The Microfinance Catalyst

Banco Compartamos in Mexico and SKS Microfinance in India illustrate impact investors’ catalytic role. Both started as NGOs (following the Grameen model) and received millions in grant money from development institutions to start lending operations. They also got access to low-cost lending from government banks and multilateral institutions such as the International Finance Corporation (the World Bank’s commercial-lending arm) and the US Agency for International Development.

Within a few years, as their loan books began to grow rapidly, Compartamos and SKS created for-profit businesses that were owned by their respective NGOs. Subsequently, they raised equity capital from investors seeking to make a social impact – Compartamos from Accion and the IFC, and SKS from Unitus, Silicon Valley venture capitalist Vinod Khosla, and an Indian government development agency.

An initial public offering in 2007 followed for Compartamos, valuing the company at $2.2 billion. SKS raised more equity from investors such as Sequoia and Odyssey Capital, before going public on the Indian stock exchange in 2010, raising about $358 million at a valuation exceeding $1.6 billion. Impact investors’ support eventually led to flows of commercial capital – both VC funding and IPO investors – into Compartamos, SKS, and many other microfinance institutions.

Despite these successes, however, microfinance has struggled recently in India. Credit histories cannot be shared, because a credit bureau is just getting started. Moreover, an appropriate consumer-protection code and a nationwide regulatory framework are still lacking.

Not surprisingly, some have sought to exploit the poor as a result, which has put pressure on the authorities to do something. Unfortunately, this often results in inadvertent harm. For example, the Andhra Pradesh state government passed a restrictive ordinance making it difficult for microfinance institutions to recover their loans from their clients. As a result, many institutions had to write off much of their loan portfolios and take heavy losses, sending shock waves through the industry and the investor community – and causing the poor to suffer.

The lesson is that markets simply cannot work without accompanying public goods and high-quality government supervision. Although impact investors can lay the groundwork for commercial investors, they must also work in unison with government authorities to ensure well-functioning market systems. Only when such systems are firmly established will the poor be able to participate in today’s vast global economy.

Tarun Khanna is Director of the South Asia Initiative at Harvard University, a professor at Harvard Business School, and a member of the board of SKS Microfinance. Jayant Sinha is Managing Director of Omidyar Network India Advisors.

Copyright: Project Syndicate, 2011.www.project-syndicate.org

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