by attracting large investment flows, has sometimes undermined true success.

Learning from Professor Schumpeter

“Development” in English signifies both outcome and process. Outcome has been drilled into many minds by the Amartya Sen–inspired Human Development Index, which scores each country on the income, health, and education of its populace. But process is truer to the word, which, like “evolve,” comes from the Latin volvere, “to roll.” Chapter 6, with its focus on measurable impacts, worked under the outcome definition. Chapter 7 blended the two conceptions, taking freedom as both end and means. This chapter hews to the process sense of the word, and more concretely than in Sen's broad reasoning. My starting point is recognizing that through the process of industrialization, certain societies have become rich over the last few centuries, not merely by enhancing various mutually reinforcing freedoms, but by enduring long processes of economic churning in which new ways of making things continually displace old.

One practical question that drives this book is how much good can be done by investing in microfinance, whether with $25 or $25 million. Judging success relative to the Schumpeterian reference point is fairly easy: investors and advisers have made microfinance what it is today. But whether such success improves the lives of poor people is less certain. Making that link as best we can requires a broad understanding of the process of national economic development and the role of finance within it.

In the history of economics, Schumpeter is the leading proponent of the view that development is an evolutionary process fueled by finance. Now, his theory is incomplete: even today, why certain countries begin industrializing at certain times is not fully understood.⁹ But he did observe correctly that when economic evolution is under way, the rise of new technologies is often associated with the rise of new corporations—makers of steel, software, and so on. “It is not the owner of stage-coaches who builds railways.”¹⁰

To use yet another word from that Latin root, development is a series of revolutions, brought about by the continual birthing of new institutions. In fact, these new institutions need not be corporations. Nonprofits, such as the Red Cross, and institutions of governance, such as the British Parliament, also arise to put their stamp on society. They produce new things that people value or old things in new ways. A society that ceases to nurture such institutional revolutions ceases to develop. To describe the process of renewal in his 1942 book, Capitalism, Socialism and Democracy, Schumpeter popularized the term “creative destruction”:

The history of the productive apparatus of a typical farm, from the beginnings of the rationalization of crop rotation, plowing and fattening to the mechanized thing of today—linking up with elevators and railroads—is a history of revolutions. So is the history of the productive apparatus of the iron and steel industry from the charcoal furnace to our own type of furnace, or the history of the apparatus of power production from the overshot water wheel to the modern power plant, or the history of transportation from the mailcoach to the airplane. The opening up of new markets, foreign or domestic, and the organizational development from the craft shop and factory to such concerns as U.S. Steel illustrate the same process of industrial mutation—if I may use that biological term—that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism.11

In the earlier Theorie der wirtschaftlichen Entwicklung, Schumpeter laid the groundwork for the idea of creative destruction by describing an imaginary economy called the “circular flow.” I imagine it as a seaside town in medieval Italy, with winding, stone-paved streets. In the circular flow, little changes. The farmer sells to the butcher, who sells to the baker, who sells to the candlestick maker, who sells to the farmer. Income and expenditure course in predictable ways, day to day, year to year. Methods of production remain static. Credit is useful but inessential. Schumpeter knew that no economy is completely static, but he used the circular flow as an artifice. It lined up with a paradigm he wanted to revolt against: the iconic graphs of supply and demand that Alfred Marshall, the nineteenth-century dean of economics, had popularized.

The important question, Schumpeter wrote, is not what makes this equilibrium, but what breaks it: “Carrying out a new plan and acting according to a customary one are things as different as making a road and walking along it.”12 How do economies change? Where do Model Ts and microcredit come from? His answer: the essential agent is not the scientist nor the inventor but the entrepreneur, the one who strikes out to combine labor and materials in novel ways and so reroute the circular flow. “Development in our sense is then defined as the carrying out of new combinations,” he wrote.¹³ Profits exist only to reward such entrepreneurship.

The people and organizations whose stories were told in chapter 4 are Schumpeterian heroes' the Okas in Indonesia, Yunus in Bangladesh, the creators of BancoSol in Bolivia. They did not invent joint liability and mass production of financial services for the poor any more than Henry Ford invented the automobile. But through luck, vision, persistence, ingenuity, and trial and error, they made small economic revolutions. They brought new possibilities to poor customers. They created jobs. They were copied. In response to competition, they innovated again. They enriched the institutional fabric of their nations, creating new possibilities for thousands of people as employees and millions as customers. In this sense, their contribution to development is incontrovertible. This praise may seem hollow because it does not assert that microfinance is reducing poverty or even expanding clients' freedom. But consider that replicating the success of microfinance institutions in a thousand other lines of business, creating dynamic industries in everything from soap to software, would make a country rich. Except for oil fields, nothing else ever has.

Interestingly from the point of view of a book about microfinance, Schumpeter saw a special role for finance. Development could take place within the business of financial services, but far more importantly, economic development occurred because of financial services. Credit is not merely a useful thing to sell to people, like food and shirts. It is the lifeblood of entwicklung: to fashion economic novelties, entrepreneurs need purchasing power with which to hire workers and obtain materials. One of the more mind-boggling everyday facts in economics is that banks create money (but not wealth) out of thin air. You put your money in a savings account and it is still yours. The bank hands most of it to a borrower, who can spend it: one dollar becomes two. If the borrower invests the money in successful economic activities, then the growth in money is matched by growth in wealth produced. (Otherwise, inflation may result, as an expanded money supply chases the same amount of goods and services.) Without the money created through credit, Schumpeter submits, the entrepreneur could not obtain purchasing power to outbid the traditional employers of capital and labor and disrupt economic patterns. Under socialism, government planners could substitute for this mechanism through command and control, and perhaps guide development more effectively. But in the capitalist system, the hero behind the hero is the banker:

The banker…is not so much primarily a middleman in the commodity “purchasing power” as a producer of this commodity…. He has himself become the capitalist par excellence. He stands between those who wish to form new combinations and the possessors of productive means. He is essentially a phenomenon of development, though only when no central authority directs the social process. He makes possible the carrying out of new combinations, authorises people, in the name of society as it were, to form them. He is the ephor of the exchange economy.14

Schumpeter overreached somewhat. Sometimes innovative companies are launched with savings rather than credit. And while economic development may be impossible without finance, it would be equally impossible without many other things, such as scientific advance, rule of law, and a healthy environment. A play with the banker in the leading role is a pallid allegory for the extraordinary processes of technological change of the last few centuries. Perhaps this is why Nobel-winning economist Robert Solow once remarked, “Schumpeter is a sort of patron saint in this field. I may be alone in thinking that he should be treated like a patron saint: paraded around one day each year and more or less ignored the rest of the time.”¹⁵ But the core idea seems right: significant innovation requires people to invest effort before reaping returns, and that takes finance. The financial industry is both a locus and a source of economic development.

Is microfinance worthy of the exalted status of hero behind the hero of capitalism? Probably not. If you leaf again through chapter 2, I think you'll see that financial services for the poor do not disrupt the circular flow of a national economy as much as smooth it. Perhaps when reading Schumpeter's depiction of the circular flow, I should have imagined a slum in Peru instead of a town in medieval Italy. To the extent that takers of tiny loans invest in businesses, they largely do so in low-tech subsistence activities, such as retail. They rarely hire or innovate. Yunus may be a Schumpeterian hero, but he is wrong as a practical matter to see himself in his clients.16 Microfinance flows only in the capillaries of the body economic.

A Burgeoning Industry

If the real Schumpeterian success story is about the financial institutions rather than the clients, then finance for microfinance is an example of the transformative power of credit. Those who invest in microfinance are central to its successes and failures, in enriching and disrupting the institutional fabric of nations. As a result, in the by-the-numbers review of the microfinance industry that follows, MFIs and investors are both prominent.

Microfinance Institutions

No doubt about it: the microfinance movement has built some big institutions. The twenty largest microcreditors with data on the Microfinance Information eXchange are shown in table 8-1, going by number of loans. They break roughly into three groups. Clustered at the top are large, established MFIs in Bangladesh and Indonesia whose days of fast expansion are over. (Indeed, ASA and BRAC pulled back in 2009.) Next down are the recent hyper-growers of India, led by SKS. Filling out the list are big MFIs in Africa and Latin America.

The top twenty exhibit a variety of institutional forms. The Grameen Bank and Caja Popular Mexicana, a credit union, are owned primarily or solely by their members. BRI was government owned when it entered microfinance and has since sold a minority of its shares to investors. ASA and BRAC are nonprofits. Notably, fifteen are owned by non-member investors, suggesting that outside finance is the surest way to scale.

Table 8-2 shows the top twenty on voluntary microsavings accounts. BRI looms over all, with more than 21 million accounts. The Bangladeshi big three again join BRI near the top. Below them appear microfinance institutions from many countries and of many legal structures. Notably absent are the big Indian MFIs, which are barred from taking savings.17 Most savings-taking MFIs are regulated to assure that savers' money is handled with care. The exceptions are in Bangladesh and Sri Lanka—though with recent government moves to take control of Grameen, laissez-faire may be coming to an end in Bangladesh.

Table 8-1. Number of Borrowers and Growth Rates, Twenty Largest Lenders of 2009

Source: Author's calculations, based on MIX Market, “Trends for Microfinance Institutions” (j.mp/6bjcLM [March 15, 2011]).

Note: Excludes Postal Savings Bank of China and Vietnam Bank for Social Policies because they do not emphasize financial self-sufficiency. Growth rates taken over up to five years, subject to data availability. Bank Rakyat Indonesia figure is for 2008.

Table 8-2. Number of Voluntary Savings Accounts, Twenty Largest Account Providers, 2009

Source: Author's calculations, based on MIX Market, “Trends for Microfinance Institutions” (j.mp/6bjcLM [March 15, 2011]).

Notes: Excludes the Banco Caja Social Colombia and the Kenya Post Office Savings Bank as institutions that do not emphasize financial self-sufficiency.

a. Includes an unknown number of involuntary accounts, required as part of borrowing. Number of depositors rather than accounts.

b. Number of depositors rather than accounts.

Arguably a truer sign of Schumpeterian transformation than the growth of institutions is the arrival of industries populated in each country by competing players. We saw instances near the end of chapter 5 where competition has pressed MFIs to cut costs, improve and expand services, and even lower interest rates. One study found that heightened competition from conventional banks moving downmarket into microfinance led to dedicated MFIs pushing farther downward, too.18 Within the microfinance industry, competition does appear to be increasing in most countries. One standard measure of industry concentration, often used in anti-trust enforcement, is the Herfindahl-Hirschman index. As in the statistics I presented at the beginning of chapter 5, it is the average market share of a borrower's lender. So if 100 people borrow from Lender A, 100 from B, and 200 from C, then half the loans come from lenders with a 25 percent market share (A and B) and half from one with 50 percent share (Lender C), for an overall average of 37.5 percent. The index reaches 100 percent under monopoly and approaches 0 with a swarm of tiny firms. In most countries with substantial microfinance industries and the necessary data available, the index is below 25 percent, which is equivalent to having at least four big institutions of equal size (see figure 8-1).¹⁹ The major exception in the figure is Kenya, where Equity Bank has grown explosively and without serious rival.

Figure 8-1. Concentration of Microcredit Market Based on Numbers of Borrowers, Selected Countries with Substantial Industries and Necessary Data Available

Source: Calculations by author and Scott Gaul of the Microfinance Information eXchange using underlying data from MIX Market, “Trends for Microfinance Institutions” (j.mp/6bjcLM [January 15, 2010]).

Microfinance being a business, its measure also ought to be taken in financial terms—amounts of money lent as distinct from number of loans made. Here, too, the historical trend is upward. A Geneva-based company called Symbiotics publishes the most detailed data on investible MFIs. Total microloans outstanding of the “SYM 50” group of MFIs climbed steadily from about $1.5 billion at the end of 2005, paused around $4.5 billion after global credit markets froze in late 2008, and then climbed to $5.4 billion by the end of 2010.20

Linking Microfinance to Capital Markets

Modern microfinance began in the nonprofit world, seemingly the antithesis of capitalism. But after Muhammad Yunus and the Grameen Project proved in the early 1980s that microcredit could reach thousands in short order, the movement felt its way toward sustained, commercial-style expansion. The journey to commercial maturity involved three major steps: turning nonprofit institutions into for-profits, building an ecosystem of financial intermediaries to channel capital to them through tailored deals, and issuing standardized securities such as bonds and shares of stock for trading in public markets.

Transforming Institutions from Nonprofit to For-Profit. To open branches, hire staff, and expand client rolls at a steady pace, most MFIs need money up front. They can borrow it, but if they remain nonprofit, they tend to run into two limits. The first has to do with leverage. If a nonprofit with $1 million in cash reserves borrows another million from an aid agency and lends it to poor families, a 10 percent loss on those loans will cost $100,000, a manageable 10 percent of the $1 million reserve. If it borrows and on-lends $10 million, a 10 percent loss will spell bankruptcy. That precious $1 million reserve is the nonprofit's equity, and a ten-to-one debt-equity ratio is dangerously high.

The other limit nonprofits may hit is the willingness of outside investors to lend to institutions subject to little government supervision. Government oversight of banks is meant to prevent overextended credit operations, protect depositors' savings, and guarantee timely and accurate disclosure of the bank's financial situation. When the rules are rickety, as they often are for nonprofit financial institutions, investors may stay away.

Both limits have compelled some nonprofit MFIs to transform into regulated, for-profit financial institutions. For-profits can add to their equity by selling shares to outside investors. These shares entitle investors to a say in management and a fraction of earnings. For MFIs, equity off-loads risk onto investors who are better able to absorb it.

The first transformation of a nonprofit MFI into a for-profit took place in Bolivia in 1992. Five years before, the U.S. Agency for International Development (USAID) and Acción International had helped Bolivian business leaders and philanthropists found Prodem, a nonprofit solidarity group lender. Elisabeth Rhyne of Acción described what throttled Prodem's growth:

Prodem had some access to commercial loans from banks, but these were too limited to maintain its desired rate of expansion. In 1991…. it had a total of $710,000 in commercial loans [, which] covered less than one-third of Prodem's total funding requirement. That year Prodem issued about $2 million in loans each month, expanding its portfolio from $2.4 million to $4.6 million…. Acción International's Bridge Fund, a guarantee mechanism set up with funding from USAID, Ford Foundation, and others, guaranteed repayment of [Prodem's loans from banks]. Without guarantees, Prodem's “collateral” for a loan from a bank was its own loan portfolio, which consisted of unsecured loans that bankers and banking authorities considered too risky to use as security. Moreover, no bank wanted to face the unpleasant possibility of chasing down an NGO whose aim was to lend to the poor and whose owners were not liable for the organization's assets. Unless Prodem were to enter the financial markets as a full-fledged member, it could not hope to gain access to the amounts of finance it would need.21

The idea for transforming Prodem into a commercial bank for the poor was a businessman's. Canadian Martin Connell came into his fortune as a third-generation chief executive of his family's mining company and had engaged with friends in venture capitalism. He empathized with micro-entrepreneurs he met on travels in poor countries. In 1983 he created the Calmeadow Foundation, and, after an encounter with Acción's Jeffrey Ashe, who pioneered solidarity-group lending in Latin America, Connell found a mission in a commercial vision of microfinance.²² He became involved with Prodem and helped persuade its board members and other backers to take the leap to for-profit status.

After several years of planning and studying Bolivian law, Prodem transformed into BancoSol, a for-profit bank. Formally, Prodem gave its loan portfolio to the new legal entity BancoSol. In return, Prodem got a large ownership stake in the for-profit microbank.²³

Initially, BancoSol raised equity capital from mission-driven institutions, including Calmeadow, Acción, and the Inter-American Investment Corporation, an arm of the Washington, D.C.–based Inter-American Development Bank. In their willingness to take risks that profit-oriented investors still shunned, these institutions provided a stepping-stone to commercialization. Since then, other MFIs have grown and transformed in the same way, including Compartamos and some Indian microlenders in table 8-1.

The transformation of nonprofits may have been necessary historically as the pioneers felt their way to capitalism, but perhaps today's MFI founders need not repeat history. If the destination is profit-making, why not just go there directly? That is the philosophy of the German ProCredit Group. Today ProCredit owns banks in twenty-one countries. One of the first began in Bolivia under the name ProCrédito, as recounted in chapter 4, just when Prodem was transforming into BancoSol. ProCrédito, too, began as a nonprofit but transformed in just three years. Most newer ProCredit banks, from Armenia to the Democratic Republic of Congo, have simply started as for-profit financial institutions.²⁴

The Microfinance Investment Bankers. True to Schumpeter's thinking, another sign of the commercialization of microfinance is the increasingly diverse financial ecosystem supplying it with finance. Here, too, the history begins in Bolivia—and yet traces its inspiration back much farther. Connell recounts:

The board meeting of BancoSol in early 1993…. was a positive one. The bank was showing healthy growth in assets and profits, and the feeling coming out of the meeting was energizing and optimistic. Considering that BancoSol had only been open for a little over a year, the small group of board members at the courtyard bar outside the meeting room had reason for a moment of self-congratulation…. What next, we mused?

It was Ernst Brugger who then tossed in his vision of an investment fund that would help create more BancoSols…. Our response was electric and instantaneous—we must do it!²⁵

Brugger was a Swiss who ran FUNDES, a foundation focused on Latin America created by the early visionary of environmentally sustainable business, Stephan Schmidheiny. Today Brugger chairs BlueOrchard, the leading specialist microfinance investment company. Looking back on those early days, Brugger described his inspiration: “It seemed like a good time for that, like Europe in the 19th century, when the sparkassen were first established. I could see that these microfinance institutions were well planned, but they needed strong partners to grow.”26 As a partner, however, a microfinance investor would play a role quite different from that of the municipal governments that backed those old savings banks. Instead of guaranteeing the safety of savings, they would finance loans.

With Connell's support, the world's first microfinance investment vehicle (MIV), ProFund, opened its doors in 1995. The purpose was to demonstrate that microfinance investors could earn respectable returns and eventually get their capital back, or “exit,” by receiving full repayment on loans made or selling outstanding claims to other investors. The plan was to raise funds from noncommercial institutions like those that had invested in BancoSol, purchase equity in Latin MFIs, continue for ten years, then sell all its holdings and shut down. No one knew if it would work. Each investment in an MFI was a novel and complex legal deal. ProFund's director, Alex Silva, had to pound the pavement in search of investors, rather opposite the situation today. ProFund eventually placed $23 million in fourteen MFIs. Some did lose money, especially in dollar terms. Investors in Latin America in 1995–2005 faced fierce headwinds: financial crises in Paraguay and Ecuador; political chaos in Haiti and Venezuela and Bolivia; and depreciating currencies all around that eroded returns in dollars. But enough MFIs did well to earn the fund an average 7 percent a year over the decade. The big gainers were BancoSol, Mibanco in Peru, and Compartamos.²⁷ The return was low for the risk, considering that a super-safe U.S. money market fund earned 4.3 percent annualized over the same time.²⁸ Yet it proved microfinance a serious enough play to attract investors whose risk-return calculus included a “social” bottom line.

As intended, ProFund spawned an industry. At the end of 2009, more than 100 MIVs operated, along with a handful of other funding intermediaries, including ProCredit Holding. The five biggest fund managers together had $3.7 billion in assets and the entire class held $8 billion, nearly 350 times ProFund's capital (see table 8-3). Some MIVs, such as ProFund's younger sister AfriCap, specialize in one region, while others are global. Some stick to debt, many favor equity, and some do both. Most chase the top-tier MFIs that can absorb capital most readily. Others invest in less-established, dicier MFIs, typically sharing ProFund's desire to help young ones mature.

Table 8-3. Top Microfinance Asset Managers, End-2009

Source: Reille and others (2011).

As a group, MIVs appear to be doing roughly as well as ProFund did. The Symbiotics “SMX” index, which tracks the performance of a group of MIVs mostly investing in debt, returned 34.1 percent over 2004–10, equivalent to 4.3 percent a year with compounding. That is 2.4 percentage points above the U.S. dollar money market return during the period, a bit less than ProFund's margin of 3.7 points. Earnings in terms of the euro were lower because it climbed against the dollar (see figure 8-2). Performance was poor in 2009–10; it remains to be seen whether this was a transient consequence of the global financial crisis or the arrival of a new era in which a capital glut depresses earnings.²⁹

Issuing Securities. The final step to the capital markets has been for MFIs to issue securities, transferable promises to pay out money to the holder under specified conditions. These have been of two main kinds. One is modern and complex, yet familiar for its role in creating housing bubbles: the securitized loan. In their details, loan securitizations are 100 times more intricate than I could convey in a paragraph. At base, MFIs sell microloans on their books—IOUs of poor people—to investors. The MFIs get cash now and the investors get future cash flow. The MFIs continue to collect debt service on those bundled loans, keep much of it to cover costs, and pass the remainder to investors. Meanwhile, having increased their reserves, MFIs are free to make more loans—and sell those, too, in a continuing cycle. In the hands of financial engineers, loan-backed securities can take many forms. Repayment flows can be split into principle and interest or junior and senior tranches, the junior ones taking the hit first from partial defaults. Another wrinkle: donor agencies have often guaranteed some or all of the promised payments in order to nurture such innovation and support microfinance.

Figure 8-2. Performance of Symbiotics Microfinance Index in Dollar Terms, 2004–10

Source: www.syminvest.com.

The first microfinance securitizations took place in 2006. In May of that year, ProCredit Bank Bulgaria sold ü48 million of its loans to institutional investors. A few months later BRAC created a structure through which it is selling $180 million in loans over six years. They are denominated in Bangladesh's currency, the taka, so foreign investors rather than BRAC bear the risk that the MFI's home currency will lose value.³⁰ Securitizations have become most popular in India.

The guarantors and investors in microcredit securitizations are taking on more risk than it would seem at first. Daniel Rozas, a microfinance industry analyst, has shown that when an MFI goes bankrupt, its loan portfolio tends to disintegrate. People stop repaying current loans if they think it won't help them get access to future ones, as it wouldn't if the MFI goes defunct.31 Contrast that with mainstream finance, where a bank can collapse yet sell off its loans at 100 cents on the dollar. That happened to me once, in a way: in the bubbly days of the U.S. mortgage market, a hot Internet-based lender called DeepGreen gave me a home equity line of credit with a great interest rate—maybe too great because not long after the company went under. It sold my loan, at a price that I assume reflected my good credit history and adequate collateral, to PNC Bank. I had never met PNC before but kept paying the interest so as to keep my home. But imagine how quizzically a Peruvian slum dweller would gaze upon a loan officer from Microcreditor B who showed up at the door asking for the payments on her loan from Microcreditor A. Microcredit's “collateral” cannot be repossessed. It is embedded in relationships built over time among borrowers and loan officers. Thus microcredit portfolios are like sand castles: they can be large and elaborate, but without constant maintenance, they can quickly fall apart. And they are very hard to transport from lender to lender. In the language of finance, securitized microcredit loans contain equity risk because their value remains tied to that of the issuer.

The class of microfinance security is traditional: bonds and stocks. One important, early issuance in this category came in 2004 when Compartamos borrowed 500 million Mexican pesos by selling bonds. Because of doubts about whether investors would risk lending to a young business in a commercially unproven industry, the World Bank's International Finance Corporation (IFC) partially guaranteed Compartamos's payments to bondholders.³² Five years later, the Mexican MFI had earned enough investor confidence to issue 1.5 billion pesos in bonds without an IFC assist.³³

Stock issuances have occurred less often, served different ends, and generated more controversy. To date, flotations have mostly not raised capital for MFIs.³⁴ Rather, they have allowed existing owners to exit, selling what was once their private equity to the public, often at great profit. In 2003, the century-old, government-owned BRI became the first publicly traded MFI after the government sold 30 percent of its stake on the national stock exchange.35 The IPO of Kenya's Equity Bank in 2006 arguably matters more historically because it was the first debut of a young modern-wave MFI on a public stock market. For AfriCap, the African ProFund equivalent, the IPO and subsequent run-up turned $1.6 million into $32 million.³⁶

Two other IPOs have strained the microfinance movement like nothing else in its history. The first came in 2007: Compartamos went public. Acción, the IFC, and other early investors sold 30 percent of the company, together earning $450 million for stakes that had cost $6 million.³⁷ The founding co-CEOs of Compartamos became the “first microfinance millionaires,” in the words of Morgan Stanley's Ian Callaghan.³⁸ The fortunes made by charging the poor 100 percent interest reignited ancient debates over usury, as noted in chapter 7. Compartamos defended the sale as helping the microfinance industry mature and grow: its profits would attract competition in Mexico.³⁹ Acción said that it wanted to exit the bank in order to invest its gains ($135 million) in younger institutions in poorer places.⁴⁰

Although the event was explosive within the international movement, it was never that controversial within Mexico, and the country's microcredit industry continues to grow apace. In contrast, the 2010 IPO of SKS in India, also introduced in chapter 7, triggered a domestic backlash that has brought the industry to its knees there. That flotation earned founder Vikram Akula and famed venture capitalist Vinod Khosla more than $80 million each, at least at peak stock prices.⁴¹ No one had ever made anything close to such sums by banking the world's poor. Investors paid so dearly for the shares because of SKS's track record of rapid growth, its streamlined operating methods, and the vast Indian market still untapped. But on October 14, 2010, amid a media drumbeat about microcredit-induced suicides, the government of Andhra Pradesh ambushed the industry with a law that essentially shut it down in the state. Andhra Pradesh was India's microcredit hotbed, with 6.2 million of the country's 29 million microloans and $1.2 billion of $3.9 billion in outstanding amounts.⁴² The MFIs, their creditors, and their investors will probably have to write off most of that $1.2 billion. We'll come back to that story later in this chapter.

Table 8-4. Cross-Border Financing for Microfinance, by Destination, 2009

Source: CGAP (2010b).

Notes: “Net new commitments” include exchange rate effects. For donors, “commitments” are funds committed to active microfinance projects, whether or not disbursed, whenever disbursed. Outstanding funds to projects now considered inactive are not counted. For investors, “commitments” include all funds placed. Loans are counted in full until repaid in full.

Investment Flows

As financial channels proliferated—MIVs, private equity, loan securitizations, bonds, IPOs'the funds flowing through them swelled. CGAP calculates that at the end of 2009, donors and international investors had poured at least $21.3 billion cumulatively into microfinance institutions, an increase of $3.0 billion from twelve months earlier. In dollar terms, most of the new investment went into Eastern Europe, Central Asia, and Latin America (see table 8-4).⁴³

Historically, nearly all this foreign investment has come from institutions and individuals with social missions (see table 8-5). Traditional donor agencies, including USAID and Germany's Gesellschaft für Technische Zusammenarbeit, accounted for 7 percent of the cumulative end-2009 total. International agencies, including the parts of the World Bank that lend to governments, held 20 percent. Foundations and other private donors had 5 percent. “Development finance institutions,” which are agencies that invest public money in the private sector, made up the largest category, at 42 percent of outstanding funds. That left just 26 percent in the hands of private investors, probably most of whom invest in pursuit of the “double bottom line” of modest profit and social betterment. They include Khosla, New Zealand billionaire Christopher Chandler, who bought a controlling stake in India's SHARE Microfin for $25 million in 2007, and Kiva, the website that lets users lend as little as $25.44

Table 8-5. Cross-Border Financing for Microfinance, by Source Type, 2009

Source: CGAP (2010b).

Notes: “Net new commitments” include exchange rate effects. For donors, “commitments” are funds committed to active microfinance projects, whether or not disbursed, whenever disbursed. Outstanding funds to projects now considered inactive are not counted. For investors, “commitments” include all funds placed. Loans are counted in full until repaid in full.

The numbers in table 8-5 suggest that the hand-off from public to private investors long envisioned by the proponents of commercialization is occurring. In 2009, probably for the first time, net flows from private investors exceeded those from public, in a 51–49 ratio. In fact, aid agencies, as distinct from official agencies that invest in the private sector, divested on net in 2009. Meanwhile, of the 51 percent private share, 43 percent came from individual and institutional investors, as distinct from charitable donors.

MFIs also raise capital from investors at home, though little is known about how much. Good numbers are available for India and deserve mention because they are large enough to be globally significant. A long-standing Indian policy of “priority-sector” lending requires domestic banks to devote 40 percent of their credit (and foreign banks 32 percent) to certain groups, such as self-employed people; certain activities, such as agriculture; or certain financial channels, including MFIs and self-help groups (SHGs).45 The lending to microfinance has been small within the priority-sector lending landscape but large from the point of view of the microfinance industry, in which it fueled fast growth. As of March 31, 2010, loans to MFIs totaled at least 138 billion rupees ($3.1 billion). Those to SHGs were 272.66 billion rupees ($6.1 billion).⁴⁶ It is this easy access to credit that so tantalized venture capitalists. Every rupee they put into an MFI could easily leverage 5–8 rupees in bank loans.⁴⁷ All the profit from those loans went to the equity investors.

When Is Creative Destruction More Creative than Destructive?

Besides the commercialization of microfinance, I can think of only two comparable instances where philanthropy and foreign aid have helped develop a global industry and a supporting financial ecosystem in order to serve poor people: the savings bank and credit cooperative movements of the nineteenth century (see chapter 3). It seems a constant of history that the poor need financial services, are willing to pay for them, and yet are underserved by reliable institutions. Foreign aid and philanthropy have catalyzed industrial flowerings that respond to the need.

Still, especially in the wake of the debacle in Andhra Pradesh, it is impossible not to question the hot trend of microfinance. Is the commercialization of microfinance, with its promise to bring reliable services to billions, a dangerous capitalist fantasy? Is it'to use an epithet popular among British intellectuals—destructively neoliberal?⁴⁸ As with so much in microfinance, the truth is ambiguous.

To organize our thinking about this question, this section offers two framing ideas. Both are inspired by ecology. The first is the distinction between growth and development. The second is about the value of linking microfinance institutions to their environment in multiple ways.

Herd Mentality

Jutting out of the Bering Sea halfway between mainland Alaska and Siberia is St. Matthew Island, a 30-mile-long landscape of rolling hills, subarctic tundra, freshwater lakes, and dizzying cliffs where seabirds nest.49 The island's isolation and harsh winters have prevented Westerners from permanently settling it. In 1944, the U.S. Coast Guard installed a radio beacon on the island as part of an advanced navigation system for pilots at air and sea called LORAN. It was the GPS of its day. Along with the equipment, nineteen cooks, medics, engineers, and other personnel were stationed on the island. For an emergency back-up food source, the Coast Guard also shipped in twenty-nine reindeer and loosed them to browse on the isle's thick mats of lichen. But World War II soon ended and the men left. The reindeer stayed behind, on what science writer Ned Rozell described as an “ungulate paradise.” Over the next twenty years, the animals fattened off the land and, free of predators, multiplied into the thousands. In a famous research paper, U.S. government biologist David Klein captioned a 1957 photograph of four bulls with a comment on their health: “Note the rounded body contours and enlarged antler size.”⁵⁰ Recalling an expedition to study the herd in 1963, Klein said, “We counted 6,000 of them. They were really hammering the lichens.”⁵¹

But then the paradise became a purgatory. In Rozell's words:

[Klein] heard a startling report from men on a Coast Guard cutter who had gone ashore to hunt reindeer in August 1965'the men had seen dozens of bleached reindeer skeletons scattered over the tundra. When Klein returned in the summer of 1966, he, another biologist and a botanist found the island covered with skeletons; they counted only 42 live reindeer, no fawns, 41 females and one male with abnormal antlers that probably wasn't able to reproduce. During a few months, the reindeer population of St. Matthew had dropped by 99 percent.⁵²

In his research paper, Klein concluded that dwindling food supply, with an assist from an extreme winter in 1963–64, doomed the herd.53 Storms in February brought wind gusts as high as 63 miles per hour (101 kilometers per hour) and sustained wind chills below –40°F (–40°C) for days on end. The state of development of fetal skeletons, found nestled within the skeletons of their mothers, dated the die-off to that same month.⁵⁴

Although the severe weather magnified the effect, the rise and fall of the reindeer of St. Matthew Island is a classic illustration of the idea of overshoot. In the beginning, a positive feedback loop generated fast growth: the more reindeer there were, the more fawns were born each year. Then a negative feedback loop kicked in: the more animals, the less food per animal, and the less ability to survive and reproduce. If the population somehow could have gauged and adjusted to its distance from the maximum sustainable population level—as pregnant rabbits can by reabsorbing embryos—then the herd might have coasted smoothly to that limit. The upper left of figure 8-3 shows a simulation of this ideal, marking the sustainable level as 100. The rate of increase at any point along the curve relates to two factors: current population and distance from the sustainable level of 100 (“headroom”).⁵⁵ Increasing the number of fawns per litter in the simulation causes faster growth (upper right of the figure), and the population slams into, but still remains within, the ecological limit.

But on St. Matthew Island, feedback about limits arrived late. This is simulated in the diagrams by making growth at any given time depend on headroom in the past rather than the present. It turns out that when litters are small—when the growth drive is low—the feedback lag does no harm, because headroom in the recent past nearly matches headroom now. Information is accurate, and the herd still coasts to equilibrium (lower left). But if the drive for growth is high and information about limits is delayed, the population repeatedly overshoots and collapses (lower right). In the abstract example in the figure, even without savage blizzards, the population plunges 79 percent, from 188 to 39.

This is why ecological economists have long distinguished between growth and development. Herman Daly, eminent in the field, explains, “To develop means ‘to expand or realize the potentialities of; to bring gradually to a fuller, greater, or better state.’ When something grows it gets bigger. When something develops it gets different. The earth ecosystem develops (evolves), but does not grow. Its subsystem, the economy, must eventually stop growing, but can continue to develop.”56

Figure 8-3. How Fast Growth and Delayed Feedback about Limits Cause Overshoot

Source: All panes plot with x_t = 1 for t ≤ 0, g = 1 for slow growth and 10 for high growth, L = 0 for no delay and 15 for delay.

Growth can constitute development, making it worthy of the label “healthy growth.” Children should grow as they develop; those who do not have developmental problems. The growth of the mobile phone industry in poor countries also seems developmental. In that case, development first occurred within the industry as entrepreneurs solved technological and business problems, thus becoming more sophisticated about how to do their jobs. Then, by scaling up and creating new possibilities for connection, the industry brought development to society as a whole.

But growth can be unhealthy beyond certain bounds: think of those reindeer, the childhood obesity epidemic in the United States, and the expanding appetite for coal and oil that is causing climate change. Daly calls this uneconomic growth. “Growth for the sake of growth,” declared eco-radical Edward Abbey, “is the ideology of the cancer cell.”57 In fact, what we usually refer to as economic development consists of both development and growth as Daly means the words. It involves both increasing complexity and expanding economic activity. The expansion has occurred above all in the amount of energy consumed, and while it has literally fueled much development, it is overrunning ecological bounds, making it partly uneconomic.

Daly's homily on growth and development puts microfinance in an interesting light. Microfinance certainly has grown. To what extent is it leading to development, in the sense of complexification, within the industry and beyond? After all, it is always dangerous to push loans. Think of microcredit as you read this quote from economist John Kenneth Galbraith on herd mentality in finance:

In all speculative episodes there is always an element of pride in discovering what is seemingly new and greatly rewarding in the way of financial instrument or investment opportunity. The individual or institution that does so is thought to be wonderfully ahead of the mob. This insight is then confirmed as others rush to exploit their own, only slightly later vision….

As to new financial instruments, however, experience establishes a firm rule…. that financial operations do not lend themselves to innovation. What is recurrently so described and celebrated is, without exception, a small variation on an established design, one that owes its distinctive character to the…brevity of the financial memory…. All financial innovation involves, in one form or another, the creation of debt secured in great or less adequacy by real assets…. All crises have involved debt that, in one fashion or another, has become dangerously out of scale in relation to the underlying means of payment.⁵⁸

To connect this with the lessons of figure 8-3, a financial market overshoots when information about its “scale in relation to the underlying means of payment” is unavailable or unheeded and when its drive for growth is aggressive. Neither ingredient alone is necessarily destructive.

But both have been abundant in microcredit. As for the first, the ample investment flowing into the industry has fueled fast growth. The social motivation behind this capital adds to the danger by dulling business sensibilities. And once aggressive lending starts at one MFI, it is contagious within a country. Initially conservative managers abandon caution in order to keep up with their peers. And they find that the easiest way to recruit new customers is to offer microloans to people who already have them. Such people understand how microcredit works—and might want a new loan to pay off an old one. Yet sustainable lending calls for a delicate balance of risk taking and conservatism. To maintain that balance, MFI managers need training programs for new workers, pay formulas that do not overly reward disbursement, and internal data systems for tracking portfolio health. All take time to build and refine.59 Growth that outpaces this internal development is the growth of a weed tree. As one MFI manager in Bosnia rued, “We were focused on competing instead of building our capacity.”⁶⁰

The other crisis-inducing ingredient is a lack of robust ways to judge whether clients can handle the debts they have contracted. Multiple microcredit borrowing is fine within bounds. Out of conservatism, each microlender may impose a rigid repayment schedule and give less credit than people need and can handle. By overlapping loans from several sources, borrowers can blend the individually rigid loan schedules to meet their needs.⁶¹ But especially when lending is growing fast, it is hard for clients to judge when credit has become too much of a good thing. The classic solution is for microlenders to share information, such as through a credit bureau. But many poor countries lack effective credit bureaus that cover poor people.

This problem is especially rampant when MFIs lend through groups. When Yunus and his students devised their form of solidarity lending, when Ashe and his staff did the same in the Dominican Republic, and when John Hatch and his associates devised village banking, their clients had no comparable alternatives. Recall from chapter 5 that group microcredit cuts costs by offloading onto clients the tasks of selecting and monitoring each other. Thus the financial health of group microcreditors depends on the judgment of their borrowers. It is unclear whether that judgment remains reliable as multiple borrowing becomes the norm. One can imagine that much as mortgages with teaser rates became common in some American communities, multiple borrowing becomes dangerously normal in a microcredit-saturated milieu. Everyone accepts multiple borrowing for no better reason than that everyone does it.

As with banking generally, the history of microcredit is sprinkled with implosions. And as with banking generally, while all have been regrettable, none has been fatal. Bolivian microcredit experienced an early instance in 1999. As mentioned in chapter 7, years of rapid microcredit expansion had attracted an aggressive new breed of consumer lender that helped people with salaries buy goods such as televisions. Elisabeth Rhyne described the dynamic:

Poaching clients from other institutions through the offer of larger loans has proven to be an extremely successful marketing technique in Bolivia, as elsewhere. And it has been shown repeatedly that clients are not good judges of their own debt capacity. Apparently credit is like good food: when seated at the table in front of a feast, many people eat too much and regret it later…. The truly unfortunate dynamic is that if over-lenders are successful at luring clients away from more responsible lenders, the responsible lenders are virtually forced to follow suit. The pressure to lend more to keep good clients is nearly as irresistible as the client's desire to borrow more. Worse, if clients begin using one loan to pay off another, the game becomes…. “Who collects first?” In short, the sector as a whole starts to become one big Ponzi scheme.⁶²

The good news is that the Bolivian microcredit industry survived the crisis, the wiser and stronger for it. One key improvement was a credit bureau. Lenders who had resisted sharing information about their clients agreed to do so in order to get a fuller picture of each borrower's debts.⁶³ Daly has written about the need to move from an “empty world” mentality that treats natural resources as inexhaustible to a “full world” one that accepts limits.⁶⁴ In effect, the creditors in Bolivia recognized that their ways of doing business, which were developed in an empty world, had to be adapted to the full world of a mature microcredit market. They needed better feedback about how close they were to their clients' borrowing limits. So do microcreditors in other countries.

Connections

When does microfinance enrich the economy? When we think of an economy as an island ecosystem and microfinance as a species within it, the growth–development distinction provides a partial answer. But the focus on scale is rather one-dimensional. The ecological metaphor can be plumbed for a richer understanding of the potential constructive role of microfinance. We can say more generally that a species enriches its ecosystem when it links to other species in diverse ways, such as through competition, predation, and symbiosis. By the same token, a financial institution contributes the most to its host economy when it links to other economic actors in diverse ways. Notice that the Bolivian microcreditors survived the crisis by linking more strongly to each other, in sharing information. Multiple ties add resilience and stability to the financial industry and to the economy as a whole.

This might seem like fuzzy analogizing. But it is precisely the propensity to connect that puts financial services at the heart of economic development. Each loan, savings account, and insurance policy is a link between two or more parties. The more such threads an MFI spins, the greater its contribution to the economic fabric. With some services, such as money transfers and checking accounts, the connective nature is explicit. With others, interconnection seems to arise as a side effect, as when banks use the funds of savers to finance borrowers. Historically, just as the invention of movable-type printing accelerated the flow of information and ideas, the rising sophistication of financial institutions accelerated the circulation of two other intangibles—purchasing power and risk—opening the way for industrialization and affluence. Today, an industrial country's financial system includes banks, brokers, insurers, regulators, credit bureaus, bond raters, mutual fund companies, stock and bond exchanges, and a bevy of other institutions. After the international financial crisis, you might smirk at such enthusiasm for the wonders of the financial system. But the credit market freeze-up was aptly compared to a heart attack. After wars, natural disasters, and epidemics, nothing does more economic damage than a financial crisis.65 In the long run, a healthy financial system helps keep the rest of the body economic healthy.

Ross Levine, an economist at Brown University, counts five ways that a financial system connects to and supports economic development.⁶⁶ First, it mobilizes savings. Every economy has people who have saved more than they want to invest in their own businesses and people who have good ways to invest more than they have saved. Often, the investors need large sums over the long term, while savers individually offer small amounts and want the option to withdraw on short notice. Banks, stock and bond markets, investment funds, and brokers bring savers and investors together to mutual advantage, providing companies with patient capital while promising savers liquidity to the degree they need. Walter Bagehot, who edited The Economist early in its history, wrote about this process. He observed the fluidity with which London bankers and brokers issued and bought bonds to finance seafaring traders and American steel plants. He asserted that Lombard Street, the locus of these dealings, was a key to British economic dominance: “A million in the hands of a single banker is a great power; he can at once lend it where he will, and borrowers can come to him, because they know or believe that he has it. But the same sum scattered in tens and fifties through a whole nation is no power at all: no one knows where to find it or whom to ask for it.”67

Levine enumerates two other functions closely related to savings mobilization: allocating capital and holding the users of capital accountable. Bankers do not mechanically disburse the savings they mobilize; rather they check credit histories, scrutinize investment proposals, analyze market risks. They serve the economy by channeling capital to where it ideally will produce more value. Meanwhile, the arm's-length split between the providers and users of capital increases accountability. Investors' demands for upright accounting and proactive management prod companies toward efficiency and innovation.

Fourth, just as the financial system pools savings, it pools risk, in part for the same reason: to move that which is pooled to those who can manage it better. A deep-pocketed insurance company, for example, can absorb the $100,000 shock of a cancer diagnosis more easily than a middle-class family, so it makes sense for the family to pay the company to take the risk. Even better, pooled risks sometimes cancel out. To an actuary, an insurance company's commitment to cover cancer risks for a million people might be costly but is not risky: the number of claims submitted each year is predictable. By the same token, mutual funds allow even small investors to reduce risk through diversification, letting them buy fractions of a thousand companies with a thousand dollars. Diversification hardly eliminates the risk of investing in the market, but it reduces it and thereby makes it easier for all companies to attract capital.

Finally, through electronic transfers, paper checks, trade credit, and currency and commodity exchanges, a financial system lubricates commerce. The easier it is for companies to buy in the market what they do not make themselves, the more they can specialize. And division of labor, as Adam Smith famously observed of a pin factory, raises productivity.

Financial systems often perform these five functions poorly. They are unruly, bedeviled by the unpredictable interplay of greed and fear, faith and doubt, fads and contrarianism. Complete government control of banks and elimination of financial markets might squelch these worst tendencies—but at the cost of market discipline over who gets finance. So in most countries, the financial system is an awkward and flawed mix of public and private players.

The microfinance industry will probably never play a central role in the transformative economic processes that increase productivity, create jobs, and lift people from poverty. But the example set by the mainstream financial system is, broadly, the one to follow: microfinance institutions will contribute most to economic development when they become full intermediaries, taking funds from some locals and placing them with others. The more diversely they connect to their context, the more they will help the economy move “gradually to a fuller, greater, or better state.” And the more the potential extremes of their behavior will be checked. This means taking capital from investors at home as well as abroad. It means taking savings. It can even mean channeling microsavings into loans for entrepreneurs a step or so up the economic ladder—who might hire the savers.68 “Long evidence (even back to 16th century Europe),” observes microfinance expert Marguerite Robinson, “indicates that financial intermediaries are more stable, profitable, and sustainable than credit-focused organizations.”⁶⁹ The historical pattern seems to hold for microfinance. Not least because of regulatory oversight, companies are more cautious when they on-lend the savings of the poor than when they on-lend funds from rich social investors from the other side of the world.

Emulating mainstream finance in its propensity to connect also means moving into the money transfer business. For example, in the market of Kisumu, Kenya, on Lake Victoria, I saw stall owners using the mobile money system M-PESA to pay for long-distance shipments of goods. By providing a safer way to make cross-country payments, it was reducing the frictions of domestic trade. More precisely, by democratizing access to a service formerly available only to the elite, it was allowing poorer people to engage in trade. Given the role that trade has played in economic history, this unexpected effect of mobile money seems profound.70

Recent Travails of Microcredit

After years of steady expansion and good press, microcredit ran into serious trouble in a handful of countries in 2009 and 2010. The exact circumstances differ by country, but a common and most likely essential thread can be discerned: fast, credit-dominated growth. In general, the growth was driven by a mix of motives. The pursuit of profit was one, especially in India, where MFIs brought in private-equity investors looking for high returns. But as we have already seen, most of the investment in microcredit has been socially motivated. Profit has not been the main lure. Thus these bursting bubbles may be the first in history filled more by generosity than greed.

This section reviews a sampling of these events in order to illustrate the difference between growth and development and the value of multiplying connections.

Before the debacle in India, in 2008–09, the microcredit industries in Bosnia, Morocco, Nicaragua, and Pakistan all crashed.⁷¹ According to a CGAP review, typically 30–40 percent of active microcredit borrowers had more than one loan in these nations (or in Pakistan, in certain districts), which meant that multiple borrowers accounted for the majority of loans. Yet until early 2008, all seemed well, going by the numbers. One standard measure of loan portfolio health is the portfolio at risk over 30 days (PAR 30)'the share of outstanding loan amounts owed by people at least 30 days delinquent. PAR 30 stood at a tranquil 3 percent in Nicaragua and 2 percent in the rest. Yet eighteen months later PAR 30 had shot up. Most of the increases took place in the first half of 2009 (see table 8-6).⁷² As figure 8-4 shows, by the end of 2009, microcredit portfolios had shrunk in Bosnia, Nicaragua, and Morocco, somewhat reminiscent of the overshoot and crash in the herd simulations in figure 8-3. Comparable data were not available for Pakistan.

The CGAP report cited three common causes, all symptoms of fast growth combined with an inability to detect and respond to information about how much more credit borrowers could safely handle: “concentrated market competition and multiple borrowing,” “overstretched MFI [management] systems and controls,” and “erosion of MFI lending discipline.”73 The clients' ability to handle debt is an external limit MFIs must stay within, but they also face an internal one: the ability to blend incentives and oversight to keep lending on an even keel. Since quality of management matters, there is no universal speed limit for MFI expansion.

Table 8-6. Anatomy of Four Microcredit Crises

Source: Chen, Rasmussen, and Reille (2010).

a. Crisis districts.

Bosnia and Herzegovina

After peace was achieved in Bosnia and Herzegovina in 1995, western agencies funded the creation of several MFIs that emphasized individual loans for small businesses. Loans at ProCredit's bank, the first to enter, quintupled in total value between 2001 and 2007. EKI, an affiliate of the American NGO World Vision, grew by a factor of eighteen in the same years, and Mercy Corps's bank, called Partner, expanded twenty-fold.⁷⁴ Then the bubble burst. Al Jazeera reported:

In pursuit of commercial scale and personal gain, microfinance lenders issued more loans than ever, expanding their loan book and earning the loan officer involved a personal commission.

These loans were increasingly spent by borrowers on consumer goods rather than the modest business assets for which they were intended. Rather than equip a hairdresser, buy a van or a cow, they now more often than not went on weddings, cars or TVs.

Figure 8-4. Total Value of Outstanding Microloans in Bosnia, Morocco, and Nicaragua

Source: Author's estimates, based on MIX Market, “Trends for Microfinance Institutions” (j.mp/4RMKJj [March 15, 2011]).

 

“The clients were aware that there are many microfinance lenders offering loans and wherever they could go they could get it. They were attracted by the possibilities and rushed into it without thinking,” says [Selma Cizmic of the nonprofit MFI LIDER].75

Recently, the European Union and the World Bank's IFC injected new funds to prop up some of the struggling MFIs.⁷⁶

India

In the first draft of this book, I described India as being on everyone's watch list. In late 2010, it came off the list. The drama in Andhra Pradesh state has been an ambiguous interplay of growth, competition, ideology, and politics. Thanks to ample finance from investors of various stripes—public and private, profit and nonprofit, domestic and foreign'the state's MFIs and SHG programs posted nearly unprecedented growth numbers in recent years (table 8-1). In Andhra Pradesh, multiple borrowing became common because MFIs found it easier to shadow their peers, starting groups where people were already familiar with microcredit, than to strike into virgin territory.77 In fact, MFIs reportedly piggybacked on each other's organizing efforts, making loans to groups formed by their competitors or, in the case of SHGs, doing the same after breaking the SHGs into smaller groups.

Yet if MFIs were eager to hand out money, they remained true to their organizational character when it came to getting it back. Smooth, quick weekly meetings remained essential to efficiency. Delinquency was dealt with swiftly lest it spread. This appears to have had two fateful consequences. First, stories began to emerge in the local papers and television channels of people hounded by loan officers to the point of suicide. The truth seemed murky. Some media outlets had ties to politicians who spied an opportunity for electoral gain by pinning responsibility on their opponents. Farmer suicides are nothing new in India, sadly. And people so desperately in debt as to end their lives typically owe to many kinds of creditors, including friends, family, and moneylenders. Yet after visiting the state in November 2010, a month after the government all but shut down microcredit there, I became convinced of the broad plausibility of a microcredit–suicide link. As noted in chapter 7's section on multiple borrowing, microcredit is distinguished among sources of finance available to the poor in its rigidity—its persistent demand for on-time payment; this insistence can lead to a triggering event for suicide, such as a humiliating public hectoring by a loan officer.

The second fateful consequence of aggressive collection on the part of private MFIs was the unraveling of government-backed self-help groups. As also noted in chapter 7, SHGs are culturally more elastic and less aggressive about loan collection. Thus when cornered by loan officers from both directions, women would default on SHGs first. The managers of the SHG program watched as their funds leaked into the coffers of for-profit MFIs. Combined with the record windfall from the IPO of SKS Microfinance and the suicide stories, the unraveling of SHGs became intolerable. These same managers wrote the law enacted in the fall of 2010 to rein in MFIs.⁷⁸ The explicit purpose of the law was to protect SHGs, which were “being exploited by private [MFIs] through usurious interest rates and coercive means of recovery resulting in their impoverishment & in some cases leading to suicides.”⁷⁹ As the leader of commercial microfinance in India and the chairman of BASIX, Vijay Mahajan, put it to me, the government became both a player and a referee.80

But while assailing the crackdown as a biased overreaction, Mahajan was quick to say that it overreacted to a real problem. In chapter 7, I told of meeting with women in a village west of Hyderabad, the capital of Andhra Pradesh, where the number of MFIs had jumped from two to five. I also told of hearing about villages where MFIs became so numerous that they ran out of days of the week on which to hold meetings. It was not hard to see how the sudden influx of credit would get some people in trouble. Such destructive and self-destructive growth was the opposite of development as industry building. As Graham Wright, India office head for the research firm MicroSave, had warned a year before:

The poor have moved from having no access to credit (except from extortionate moneylenders) to being able to access loans from 3–4 MFIs at the same time. This change has occurred in the space of 2–3 years. It might be that the poor took loans from as many MFIs as were offering them, because they were available, without really understanding the implications of having to repay all these loans and the stress that this would incur in the lean season. In their pursuit of growth, MFIs' staff do little or no due diligence and simply leave this to the groups. They should have found out about the existing debt burden of the borrowers.⁸¹

At an industry conference weeks after the Andhra Pradesh law was enacted, there was an eerie sense of the walking dead. Almost no one had anything good to say about India's commercial microfinance industry. Most quietly wondered whether some of India's biggest MFIs, with high exposure in Andhra Pradesh and small equity cushions to absorb losses, would go under. A couple of weeks later, Vineet Rai, a prominent social investor in microfinance, declared, “No logical person would invest in microfinance right now, because there is no microfinance right now.”⁸²

Although the Andhra Pradesh microcredit industry did not simply pop under its own weight like a classic bubble would, the overshoot-and-collapse paradigm captures aspects of what happened. Much less obvious is that the other ecological pattern I offered earlier—enrichment through connection—does, too. In an insightful analysis, Elisabeth Rhyne explains:

Although large MFIs were allowed to convert from non-profits to commercial institutions, they were not licensed to take deposits, in part because they would have become competitors to the public sector banks. Deposit-taking, properly supervised, would have allowed the MFIs to raise funds locally, both from clients and others in their neighborhoods. It would have created a balanced portfolio of products and revenue sources, rather than exclusive reliance on the micro-loan mono-product. Instead of unbalanced mono-product giants, MFIs like SKS might have grown up to look more like Mibanco in Peru, Equity Bank in Kenya or BRI in Indonesia, all with solid loan and deposit bases. When clients have a place to save (and banks have an interest in promoting savings) they may be less likely to fall into debt traps.83

In addition, Rhyne points out that unlike in Bolivia, where the nonprofit Prodem became a major shareholder of its for-profit offshoot BancoSol, Indian law barred nonprofits from holding stakes in for-profits. The original nonprofit SKS, for example, got no shares or board seats on the for-profit SKS. If that connection had not been severed, it might have tempered the pressure from venture capitalists on the board to hit short-term growth targets so they could sell their shares at a high price through an IPO.⁸⁴

Nicaragua

Industry consultant Barbara Magnoni gives a glimpse of the story in Nicaragua:

At [a conference] in El Salvador in 2007, I knew there was a bubble as I watched investment funds competing to get face time with a number of Nicaraguan MFIs. Already, the market had grown substantially since 2004; Findesa (now Banex) had a loan portfolio of US$125 million, up from US$33 million at the end of 2004. I wondered why it made sense to lend to so many small MFIs in one country with 5 million people, 600,000 informal sector workers and 300,000 credit clients….

I visited Findesa later that year in Managua and asked the CFO what the institutions' main competitive advantage was. His answer reinforced my fears. He said, “We are very good at raising money from foreign investors.” Debt financing was clearly flowing to Nicaragua, with high profile, fast growing institutions like Findesa bringing in the bulk of the money; yet how would these MFIs' loan portfolios grow? Mostly, by trying to compete for each other's clients, ultimately adding to the clients' debt burdens. Implicit in this strategy is a loosening of credit methodology.85

A borrower's revolt soon gelled in Nicaragua, the Movimiento de No Pago (“No-Pay Movement”). President Daniel Ortega backed it. BANEX eventually succumbed, declaring bankruptcy in 2010. ProCredit's bank survived, if wounded, perhaps thanks to the financial reserves of its parent company. So did MFIs that had expanded more conservatively.⁸⁶

Pakistan

As late as June 17, 2008, prospects looked sunny for the Kashf Foundation, a major microlender in Pakistan. On that day, the Japan Credit Rating Agency issued an upbeat analysis: “While maintaining controls and asset quality against the backdrop of rapid growth is critical, KF is considered to be well poised to take on this challenge in view of its tested lending methodology and tailor-made software which ensures effective monitoring.”⁸⁷

The number of outstanding loans had increased tenfold during 2003–07, from 29,655 to 295,396. But by the end of 2008, Kashf recognized a shocking 22 percent of its loan portfolio as at risk. It set aside $15 million, more than a third of the start-of-year portfolio, for write-offs. But it was not forthcoming about its financial fiasco.⁸⁸ Its 2008 annual report admitted the truth only where it could not be avoided, in a few key lines of the income statement. An independent report from the Pakistan Microfinance Network revealed more but shied away from mentioning Kashf or other MFIs by name: “[MFIs'] internal controls lagged expansion: Because of pressure on staff for quick outreach, coupled with multiple responsibilities of loan officers, inadequate staff incentive systems, and weak internal monitoring and control systems, some microfinance loan officers across various key [MFIs] appeared to be short-circuiting operational procedures and risk control systems.”89 Laxity opened the way for blatant abuses:

Group leaders and activists get an opportunity to turn into commission agents primarily because the [MFI] staff, lending through solidarity groups, tend to delegate [a] significant portion of their client selection responsibility to group leaders or activists. Having a de facto power to accept or reject a potential borrower in a group, the group leader has the power to provide or refuse access to financial services to potential clients. This power allows group leaders to charge [a] commission from borrowers for access into a group….

Often, the group leader had accessed more loans from an [MFI] than the [MFI] had record of by borrowing through a “dummy” or “ghost” borrower. In some cases the group leader and the “ghost” borrower had subdivided the loan amount and thus the repayment responsibility as well.⁹⁰

This kind of out-of-control, free-wheeling lending is just what you might expect when the profit motive takes over microcredit. But the Kashf Foundation is a nonprofit, and most of its money came from three institutions not known for profiteering: a New York–based social investment fund called Acumen Fund, the Grameen Foundation, and the World Bank.⁹¹ Because motives other than profit can drive unsafe microlending, it is more useful to focus on the pace and quality of growth than its drivers.

In Search of Developmental Growth

The recent difficulties in microcredit industries across four continents—especially those in India—have pushed the pendulum of public opinion against microfinance. Many now ask, does microfinance actually work? Or is it on to the next hot thing in philanthropy? In the context of this careful investigation, the question is whether microfinance can be more creative than destructive. The answer depends in part on how much hope there is for structural changes to steady the industry. This section looks at two changes that already put microfinance on a more even keel in some countries: credit bureaus and deposit taking.

Credit Bureaus

Business people generally resist sharing information about clients with competitors, so credit bureaus arose in rich countries only after bitter lessons about their necessity. Just so, information-sharing systems are being established or strengthened in Bosnia, India, Morocco, and Pakistan.92 As in Bolivia before, such new institutions enrich the economic fabric in the Schumpeterian spirit of development. They make new information-sharing connections between lenders, with consequences for their relationships with borrowers.

An effective credit bureau provides better information, and in so doing, better incentives. It gives lenders a fuller picture of current debts, thus about clients' “headroom” for additional borrowing. Although it is impossible to know exactly whether a person has too much debt, because capacity to repay depends on the uncertain future, with better data a lender can exercise better judgment. It can combine information about a client's outstanding debts and credit history with conservative rules of thumb—for instance, that mortgage payments should not exceed a third of income. A credit bureau also allows lenders to infer reliability from credit histories, which in turn encourages clients to borrow conservatively and repay diligently for fear of compromising their access to finance.⁹³

A major prerequisite to building a credit bureau is a way to reliably identify people, in order to match up records from various lenders and prevent fraudulent use of multiple names. Everyone must have a number. The poorer the country and the poorer the people within it, the less likely they are to have been incorporated into such a unique identification system. Fortunately, breakthroughs may be imminent. As discussed in chapter 7, in 2009, the Indian government launched an ambitious project to create a national identification system and tapped famed Infosys cofounder Nandan Nilekani to run it.

Of course, America had three credit bureaus—and a mortgage meltdown. In Andhra Pradesh, MFIs already knew that multiple borrowing was ubiquitous. But just because credit bureaus are not sufficient, that does not make them unnecessary.

Taking Deposits

As we reach the end of my assessment of microfinance, a recurring theme becomes apparent: the value of microsavings. The first notion of success we examined is development as escape from poverty. In that context, a randomized study found that offering a commitment savings account to market vendors in Kenya raised spending among the female vendors.94 No randomized studies have found such impacts from microcredit. As for development as freedom, it is hard to see how voluntarily saving too much would lessen a poor person's control over her life, as long as the savings are safe. Once again, the same is not true for credit. And regarding development as industry building, an MFI that complements credit with savings services becomes a financial intermediary, a new node in the economic web connecting those with money to set aside with those who have immediate uses for it.

Happily, many MFIs have become true microbanks, doing both credit and voluntary savings. Their savings accounts take various forms. Some are completely liquid, allowing deposits and withdrawals of any amount at any time, or nearly. Others are time deposits, like certificates of deposit, which are locked up for agreed periods and pay higher interest in return. In between are semi-liquid accounts, like the ones in the Kenya experiment, which limit the number, amount, or both of transactions per month through rules or penalties. The global goliath of microsavings, BRI, offers all three.⁹⁵ Partly inspired by BRI, the Bangladeshi groups ASA, BRAC, and Grameen got serious about voluntary savings in the late 1990s.⁹⁶ Grameen in particular accumulated large sums through commitment savings accounts. Some ProCredit banks are also seriously into savings, as are Equity Bank in Kenya, and BancoSol and other MFIs in Latin America.⁹⁷

Yet in many countries, microcredit still overshadows microsavings. I can see good, tough reasons for the disparity. Letting people put in and take out money when they please cuts against the mass-production strategy of microcredit, as explained in chapter 5. It makes microsavings accounts more expensive to administer than microloans of the same size. In addition, in Latin America especially, many people shudder at memories of hyperinflation, which destroyed monetary savings and taught people to save in gold and goats.

Finally, and perhaps most importantly, start-up nonprofits generally should not be entrusted with what is referred to in the trade as other people's money; yet the organizations can give out loans the day they open their doors. While there are some notably successful examples of unregulated deposit-takers (see table 8-2), the global consensus is for supervision because government banking experts are better positioned than ordinary savers to judge whether their money is being used prudently. The problem is that supervision is costly for all concerned. Small institutions may lack the administrative and financial capacity to comply with complex rules and liquidity requirements. And underfunded supervisors in poor countries may not have the staff to track more than a handful of large institutions.⁹⁸ So the general thrust in financial regulation is toward conservatism in granting permission to take savings. Most progress in microsavings has occurred in the countries where microfinance flourished earliest, such as Bolivia, Indonesia, and Peru. Perhaps credit is a pioneer species, the lichen that colonizes bare rock so that the successor, savings, can take root. Perhaps expecting MFIs to take savings in their earliest days would be like expecting oaks to root in bare rock.

Perhaps—but that is not the whole story. In general, MFIs can raise funds for lending from three sources: retained profits from lending; outside finance, including loans and equity capital; and customers' savings. Usually they will do whatever is easiest—and outside finance has been pretty easy since the mid-2000s. Why should a microfinance institution bother with the administrative and regulatory hassle in maintaining thousands or millions of small savings accounts when it can raise grants and low-interest loans from investors? This observation leads to what Dale Adams, emeritus economics professor at Ohio State and longtime savings advocate, calls Shaw's Law, after the American economist Edward Shaw: “Deposits will only be mobilized when there is little or no outside funding available to potential deposit takers.”⁹⁹ Adams recounts:

In the early 1990s I saw a dramatic example…in Egypt where [US] AID spent a good deal of money trying to reform a traditional agricultural bank, including stimulating more deposit mobilization. These efforts were later undercut by a large World Bank loan that provided funds to the bank more cheaply than the bank could obtain them from depositors. The agricultural bank quickly lost interest in the difficult task of mobilizing voluntary deposits.100

Around the same time, perhaps wanting to associate with success, the World Bank attempted to lend to BRI. Dennis Whittle, who later left the World Bank to co-found the online charity marketplace GlobalGiving, sketched the story in a comment on my blog: “I worked with the World Bank in Indonesia back in the late 1980s and early 1990s, when BRI's microcredit program was already booming. During that time, I tried repeatedly to lend BRI $100 million at subsidized rates to expand their microcredit program. BRI's answer: ‘No thanks, that would screw up our discipline.’”¹⁰¹

A detailed study in Latin America confirmed that borrowed funds undercut deposit-taking on price, if less so among larger MFIs that can administer savings programs more cheaply per dollar held. Typically the loans MFIs take from domestic government agencies and foreign investors are at submarket rates, which is shifting the balance away from deposit taking (see table 8-7).¹⁰²

As a rule, then, the more money investors pour into microcredit, the less microsavings is taken. Accepting that savings should be the province of institutions of a certain age and size, the practical thrust of Adams' complaint is that outside money is lulling big institutions into savings avoidance and little ones into merger avoidance. To be fair, easy finance is not the only inappropriate hindrance to microsavings. Regulations in many countries impede entry into savings through rules that are explicitly prohibitory, as in India, or impractically vague. Still, banking regulations are political outcomes. Larger institutions that are hungry for savings can lobby to accelerate the adoption of favorable rules.

The lack of microsavings in turn appears partly responsible for a lack of moderation in microlending. It seems unlikely, for example, that credit-dominated MFIs in India or Bosnia would have grown so recklessly if they had been on-lending the savings of the poor rather the investments of big banks, aid agencies, and millionaires. Some combination of regulation, conscience, and fear of angering customers and politicians would probably have installed caution. Thus easy money from investors simultaneously provides the fuel for fast credit growth and reduces the compunction about burning it. In fact, if one sorts a list of the major microfinance countries by the fraction of microcredit financed with borrowings from investors, a remarkable pattern emerges. All the countries recently in credit crisis are near one end, taking little in microdeposits and much in loans from outside investors (see table 8-8).

Table 8-7. Costs of Various Funding Sources as Share of Amounts Saved or Lent, Selected MFIs in Latin America, Circa 2004

Source: Maisch, Soria, and Westley (2006), 36, 51, 95.

a. Taking savings tends to get cheaper with scale.

b. Loans to MFIs are often subsidized, which undercuts savings.

In sum, easy outside money for microcredit aggravates two ills: overemphasis on credit (to the point of inflating bubbles) and underemphasis on savings. The consequences of the first have been graphically illustrated in news coverage of Andhra Pradesh. In contrast, the underemphasis on savings is a kind of silent tragedy. Perhaps the best indicator of the size of that tragedy is BRI's record, noted in chapter 4. At the end of 2007, the bank had six depositors for every borrower (21.2 million savers, about 15 percent of Indonesian adults, versus 3.5 million borrowers). And 21 percent of BRI's non-borrowing customers lived below the poverty line, compared to just 9 percent of its borrowers.¹⁰³ Doing the multiplication, we see that BRI had twelve times as many non-borrowers as borrowers living below the official poverty line.104 Absent the deposit option, some BRI savers would switch to credit as an inferior, risky substitute while others would drop out altogether. Through deposit-taking, BRI is providing a higher quantity and quality of services to the poor. Replication of its model in more countries would improve the financial lives of hundreds of millions of people.

Table 8-8. Financing Structure of MFIs in Twenty-Five Countries with Most Loans, 2009

Source: Author's estimates based on Mix Market, “MFI Indicators” (j.mp/aDBhal [June 4, 2010]).

Note: Countries recently in crisis are boldface. Equity is total assets, including outstanding loans, minus borrowings and deposits. Data for Indonesia are from 2006. Excludes four large state-run institutions for which financial viability is not a primary objective: Banco Popular do Brasil, Kenya Post Office Savings Bank, Khushhali Bank of Pakistan, Vietnam Bank for Social Policies.

Conclusion

I began this chapter with the idea that there must be something right in a charitable project that repeatedly and uniquely produces such impressive organizations. Rather than trying to pin down the direct link from the development of such institutions to poverty reduction and empowerment, I have argued that sustainably extending the financial system to poor people is development, appropriately defined.105 Poor people deserve access to financial infrastructure just as they deserve access to clean water, sanitation, and electricity. Throughout history, most extensions of the financial system to new customers have been led by private institutions, from merchant banks to industrial life insurers. Fundamentally, the microfinance movement is about carrying that tradition forward to the planet's majority through the construction of businesses and businesslike institutions. This is not to assert that success in extending financial access has always worked out well. Nor is it to say that growth of industries is all that matters—if it were, then the cigarette industry would be a boon to progress. The point is that microfinance must be appraised from this viewpoint as part of a rigorous overall assessment.

In light of this conception of success—and in light of the various crises of 2008–10—microfinance looks flawed. That is a problem, but it should be no more fatal in our judgment of microfinance than recent credit troubles in rich countries should be for mainstream finance. If the global rich still deserve access to mortgages, the global poor still deserve access to small loans.

In fact, the greatest strength of microfinance has been in building industries that enrich the fabric of nations. Chapter 6 concluded that evidence of the direct impact on poverty is spotty and muted. Chapter 7 discovered that the firsthand reports on when microcredit empowers and when it oppresses are also disturbingly mixed. But in chapter 8, there is no disputing some basic, impressive facts. Where there were no MFIs a few decades ago, now there are thousands, serving millions. The big ones are businesses or operate like them. The industry's history is one of constant innovation, from the basic credit delivery methods to various forms of savings, from pen-and-paper bookkeeping to Palm Pilots, from foundation grants to securitized loans and IPOs. This success does not appeal to the imagination as much as lifting a woman out of poverty would. But it is more certain and should be recognized as economic development.

Accepting that microfinance has “worked” overall in this way, the practical question is how to make it work better. In particular, what is the proper role for would-be supporters? Here, the conclusion is more cautionary. On the one hand, there might not be a microfinance movement were it not for outside donors and socially motivated investors. Yet precisely because the idea is introduced from the outside, like the reindeer on St. Matthew Island, microfinance can easily undermine itself and hurt those it is meant to serve. For growth in microfinance to be healthy, the growth impulse must be counterbalanced by restraints, such as credit bureaus, nonprofit ownership of for-profit institutions, and supervision of deposit-takers. And microfinance institutions must connect diversely to capital markets and clientele. In particular, less investment from investors, notably foreign ones, will in many contexts make microfinance more successful, by encouraging more responsible lending and the taking of savings.

A big lesson is that mythologizing microfinance has distorted funding for it, undermining the industry in precisely the aspect in which it has most inborn capacity to succeed. Foreign money came easily because of microfinance's exaggerated reputation for fighting poverty and empowering women, extending some MFIs beyond their capacity. Now the pendulum is swinging against microfinance. As long it does not swing too far, lower expectations may bring greater success.

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1. Wolff (1896), 44–45.

2. Gourlay (1906), 217.

3. Rhyne (1994), 106.

4. Rutherford (2009b), 191.

5. For example, Rhyne (1994).

6. Schumpeter (1934).

7. “Evolutionary Economics” (wikipedia.org/wiki/evolutionary_economics [January 8, 2010]).

8. Schumpeter (1934), 74–75.

9 . Commission on Growth and Development (2008), 33.

10. Schumpeter (1934), 66.

11. Schumpeter (1976 [1942]), 83.

12. Schumpeter (1934), 85.

13. Schumpeter (1934), 66.

14. Schumpeter (1934), 74. The ephors of ancient Sparta were elected magistrates of the king.

15. Solow (1994), 52.

16. Yunus (2004), 207: “I believe that all human beings are potential entrepreneurs. Some of us get the opportunity to express this talent, but many of us never get the chance because we were made to imagine that an entrepreneur is someone enormously gifted and different from ourselves.”

17. MIX Market, “Trends for Microfinance Institutions” (j.mp/4RMKJj [January 15, 2010]).

18. Cull, Demirgüç-Kunt, and Morduch (2009).

19. For more details and caveats, see David Roodman, “Should Industry Concentration Cause Consternation?” Microfinance Open Book Blog, January 15, 2010 (j.mp/5GuheZ).

20. For the latest figures, see www.syminvest.com.

21. Rhyne (2001), 107.

22. Calmeadow Foundation (2005), 17–18.

23. Prodem lived on as a nonprofit lender specializing in rural areas and then transformed a second time, into the for-profit Prodem FFP.

24. ProCredit Holding (2011).

25. Calmeadow Foundation (2006), 1.

26. Calmeadow Foundation (2006), 7.

27. Calmeadow Foundation (2006); Silva (2005).

28. Based on 1995–2004 returns from the Vanguard Group; see Vanguard, “Vanguard Prime Money Market Fund Institutional Shares” (j.mp/9ltfO6 [February 15, 2010]).

29. For the latest figures, see www.syminvest.com.

30. Swanson (2008).

31. Rozas (2009). See also Christen, Lyman, and Rosenberg (2003), 27.

32. Citigroup, “Citigroup/Banamex Leads Financiera Compartamos Bond Issue in Mexico with a Partial IFC Credit Guarantee; Standard & Poor's, Fitch Assign Investment-Grade Country Rating,” press release, August 2, 2004 (j.mp/oxJ5gz).

33. CGAP, “Deal of the Month: Compartamos Diversifies Its Funding (August 2009),” November 16, 2009 (j.mp/qA60a0).

34. CGAP (2009a), 10.

35. BRI, “History,” February 2, 2010 (j.mp/c1BkOg).

36. Diouf (2010), 1; “Investor Reaps Sh2.5b from Sale of Equity Bank Shares,” 70.71 Group Blog, January 11, 2009 (j.mp/d9JW2s), using exchange rate of 77.47 Ksh/$ from XE, “KES Rate Table,” January 8, 2009 (j.mp/cS2ytf).

37. Rosenberg (2007).

38. Ian Callaghan, “Let Me In!” Forbes, December 20, 2007 (j.mp/qQIsLj).

39. Danel and Labarthe (2008).

40. Rhyne (2010), 4.

41. Chen and others (2010), 8, 15.

42. Srinivasan (2010a), 49.

43. CGAP (2010b).

44. Legatum Ventures, “Legatum Invests over 100 Crore (Us$25 Million) for Majority Interest in Share Microfin Ltd., India's Leading Microfinance Institution,” press release, May 15, 2007 (j.mp/q0NFSo); “SKS Microfinance Raises $75 Mn,” Financial Express (India), November 10, 2008.

45. Reserve Bank of India, “FAQs” (j.mp/iMMR05 [February 19, 2010]).

46. Srinivasan (2010a), 131, 133.

47. MIX Market, “Indicators for Microfinance Institutions,” data on debt-equity ratios for Indian MFIs, 2009 (j.mp/hqzNfe [April 18, 2011]).

48. Bateman (2010).

49. Winker and others (2002), 493.

50. Klein (1968), 356.

51. Rozell (2003).

52. Rozell (2003).

53. Klein (1968).

54. Klein, Walsh, and Shulski (2009), 36–37.

55. Mathematically, absolute increase is proportional to the product of these two distances.

56. Daly (1993 [1990]), 268.

57. Abbey (1977), 183.

58. Galbraith (1993), 18–19.

59. Roodman and Qureshi (2006).

60. Chen, Rasmussen, and Reille (2010), 10.

61. Krishnaswamy (2007), 5; Jonathan Morduch, “Debunking the Microfinance Bubble,” Financial Access Initiative blog, August 28, 2009 (j.mp/DiplS).

62. Rhyne (2001), 155.

63. Campion (2001).

64. Herman E. Daly, “Economics in a Full World,” Scientific American, September 2005, 100–07.

65. I credit this observation to my colleague Liliana Rojas-Suarez.

66. Levine (1997), 691.

67. Bagehot (1897), 5–6.

68. See Patten, Rosengard, and Johnston (2001), 1057, on BRI.

69. Robinson (2002), 137.

70. See David Roodman, “Connectivity Is Productivity,” Microfinance Open Book Blog, May 29, 2010 (j.mp/9kBv9K), included in appendix.

71. In Nicaragua and India, politicians accused the industry of usury and took destructive government action. The attacks in turn made it harder to tell whether the industry had damaged itself or merely had been damaged by its critics.

72. Chen, Rasmussen, and Reille (2010).

73. Chen, Rasmussen, and Reille (2010), 2.

74. MIX Market, “Trends for Microfinance Institutions” (j.mp/4RMKJj [March 15, 2011]).

75. Phil Cain, “Microfinance Meltdown in Bosnia,” Al Jazeera, January 4, 2010 (j.mp/9BOHhZ).

76. Microfinance Enhancement Facility (2011).

77. On multiple borrowing, see Johnson and Meka (2010), 27.

78. B. Rajsekhar, CEO, Society for the Elimination of Rural Poverty, Hyderabad, India, interview with author, November 20, 2010. See David Roodman, “When Indian Elephants Fight,” Microfinance Open Book Blog, November 24, 2010 (j.mp/gL4lDe), included in the appendix.

79. Andhra Pradesh Micro Finance Institutions Ordinance, approved December 2010 (j.mp/q2Em3n).

80. Vijay Mahajan, chairman, BASIX, interview with author, Hyderabad, India, November 18, 2010.

81. Transcript of roundtable discussion, Hyderabad, India, August 10, 2009, in Srinivasan (2009), 17.

82. Ruth David, “Temasek Snared in India as Crackdown Slows Microfinance IPOs,” Bloomberg, December 2, 2010 (j.mp/fbyJ8D).

83. Elisabeth Rhyne, “On Microfinance: Who's to Blame for the Crisis in Andhra Pradesh?” Huffington Post, November 2, 2010.

84. On board seats, see Chen and others (2010), 8.

85. Barbara Magnoni, “Bubble Bubble Banex Trouble,” Financial Access Initiative blog, August 25, 2010 (j.mp/ pnncm4).

86. Magnoni (2011).

87. Japan Credit Rating-Vital Information Services, “Kashf Foundation,” rating report, June 17, 2008 (j.mp/eX2dwk).

88. Kashf Foundation (2009), 32.

89. Burki (2009), 4.

90. Burki (2009), 6.

91. Kashf Foundation (2008), note 14.

92. Chen, Rasmussen, and Reille (2010), 14; Vijay Mahajan and P.N. Vasudevan, “Microfinance in India: Twin Steps towards Self-Regulation,” Microfinance Focus, January 10, 2010 (j.mp/afJCHX).

93. De Janvry, McIntosh, and Sadoulet (2010)

94. Dupas and Robinson (2009).

95. Robinson (2002), 266.

96. Rutherford (2009b), 144; Wright, Hossain, and Rutherford (1997), 315–21.

97. On Latin America, see Westley and Palomas (2010).

98. Adams (2009), 9–10.

99. Adams (2002), 5; Shaw (1973). See also Christen and Mas (2009), 282.

100. Adams (2002), 5.

101. Dennis Whittle, February 4, 2010, comment on David Roodman, “Charting Growth,” Microfinance Open Book Blog, February 3, 2010 (j.mp/cUAobc).

102. Maisch, Soria, and Westley (2006).

103. Johnston and Morduch (2007), 29.

104. Twenty-one percent of (21.2–3.5) million versus 9 percent of 3.5 million.

105. Prahalad (2006).