Could the economic crisis harm microfinance? It seems possible that high expectations paired with a collapse in funding (archetypical elements of bubbles when bursting) may erode confidence in this development tool, which – for right or wrong reasons – is currently a dominant element of international development governance.
Recently, I got my hands on a publication by Deutsche Bank Research from December 2007, predicting a fantastic acceleration of growth in the microfinance industry over the coming decade. That they would publish such a view is unsurprising, given that DB is the issuer of several microfinance investment funds; in fact, according to this paper, for every Dollar currently invested in microfinance there are a full ten Dollars of untapped demand. DB expect this situation to be remedied until 2015 by a ten-fold increase in investments from the private private-sector, bringing the total volume of investments in microfinance to 20 billion Dollars (about six times the equity value of Commerzbank). Private-sector investments already more than trebled between 2004 and 2006.
Does this kind of prognosis sound familiar, in any way? Certainly, predictions of ever faster growth in a niche market in which most firms have not yet earned a single Dollar, based on wild assumptions about unmet demand, were all too common practice during the dot.com bubble of the late 90s.
Would it be too pessimistic (or just too early) to coin the phrase “microfinance bubble”? Well, maybe it just got coined here, and possibly for good reasons.
Overoptimistic expectations have a tendency to disappoint those who hold them, and key actors in the worldwide microfinance project have been trumping each other with predictions market growth for many years.
Of course, microfinance is believed to be far more resilient against downturns than other financial investments; and possibly for good reasons. It is true that the poor have better “absorptive capacities” for economic shocks (they are used to going hungry in order repay their debts), and their businesses are “less integrated into the formal economy”, thereby less prone to the business cycle (the flip-side of which becomes apparent in boom-times).
But all positive predictions assume a continuing supply of finance; not a liquidity (or even solvency) crisis like the current one. So, given that DB based its estimates of microfinance’s growth on a ten-fold increase in private funding, what does the current crisis mean for the microfinance industry?
Neither the MicroBanking Bulletin (Autumn 2008) nor the CGAP website mention the world economic crisis yet, but it should be interesting to see how they deal with it soon. It seems doubtful that, with mortgages write-offs, bank failures, generalised liquidity dry-up, etc., that institutional and private investors will continue to find the necessary pocket money to stick into microfinance and other “social investments”; especially not ten times as much money they have deemed microfinance worthy of so far.
Assuming that microfinance really does increase the incomes of the poor, that it really is demanded by the poor (and not just taken for lack of an alternative), that it really does empower women, and so on – several assumptions which still must prove their mettle in rigorous assessment –, it would be a shame to see it land on the ever-growing rubbish heap of discarded and dismissed development concepts, just because it failed to become “sustainable”. By the way, “sustainable” means profitable without needing subsidies, in World Bank-Speak.
There is a high risk that overinflated expectations plus the worldwide economic crisis (the full extent of which is far from apparent) could lead to microfinance disappearing quietly from donor and financier agendas.
(phil)
governancexborders.com 
5 comments
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January 29, 2009 at 19:39
Espen
Hi Phil, The difference between the “IT bubble” or the “Finance bubble” and a potential “Microfinance bubble” is that IT and Finance did not have any price anchorage; they were assets with no value so to speak. The funds a potential investor invests in microfinance will mostly go to the client itself and not merely fund “thin air”. The only resemblance could be if MFIs start giving high loans that the client could not pay back (like they did with mortgages in the US), or the economy of the country the MFI is in crashes so the clients are unable to repay their loans (which is more likely). The reason why there is such a high growth rate is merely that more than 50% of the worlds population live on less than $2 a day and would very much like to improve their situation.
So I am not sure if there is a potential bubble on the horizon as you described. But I do agree that there is a certain risk for the investor, as with any investments made.
January 30, 2009 at 12:02
phil
Dear Espen, thanks for visiting and commenting on our new blog.
You are absolutely right to note that IT and finance stocks are completely different things from microfinance investments. I merely wanted to point out some worrisome parallels. Whether the IT and finance two were essentially Ponzi schemes, as you imply, I do not know.
The risks which I wanted to point to are two-fold: (1) that too high expectations will push MFIs to the capital markets and away from their poverty-alleviation mission and subject them to the inherent risks of the financial market, and (2) that it may someday be discovered that not all – in fact maybe not even the vast majority – of people living for less than 2$ a day need microdebt and that subsequently, in the great wisdom of donors and financiers, the baby may be cast out with the bathwater. After all, not all sick people need antibiotics (even though they are a powerful medicine), and not all poor people are Schumpeterian entrepreneurs waiting to be kick-started. This should be noted now, rather than after the experiment has already over-shot its mark.
January 30, 2009 at 12:45
Espen
Phil,
Thank you for your response, you are absolutely right but the difference with your antibiotics example and Microfinance is that there is a cost associated with medicine but not as much with Microfinance (in the same way). There is a huge R&D cost prior to delivering the drug, and there is a cost associated with producing and transporting the drug, and subsequently a risk of overproducing and thus getting stuck with unused drugs. Whereas with Microfinance, if an MFI borrow money from an investor and discover that there is a lack of demand they will merely repay the money, there is limited cost associated with it (except from interest rates). The idea behind a bobble is that it slowly grows until everyone realizes that it is filled with air; this will not happen with Microfinance unless MFIs borrow tons of money and just have them sitting in their bank account (which they wont do). You could argue that there can be a boom of MFis that go bust due to lack of demand, but that will not have enough ramifications on any financial systems to be called a bubble. Another aspect of Microfinance is the high contact rate; so it is easier for MFIs to discover emerging “unhealthy” trends.
In regards to moving away from the poverty alleviation mission; I don’t necessarily see that as a problem unless the MFIs start adopting the same behavior as “western” banks and lend to finance “air castles”. It cold be argued that MFIs could bite themselves in the tail and start lending primarily to cover consumption with a long repayment period, rather than “livelihood creation”. But I doubt that will happen as the MFIs would merely dig their own grave, unless they start selling the debt like the “western banks did”. But that will surely not happen as you wont need a PhD in order to realize that the risk of such an investment is enormous.
In regards to Demand: Not every person in poverty is an entrepreneur, but most people want saving accounts, insurance, and other Microfinance services that may help them secure their future. So I have no doubt banking services to “the poor” has come to stay.
Espen
January 30, 2009 at 14:21
phil
Espen, indeed I also hope that microfinance is here to stay, at least for as long as necessary. Since, in a capitalist system, finance is a necessary though not sufficient condition for entrepreneurial activity.
Whether or not most poor people really need a loan, rather than a job, or education, or healthcare (and after all loans, not deposits, are what MFIs must earn their income on) is a different issue. Above a certain threshold, MFIs will begin lending to people less capable at using loans – adverse selection. Additionally, those low-productivity markets in which poor people operate risk quickly becoming saturated, leading to repayment problems.
Thus, even if MFIs stick perfectly to their mission, twhich is to lend to the poor for entrepreneurial purposes, there is a risk of failure. This is symmetrical to what happened in the “sub-prime crisis”: mortgage lenders lent to potential homeowners for the purpose of buying a home (which is what they are supposed to do), but because of too much liquidity and too high expectations, they lent without sound consideration of their borrowers’ capacities.
When I say that a potential microfinance bubble may burst, this is for two separate reasons. Firstly, due to the current lack of funds, microfinance may slowly disappear; being less of a bursting bubble than simply a regrettable de-flation of the, in principle, completely sound project of microenterprise finance. Secondly, there is the risk that exaggerated expectations of ‘absorptive capacity’ and profitability and of other benefits will be disappointed by the simple realities of life in a third-world country without sound institutions. If financiers and donors then pull back altogether, even those projects which would truly have been beneficial would disappear.
February 18, 2009 at 12:49
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