The NYTimes is carrying a compelling article by Mohammed Yunus arguing against what passes today for microcredit. Trying to distinguish between Grameen Bank’s social benefit-first model, and that of commercial microcredit institutions that have caused such a massive backlash, he says:
In 1983, I founded Grameen Bank to provide small loans that people, especially poor women, could use to bring themselves out of poverty. At that time, I never imagined that one day microcredit would give rise to its own breed of loan sharks.
Commercial microcredit has given microfinance a bad name and suffered for it. Following on a political backlash against MFIs in India, shares in SKS Microfinance have plunged to less than half of their peak in Sept-Oct 2010. The industry has seen collection rates fall to 20%, from the enviable 99% it enjoyed previously. The state of Andhra Pradesh, where much of the lending is concentrated, has passed a new law substantially restricting the activities of MFIs and the national government and central bank are likely to come up with new nationwide regulation as well.
To believe industry pundits much of this has to do with political convenience. Asking the poor not to pay their debts is a populist measure to score easy political points. MFI proponents have also indicated that the industry itself needs to be better at elaborating on the benefits it provides.
Is commercial microcredit an illustration of mission drift?
Yet it cannot be so simple. If MFIs do provide an irreplaceable service to the poor why are those same people happy to see MFIs go out of business? Perhaps the backlash is simply a reaction to what we know is wrong with microcredit, and to how far it has drifted from its roots:
Commercialization has been a terrible wrong turn for microfinance, and it indicates a worrying “mission drift” in the motivation of those lending to the poor. Poverty should be eradicated, not seen as a money-making opportunity.
We have known for some time that microcredit may not be a panacea for poverty. Neither the impacts nor mechanics of poverty alleviation through microcredit are obvious. Microcredit, as a business, is immensely successful. Microcredit, as a tool for socio-economic development has been of questionable effectiveness.
Rather than address this obvious disconnect MFIs in India have been busy growing big. And some have been busy cashing in. Little thought has been given to fixing what does not work or explaining what we do not understand.
What is clear is that the industry, which emerged with the express purpose to help lift people out of poverty, has simply neglected the most basic of infrastructure requirements such as a credit bureau. If the backlash has been politically convenient for bureaucrats and politicians, the lack of any emphasis on development has been economically convenient for the industry.
What happens in microcredit will happen in any social business
No doubt the industry will be forced to address these shortcomings and may move closer to the social roots from which it had drifted. However, this backlash exposes a fundamental contradiction most social businesses face.
A growing view in western thinking has been that for-profit business models can serve as a complement or alternative to philanthropy and public spending. Failing public schools can be replaced by (or have been replaced by) cheap private ones; ineffective health systems can be replaced by private clinics; lack of electricity, water, and other basic necessities can all be addressed by private providers.
This view, that difficult social issues can be addressed by businesses “at the bottom of the pyramid” has been propogated by many and has led to a rush of professionals from investment banking and management consulting to the sector. The logic is that since public money is insufficient to tackle these issues, profitable approaches will encourage the trillions of private wealth to enter this field. JP Morgan even went so far as to call impact investing an “emerging asset class.”
Yet, this entire movement can trace its roots back to microcredit. And if microcredit hasn’t proven to be particularly successful at balancing social impact with business returns, can impact investing do better?
We expect that social businesses (to use the term loosely) provide social impact as a direct corollary to the business objectives. Thus, microcredit helps people out of poverty through provision of loans. Yet, the two impacts are rarely in alignment – more loans to an individual does not translate into a faster climb out of poverty, just to indebtedness. Private education may be better than public education and help empower a generation. But a private provider, once entrenched, would be encouraged to maximize profits to the point acceptable to customers – yet, it is hard to imagine how higher fees could possibly benefit the poor. The same can be said for healthcare providers. They, like private schools, would be encouraged to provide the lowest level of service acceptable to customers, so long as it beats that of the public school.
If we are to ensure this does not happen in the broader universe of social business and impact investing we must first be intellectually honest about one thing.
Social businesses are essentially businesses. Private capital may help them grow but it brings with it a strong tendency to turn social businesses from being social to being businesses.
For investors, this means if we wish an organization to remain true to its social objectives we can ask it to operate as a charity. Alternately, we can require it to meet its social objectives either through regulation or incentives. But to expect that social businesses will, without being coerced, somehow not drift from their social objectives towards their business imperatives is naive.
For businesses themselves, it means they must acknowledge this dichotomy and be clear about where they position themselves. Being seen as social comes with a responsibility to live up to that promise, or risk a subsequent backlash when the disconnect between promise and reality is exposed.