Microfinance Expands in For-Profit Sector

Published on July 21, 2010

The Financial Times reports that SKS Microfinance, India’s largest lender to the poor, will to raise $350 million later this month in an initial public offering.  Microfinance attempts to provide very small loans to poor people who do not have access to traditional credit and have often resort to loan sharks to obtain seed capital for starting a small business.  Many of the initial efforts in this area were funded by nonprofit organizations.  However, in recent years, there has been more interest in microfinance in the for-profit sector.

A related article published by the Financial Times in 2008 provides much more history regarding the growth of microfinance in recent years.  For many who were involved in the charitable origins of modern microfinance in the 1970s, there is a significant amount of suspicion regarding the profit motive of private firms such as SKS.  However, much of this seems to stem from an inherent distrust of private markets and the profit motive according to Dean Karlan, a microfinance economist at Yale:

Dean Karlan, a microfinance economist at Yale, is frustrated by this lack of serious research into what works. He also thinks that Yunus’s talk of “the moneylender’s thinking” is unhelpful. “I don’t care why the bank is doing what it’s doing,” he says. “If you’re trying to make the world a better place but you’re not, that’s bad. If you’re trying to make profits and don’t care about people, but make them better off anyway, that’s good.”

To be sure, the interest rates charged by private microfinance firms can appear high when compared to typical interest rates in mature banking markets.  However, some of this can be explained by the high overhead of dealing with large numbers of very small loans.  Improved technology should eventually increase efficiency to the point where overhead costs come down and make very small loans more economical.

The bottom line is that private firms see a large need that is not being met in the nonprofit sector and seek to fill the gap.  Assuming that countries such as India put in place some basic consumer protections, the financing offered by firms like SKS should come with terms that are far less onerous than approaching the local loan shark and risking bodily harm if loan repayment schedules are not met.

For more on the related topic of providing banking services for the rural poor in developing countries, read this article from The Economist published earlier this year.

Disclosures:  None.

Microfinance Expands in For-Profit Sector
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