The Microfinance Catalyst

CAMBRIDGE – So-called impact investors – providers of capital to businesses that solve social challenges while generating a profit – are the current rage in economic development. US President Barack Obama’s Office for Social Innovation and Civic Participation recently convened more than 100 practitioners to discuss how impact investing could be unleashed in the United States and the developing world. The United Nations Foundation and the US State Department have launched a $50 million public-private partnership to promote clean cooking stoves in poor countries. In the United Kingdom, the Netherlands, and France, development agencies are looking to reposition some of their funding to businesses serving the poor.

According to the World Bank, roughly 1.4 billion people live in extreme poverty (earning less than $1.25/day), and 2.6 billion in moderate poverty (less than $2/day). More than a billion of the moderately poor – a number that exceeds Africa’s total population – live in South Asia. Can impact investing do more to reduce global poverty than so many previous efforts, all of which have struggled to have any impact at all?

Impoverished populations desperately require lighting, fuel for cooking, affordable and accessible health care, clean water, elementary education, and financial services. Government programs to supply these needs are plagued with corruption (by some estimates 50-70% of all welfare spending in India is stolen) and unable to provide quality services. Moreover, large companies have been unable to serve these populations’ needs, because to do so would require them to reinvent their existing business models around new product, distribution, and pricing paradigms.

This type of disruptive innovation usually comes from entrepreneurs. But entrepreneurs face daunting barriers, such as inadequate logistics, lack of consumer financing, poorly trained workers, consumer distrust of new technologies, high-cost marketing channels, backlash from existing merchants or moneylenders, and under-developed regulation.

Surmounting these business challenges is an expensive and slow process, and new ventures require many years to become cash-positive. As a result, commercial providers of debt or equity cannot get the high returns and quick exits that they seek.

When both governments and markets fail, impact investors can stimulate change. Microfinance – its advent, rise, and recent crises – shows how.

The microfinance industry began in the 1980’s in Bangladesh with the non-profit Grameen Bank and BRAC Bank. Donors soon helped launch other microfinance institutions in Mexico, India, Peru, Indonesia, and many African countries, where they could offer loans at 25-30% interest rates – well below traditional moneylender rates of 60-100% – and still generate strong profit margins. Today, the microfinance industry serves about 150-200 million borrowers around the world, and has grown rapidly by securing access to several billion dollars in equity financing.

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