(Part 3 of 4)
Does the end justify the means? When we are talking about the most pressing problem on earth — poverty — does it still matter where the money comes from or from whom, for as long as this is used to better someone’s life? Philanthropy has, since time immemorial, been criticized for benefitting the donor rather than the beneficiary, providing an outlet for a person to right his moral wrongs via finance. Still more problematic is when philanthropy becomes a tool to further one’s economic or political agenda. This has occurred in many instances from the smallest village fundraisers to election campaigns to large, institutionalized foundations. Microfinance does not lack in its share of problems relating to the discrepancies between mission and funder’s agenda.
We examine this today as I continue in my series sharing findings of a research project I supervised for my student in Paris, wondering: why and how would Microfinance emerge in Western Europe? We found that there were three characteristics of Microfinance in Europe which allowed it to re-integrate people into society — its primary onus: 1.) A focus on entrepreneurial and inclusion loans, 2.) Entrepreneurship training, and, 3.) For-profit status with non-profit funding. Today we continue this series, explaining our findings on the third characteristic.
In the developing world, one of the main trends that shifted the models of microfinance towards more market-driven strategies was when microfinance institutions (MFIs) began accepting different sources of money. With the increasing interest in the movement, not only in what it could achieve but also in the investment opportunity, many people began jumping on the trend disguised as benefactors. The diversification of funding sources and ownership largely influenced the MFIs’ strategies and policies, consequently leading to a change in firm type from non-profit to for-profit. By transforming from NGOs to Non-bank Financial Institutions (NBFIs), MFIs were able to distribute profits to its shareholders and have better access to technology. However, they also tended to use more individual lending, accompanied with larger loan amounts and longer repayment terms. In Latin America, many MFIs were forced to make this transformation in the face of competition, specifically with commercial banks, with an increasing percentage now listed as for-profit organizations. Just to highlight this point — globally speaking, large banking houses Citigroup, Deutsche Bank, and Morgan Stanley are already in the space.
While accepting more funding may make the firm more efficient, distributing dividends to shareholders and being controlled by capital markets is where heavy debates come in. So how is Europe learning from this as it rolls out its own version of the practice?
It is interesting to note that apart from Switzerland, NGOs in Western Europe are not allowed to provide financial services and therefore cannot act as microfinance institutions and lend money. For this reason, NGOs assume the role of intermediary between the individuals who need micro-financial products and services, and banks that provide funding. NGOs do all the preparatory work with the future beneficiary to determine his need, verify the eligibility and help him with his project. In this way, their role remains clear and less muddled.
Meanwhile, private banks called Microbanks are the main actors of the microfinance industry and hold a for-profit status. Though they are private and can act in autonomy to a certain extent, EU regulation on MFIs means that their activities are largely limited, disadvantaging them compared to traditional banks. For instance, Italian regulation sets a cap on the interest rates of MFIs in Italy. Similarly, selection criteria to be eligible for microloans are more stringent and interest rates are fixed at around 10% in the UK. Thus, while they have a for-profit status, many merely break even. For this reason, MFIs limit the risk of default by excluding some customers to have a better quality of portfolio, thus effectively limiting the outreach.
A second form is the cooperative model. In these organizations, the beneficiaries are also the owners of the cooperative, as they need to subscribe to a share to be able to benefit from its services. By being owner of the cooperative, each member has a voting right during the General Assembly of the organization. Community-based models are similar to what we see in developing countries and usually target migrants coming from developing countries.
Finally, Autonomous Public Programs funded by regional departments also exist though are highly criticized by microfinance professionals for the fact that they give interest-free loans (0% interest rates, no administrative fee and no guarantee required).
The funding sources of MFIs are key in illustrating the social inclusion approach. MFIs in Europe are financially supported by diverse institutions ranging from microfinance foundations, small foundations that promote entrepreneurship, and large banking groups which have created foundations with the specific purpose of financing microfinance activities. For instance, BNP Paribas acts as a major financial contributor to the microfinance industry in Europe and in developing countries by financing microcredit portfolios, entering in some MFIs’ capital or providing technical support, whereas the Grameen Crédit Agricole foundation focuses its activity on the developing world. This availability of diverse capital counters the losses that tight regulation imposes upon them. For instance, as one of our interviewees explained, in their model they accept a default rate of up to 20% but when default occurs, they don’t take the entire loss due to the guarantees provided. In fact, most professional-entrepreneurial loans are guaranteed up to 70% while the individual loans are guaranteed up to 50%.
It is thus with clear and concise barriers of what entities are and are not allowed to do, and delineated objectives that Microfinance in Europe is able to have a social inclusion focus. There is no need to justify the means, just specific ends to specific means. n
Notes: This article is based on a co-authored working paper originating from the Master Thesis of Hélène Laherre under the supervision of the author at the IÉSEG School of Management (Catholic University of Lille) in Paris, France. References are available upon request.
Daniela “Danie” Luz Laurel is a business journalist and anchor-producer of BusinessWorld Live on One News, formerly Bloomberg TV Philippines. Prior to this, she was a permanent professor of Finance at IÉSEG School of Management in Paris and maintains teaching affiliations at IÉSEG and the Ateneo School of Government. She has also worked as an investment banker in The Netherlands. Ms. Laurel holds a Ph.D. in Management Engineering with concentrations in Finance and Accounting from the Politecnico di Milano in Italy and an MBA from the Universidad Carlos III de Madrid.