On profits and progress

A front page story in today’s New York Times details how large banks are profiting from serving a majority of microfinance clients, fueling debates about the high interest rates they charge to poor borrowers. Longtime microfinance proponents remain steadfast that high micro-borrowing rates put investors’ interests ahead of the poor. From a broader perspective, others argue, it’s not only investors who profit from high interest rates; the poor also profit from the expansion of commerce, and in the process sow the seeds of true social progress.

Globally, the average micro-borrowing rate is 37 percent. That’s a higher rate than almost all larger loans in developed and developing markets, due to high risk perceptions and high transactions costs of working in undeserved rural and urban markets.

Microfinance’s proponent-in-chief, Grameen Bank founder and Nobel-laureate Muhammad Yunus, has frequently appeared on record as against rates more than 10-15 percent above the cost of raising capital. To earn more than that, he says, is venturing into the world of loan sharks and thieves he originally sought to combat. Yunus’ reserves his most visceral condemnations for Compartamos, a microfinance institution that raised eyebrows in April 2007 when it became the first publicly traded microlender. Compartamos reportedly charges an average annual interest rate of 82 percent, far above what it must pay to its investors.

Curiously, a powerful counter-argument comes straight from the experience of a Grameen-birthed business, Grameenphone, which made headlines in 2009 when it  became a publicly traded company. It too caught early criticism for charging what some perceived as a steep price for its services – four taka per minute, instead of the one taka price that social business advocates suggested. Why? According to Grameenphone founder Iqbal Quadir:

….insisting on a higher price to start sustained the initial investment and eventually led to greater economies of scale. Furthermore, the venture’s profitability resulted in competition and innovations that caused prices to drop. Indeed, the average price of Grameenphone services today is below one taka per minute. By not insisting on a strict social agenda, the scope of problem solving was expanded. (Read the full article here)

Grameenphone’s high pricing sustained further investment into technological and commercial capacity, laying a foundation for massive social benefits in return.  Grameenphone now accounts for 40 percent of cellular telephone usage in the Bangladesh market, thanks to its village-based “Phone Ladies,” the poor entrepreneurs at the heart of its business. Microfinance institutions can also dramatically scale-up their social impact through higher interest rates. That impact isn’t immediately apparent, however, at the individual level. Stepping back and looking at the bigger picture, according to Quadir, the impact is clear:

While the aggregate effect of present-day ventures may not be visible for some time, history teaches that commercial forces have indeed been the source of a great deal of social progress. It is commerce that dispersed economic resources and flattened hierarchies in medieval Europe—giving rise to state accountability and self-governance, while remedying the sclerotic concentrations of power impeding social progress. Viewing widespread social progress as possible without first achieving commercial progress is akin to putting the cart before the horse.

Likewise with Grameenphone’s initial high pricing, high interest rates may deter a number of clients but the many who remain undeterred help lay the foundation for sustained social progress. Microfinance institutions shouldn’t fear profiting from the poor, because they can also profit with the poor, supporting the expansion of commerce to those outside existing power structures. Ultimately those are the structures that have long perpetuated injustice; undermining those structures through commerce helps to bring about a just world, not just a more livable world.

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