MICROFINANCE PAPER WRAP-UP: The Commercialization of Microfinance: Bangladesh, by Stephanie Charitonenko and S.M. Rahman

Written by Stephanie Charitonenko and S.M. Rahman and based on research for the Asian Development Bank Commercialization of Microfinance Project, this paper is 1 of 4 country case studies. The 56 page document was published in September 2002 by the Asian Development Bank, and the full text is available here.

In Bangladesh, as the authors explain, the term “commercialization” carries with it a negative connotation. Stakeholders tend to view the dual objectives of profit maximization and poverty alleviation as incompatible rather than mutually supportive. They worry that commercialization of the microfinance industry would lead to exploitation of the poor. The authors, however, argue that “commercialization” or, “the application of market-based principles to microfinance,” is necessary if microfinance is going to achieve the scale necessary to fulfill the demand for microfinance services: credit, savings, insurance, payments, and money transfers.

The authors describe commercialization as a progress along a continuum which begins as a subsidized MFI adopts a for-profit model that applies cost-recovery interest rates, progresses towards operation and financial self-sufficiency, uses market-based funds (loans from commercial banks, savings deposits, etc), and graduates to a for-profit formal financial institution that is able to attract equity investments.

At the time of publication (as is still true today) the microfinance industry in Bangladesh was dominated by the quasi-commercialized Grameen Bank and two very large commercially viable NGOs, the Bangladesh Rural Advancement Committee (BRAC) and the Association for Social Advancement (ASA). Beyond these three large microfinance institutions (MFIs), there existed numerous poorly performing and subsidy depended NGOs and government microcredit programs with repayment rates that vary between 19.6 and 98.6 percent. At the end of 2000, grants and concessional funds accounted for 41 percent of the loanable funds in the microfinance industry.

Beyond being financially self-sustainable and not reliant on insecure sources of funding, such as grants, the authors describe a number of other advantages for microfinance organizations that commercialize. A for-profit financial institution is subject to much more stringent regulation and supervision than an NGO. As such, commercialized MFIs can more easily access larger market-based sources of debt to finance expansion and reach an economy of scale. Once enough MFIs reach scale and saturate the market, increased competition will theoretically drive down interest rates, and increase the quality of the product delivered to the customer. The authors observe that as competition increased in Bangladesh there was a diversification of financial products to meet customer demand including larger loan sizes, more flexible repayment schedules, housing loans, education loans, leasing services, savings products, and microinsurance.

Market-based sources of funding include loans from apex institutions (Asian Development Bank, World Bank, etc), private investment funds, and commercial bank loans (more recently, in other parts of the world, MFIs have sold equity through public offerings). A further source of market-based funds accessed by MFIs is savings deposits. According to the authors, “Savings are perhaps the most important factor in developing the domestic investment needed for sustainable economic growth.” As a bank, the Grameen Bank is the only MFI in Bangladesh allowed to collect and mobilize savings from borrowers and non-borrowers alike. At the time of publishing its savings represented approximately one third of the total microfinance savings in Bangladesh, and 23 percent of the deposited savings were from non-borrowers.

There are, however, possible negative implications of commercialization, particularly mission drift. The authors address four types of mission drift:

1) Many Households Could Remain Unserved and MFIs Could Fail to Reach the Poorest of the Poor

Sustainability of MFIs depends on low overhead and adequate returns on loan portfolio. This means that MFIs aiming to be financially sustainable may decide to serve relatively cheap and easy to reach areas, with good prospects for repayment, leaving more difficult to reach and more risky populations underserved. The paper acknowledged that cross subsidization or grant based approaches may be needed to penetrate these markets.

The paper also argues that microfinance does not serve the “hardcore” poor well, and that it may in fact do more harm than good. It suggests that alternative programs should be developed to address this issue, and that profitable MFIs with a social mission may be the best organizations to develop them because they would have the funds to do so.

2) MFIs Might Target Women Less

The authors acknowledge that increased commercialization may lead to increased lending to men. However, they argue that this is not mission drift because it will not occur at the exclusion of women, especially considering historical evidence that women have lower risk profiles.

3) Average Microloan Sizes Would Likely Increase

The authors argue that documented increase in average microloan size was not yet an indication of mission drift because the client base remained poor households. They say that the rising loan sizes were instead a result of the client base of established MFIs graduating to larger loans.

4) Interest Rates Could Keep Rising

Although when compared to commercial banks, the cost-covering interest rates of self-sustainable MFIs may seem high, commercial banks generally do not serve the poor; thus the relevant basis for comparison for the borrowers is the informal sector which usually charges interest rates even higher. Nonetheless, at the time of publishing interest rates had been on the rise. The authors suggest that increased competition caused by a commercialized microfinance industry should serve to keep interest rates from rising further.

The Commercialization of Microfinance: Bangladesh was published in 2002, and its data is somewhat outdated. However, the document still has value in its analysis of the process of commercialization of microfinance, and its candid explanation of the positive and negative implications for undergoing such a process. The analysis is grounded in data from a nation that at the time had one of the most, if not the most developed microfinance industries in the world.

By Ryan Hogarth, Research Assistant

Further Resources:

Asian Development Bank: Home

Association for Social Advancement: Home

Bangladesh Rural Advancement Committee: Home

Grameen Bank: Home

The Commercialization of Microfinance: Bangladesh,” by Stephanie Charitenko and S.M. Rahman, Asian Development Bank: September 2002

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