Myths and Reality: Cost and Profitability of Microfinance

Recent commentary on microfinance has focused on the idea that there is a big problem with excess commercialization driven by greedy for-profit microcredit lenders. Perceptions of uncontrolled growth and excessive interest charged to vulnerable low income clients have - together with select episodes of suspected excesses - become the unquestioned narrative about microlenders. But what’s the reality? Are microfinance institutions exploiting poor clients to make big profits? Are for-profit MFIs charging higher interest rates on loans to extract high profits?

Data collected by the Microfinance Information Exchange (MIX) shows a quite different picture of the profit orientation of microfinance. High-yield, high-return MFIs that have drawn the most public ire are outliers. In fact, this small group of MFIs serves less than 10 percent of clients worldwide. The vast majority of clients borrow from MFIs that charge less than 30 percent and realize less than 30 percent return on equity - indeed, most are served by MFIs that earn less than 15 percent return on equity.

Should for-profit MFIs take the blame for excesses seen in the market? Surprisingly, the fact base again provides little evidence that profit orientation is the real problem. Returns on assets have historically been higher for non-profit institutions than for-profit, although both groups have shown lower profits year-on-year and are essentially indistinguishable at this point on other metrics. For-profit MFIs also don’t generally charge their clients more than non-profit MFIs, and both yields and expenses have declined over time (albeit slowly).  The facts belie easy assumptions: for-profit does not mean more profitable; and non-profit does not mean low cost.

The data does not support a view that more than a small group of MFIs can be accused of extracting excessive profits through exploitative interest rates. Even then, further analysis is needed to determine how these profits are distributed.

The microfinance industry needs better data to accurately assess the success and excesses of some MFIs. Thankfully a number of initiatives are working to provide an even richer fact base and new tools to assess the social and financial performance of microfinance. CGAP and MIX are pleased to participate in efforts such as the SMART Campaign and the Social Performance Taskforce, which work to deepen our understanding based on the facts, not the myths. We are also actively working to supply the industry with data to inform the debate – and insights to help avoid costly mistakes.

- Tilman Ehrbeck (CEO, CGAP), Marten Leijon (ED, MIX), Scott Gaul (Director of Analysis, MIX)

 RELATED PUBLICATIONS:

• Reviewing the Reserve Bank of India's Microfinance Framework
• Risk vs. return for MFIs
• MFTransparency and MIX Market
• India scenario analysis: What if microfinance was less profitable?

The data underlying this analysis is available on MIX Market here and here. The results reflect all institutions reporting for a given year - over 7400 observations from 1750 institutions over 7 years. Data is drawn from third-party documentation, such as audited financial statements, regulatory reporting or ratings, when possible, and these sources are available for the majority of institutions for each year. Results from a restricted sample of institutions that have provided data for all years are similar, and available here.