Professor Yunus’s Opinion

January 15, 2011

The New York Times has published an opinion piece by Muhammad Yunus on how to keep microcredit on this side of usury:

In the 1970s, when I began working here on what would eventually be called “microcredit,” one of my goals was to eliminate the presence of loan sharks who grow rich by preying on the poor. In 1983, I founded Grameen Bank to provide small loans that people, especially poor women, could use to bring themselves out of poverty. At that time, I never imagined that one day microcredit would give rise to its own breed of loan sharks.

But it has.

For close followers of microfinance, Yunus’s writing will ring familiar. For the general public, it is a concise statement of his thinking. He makes two concrete points:

• “Commercialization has been a terrible wrong turn for microfinance.” Commericalized microfinance is not really microfinance. It is usury, profiteering off the poor. It should stop. Now, as Yunus clarified in his debate with Vikram Akula at the Clinton Global Initiative last fall, he is not against profit in microfinance, but against outside ownership of microfinance institutions—that’s what he means by “commercialization.” The borrowers should own the lenders. He thus favors cooperative corporate governance, an idea that, like group microfinance itself, traces back to the early socialist Robert Owen. The Grameen Bank, of course, is majority-owned by its borrowers (page 25).
• Microcreditors should charge no more than 15% above their own cost of funds. Here, the professor valiantly takes on the ancient challenge of defining the just price of credit. Once, the Christian Church, like Islam, deemed any interest unjust. After a thousand years or so, it switched to accepting interest within reasonable bounds. A papal decision written almost exactly 500 years ago on how much interest to charge the poor stuck to principles and avoided numbers—wisely, I think.

Overall, I think Yunus makes a good point about the dangers of commercialization as he defines it. Indeed, events in India have, to a degree, vindicated him. Although I criticized his line of argument before the Indian implosion (this, this) and will do so here, I have come to appreciate a contradiction in my own thinking. On the one hand, I have doubted the value of the Grameen Bank’s example of cooperative ownership. Can others really be expected to follow it? On the other, I have blogged in praise of John Bogle for creating a cooperatively owned financial institution, the Vanguard Group. I trust Vanguard with my money because I know it is not trying to rip me off in order to favor outside investor-owners. Why should microcredit clients think any differently? Moreover, Yunus’s distinction resonates historically: all forms of group microcredit popular today descend from the credit cooperative movement of 19th-century Germany (which in turn drew inspiration from those English socialists).

So if all the microcreditors could raise all their capital from their clients then, I agree, that is the way to go.

But almost none has—not even the Grameen Bank.

Yunus’s achievements should not be slighted. In its pioneer days, the way forward for the Grameen Bank was far tougher and more uncertain than for those that followed. That said, thanks to his pioneering status and his abilities as a salesman, Yunus had help: a couple hundred million dollars from the Ford Foundation, the United Nations, Japan, and Western donors. As Vijay Mahajan, the father of commercial microfinance in India, has pointed out, microcreditors today cannot expect the same help, whether because of limited funds among private and public donors or the donors’ sense that microcredit has graduated from grants. If microcreditors today want such big chunks of capital from outsiders, they will have to buy it.

In particular, while it is true that Grameen members hold legal claim to 97% of the Grameen Bank’s net worth, they only contributed about $7.5 million in capital, at 100 taka ($1.40) per member. The Grameen Bank has not shown that microfinance can grow large purely through cooperative ownership.

In fact, as I wrote last summer, an irony in Yunus’s criticism of for-profit microlenders for going to the capital markets is that Grameen Bank is itself running low on capital, by which I mean risk-absorbing, profit sharing funds that banks are required to keep on hand in case of losses. And it is not clear (to me at least) how Grameen will get more. Maybe the government will step in…

Also of dubious generalizability is Yunus’s 15% spread cap. That limit might work in South Asia, but not very well in the rest of the world. Microcredit is cheaper to do in South Asia because of high population density—meaning that a loan officer can hit more villages in a day, serving more clients—and relative wage equality—which means that the wages of a, say, high-school educated loan officer are not so high compared to the size of the loans the poor can safely manage. That is why Grameen can charge just 20%, and why Chuck Waterfield, citing unreleased analayses, could tell a conference audience that India’s microcredit interest rates are among the lowest in the world. Where workers are more expensive relative to the typical loan size, as in much of Latin America and Africa, they must be paid from higher interest charges (or subsidies, which Yunus eschews). Also, such a rate rule discriminates against creditors aiming to serve the poorest, with particularly little, thus costly, loans; and against small, young creditors that have not yet achieved economies of scale or that are trying to earn extra profits to reinvest in their growth. Adrian Gonzalez of the Microfinance Information Exchange (MIX) determined that 75% of microcreditors worldwide are in Yunus’s “red zone,” charging spreads of more than 15%. This large group makes smaller loans on average, perhaps serving poorer people. And profiteering does not explain the widespread trespass into the red zone: even if profits were zeroed out, it would thin only to 61% of microcreditors.

So there is a kind of stubborn ignorance of facts and reason in this piece that rubs thinkers like me the wrong way—and probably helped make Yunus such an effective doer. On balance, I think it is fair to say that while Yunus has contributed much by being a pioneer, he should be more gracious in recognizing that not everyone can do microcredit the way he did it, let alone the way he says he does it.

Since I share Yunus’s diagnosis that commercial microfinance got out of hand in India yet disagree with his prescription, I should offer an alternative. A sensible proposal I heard from two microfinance leaders in India, Mahajan of BASIX and P.N. Vasudevan of Equitas, was for microcreditors, as distinct from governments, to cap their profit rates, as distinct from interest rates. At his office in Hyderabad last November, Mahajan told me that BASIX, which he founded, used to profit at the rate of 2 cents per dollar of assets (2% ROA), where “assets” are dominated by outstanding loans and “return” is interest and other income net of expenses. After competitors started raking in 5% ROA, BASIX inched up to 3% and used the extra profits to grow faster. So a cap of 2–3% might work. A few days before in a Delhi hotel lobby, Vasudevan told me that Equitas publicly limits its ROA, its Return on Equity (ROE), and the ratio in pay between the highest and lowest employees in the company.

Credit is not an ordinary product. It is weighed down by millennia of baggage, for the good reason that it can do real harm. It is like a drug in that it is potentially healthy in small doses, but also potentially addictive. So it stands to reason that sellers of this product must take unusual steps to counteract its special problems of reputation and risk.

Having taken Yunus’s piece on its own terms, I want also to view it within its political context. Remarkably, the piece mentions only the controversy in India, not the one swirling around his own head in Bangladesh. I suppose it is not in Yunus’s interest to raise awareness about that. But that does not mean his own awareness of the controversy played no role in the writing. Tom Heinemann’s documentary was unfair in only showing the dark side of microcredit, but he still did a service in shining a light on that dark side. Yunus, by focusing on interest rates, an area of relative strength for Grameen, distracts from the fact that the justness and impact of lending to the poor depend on more than rates. The amount of credit matters too, as do the quality of disclosure about program rules, the degree of competition and multiple lending. Even debt at 0% can trap the poor. Focusing on interest rates plays into the Bangladesh government’s fixation on that aspect of the credit relationship, as it sets out to investigate Grameen, drawing the investigators toward one of the Bank’s strengths. In fact, the Grameen Bank is by many accounts a leader in the flexibility and diversity, cost and transparency, of its offerings. But none of that, certainly not low interest rates by themselves, guarantees that all is well with the Grameen Bank’s clients.

In a final and remarkable parry, Yunus reminds his prime minister, who recently accused microcreditors of “sucking blood from the poor in the name of poverty alleviation,” that she once stood side by side with him and the woman who is now the most powerful diplomat of the most powerful nation, pledging to bring microcredit to millions. Prime Minister Hasina’s opinion of microcredit may have flipped since 1997, but Secretary Clinton’s has not. Perhaps Yunus is signaling to Hasina about how those abroad might take offense if her government goes too far in attacking him…or perhaps words published in New York hold little sway over deeds done in Dhaka.

Further reading: Matthew Bishop of the Economist disagrees with Yunus. Felix Salmon of Reuters disagrees with Bishop.

Possibly Related Posts

• Ironies in Yunus Attack on SKS IPO
• Akula v. Yunus: Commercial Microcredit = Just Profit or Unjust Profiteering?

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1. Bindu Ananth Says:
   January 16th, 2011 at 12:50 am

   David, another issue with Prof. Yunus’ recommendation is that it is bad financial systems design. Depositor protection is a holy grail for all Regulators and Governments. If hundreds of small, under-capitalised entities with poor ability to do asset-liability management start becoming deposit-taking entities, this will put deposits and the entire financial system at risk. There is a lot of merit to having non-deposit taking entities increase outreach of lending because if excesses happen, they can be allowed to fail. This will be impossible in the case of deposit taking entities. We say more about this here: http://ifmrblog.com/2010/12/21.....inclusion/

2. Bhagwan Chowdhry Says:
   January 16th, 2011 at 10:37 pm

   I don’t understand the bandwagon that everyone has jumped on about MFIs and lenders in general about not making too much profit. Isn’t profit precisely the incentive mechanism to encourage competition which would lead to lower interest rates? (See my blog post http://bit.ly/Myunus ) This is a robust mechanism that has worked for centuries in many different economies. If at all, governments could focus on providing subsidies and other incentives that would facilitate entry by competitive lenders. The idea that lenders should restrain themselves by limiting their profits is not a solution that is likely to work for long.

   I also second Bindu’s observation which points out that making borrowers own the microfinance lending institution imposes undue risk on them – this is the reason why regulators have been wary of allowing it. But the debate almost always seems to fault the regulators as if they are doing something wrong. This is reminiscent of the now old but faulty and specious argument that suggests that employees, rather than outside investors, should hold equity ownership of the firm.

3. David Roodman Says:
   January 16th, 2011 at 11:04 pm

   Bhagwan, I probably should have been more precise about this in my post: I think it is reasonable to consider capping (not eliminating) profit in microlending because credit markets are not ordinary. If we were speaking of businesses that sell soap (or savings) to the poor, I would not see the case. If businesses try to sell to much soap to the poor, the market will quickly correct their excess in the standard way. Laissez faire will work pretty well. Not so with credit, as we have seen: the correction is often long delayed, to almost everyone’s detriment. Conceding this market imperfection opens the way for intervention. At the least, I don’t think laissez faire is obviously optimal. Far from being impractical, capping ROA is being done now by the groups I mentioned, and both are seen as leaders in the field in India.

   I agree with Bindu that governments should not lightly grant permission to take either savings or equity from the poor.

4. Bhagwan Chowdhry Says:
   January 16th, 2011 at 11:21 pm

   Simply asserting that “credit markets are not ordinary” is not a compelling argument. One needs to understand more clearly what frictions prevent competitive entry in credit markets. Perhaps then, intervention can address those frictions directly by appropriate subsidies. The fact that some microfinance leaders, such as Vijay Mahajan of BASIX, suggest limiting ROA does not make it the optimal solution. Furthermore, they may be offering this “solution” given the political environment which may be impeding entry by ad hoc intervention that largely serves narrow political interests.

5. David Roodman Says:
   January 16th, 2011 at 11:38 pm

   Bhagwan, I have blogged extensively on what is going on in Indian microfinance now, so I am not just making that simple assertion of abnormality. In point of fact, the problem is not barriers to entry but, if anything, the opposite.

   I don’t doubt that capping ROA is suboptimal. When are real-world solutions ever optimal? Do you have a practical, politically pragmatic alternative that is superior? Please share it. Laissez faire has failed spectacularly.

   To me, capping ROA seems like a pragmatic way to balance the need for outside capital and the equally pressing need to assure the public that the institution is deeply committed to growing responsibly limiting “profiteering” or “usury.” The fact that two of the most highly respected MFI leaders in India, people who have to deal with these problems practically, gives it more credibility.

   At this point, it seems reasonable to me to think that it would make things better—not perfect, just better. Almost certainly, growth would have been slower over the last 5 years, and I think fast growth was a core problem.

6. Bhalchander Vishwanath Says:
   January 16th, 2011 at 11:42 pm

   David,

   Ownership matters more than anything else in microcredit because ownership determines who the primary stakeholder of the organization is and that in most cases determines the long term direction the organization takes.
   Thus well run non-profits and member owned organizations will invariably put their borrowers/depositors or members first.

   Now the moment we have a for-profit structure there is one whole new dimension always added and that is leverage and that changes the situation significantly.The leverage happens at multiple levels. Let us look at a for-profit MFI and see where all the leverage is happening.
   There are two leverages happening:
   - The promoter of the MFI is leveraging his or her limited capital and/or sweat equity with funds from equity investors ( first level ) and at the second level from debtors – banks.
   - Now let us assume that the MFI is funded by a VC or private equity investors. The general partners of the VC fund are leveraging their funds with funds from the limited partners (some of those may be even socially motivated foundations) at the first level. They are also leveraging funds from equity investors who invest subsequently. Finally they are leveraging funds from the debtors ( banks).

   Further VC funds have an expiration date. They need to liquidate the VC fund and give returns to their investors within a set time period ( typical 5 to 10 years. Maybe a little more in some funds). Thus there is a need for fast growth to give an exit to the limited partners and other investors due to the structure of the VC fund itself.

   While some general partners in VC/PE firms and some promoters of MFIs would have the leaderships skills to manage the complexity inherent in the structure and temper the investment expectations of the various investors, it may not always work out. Some MFIs deliberately or accidentally may lose control of the situation. And then if the interests of the General Partners of VC firms and MFI promoters get perfectly aligned then we have the MFI trying to grow much faster than what is reasonably possible. That means bigger loans to clients, operational cost reduction, knowing the client less and faster outreach.

   While Mr. Vijay Mahajan’s Basix or SKDRDP or Sewa Bank may put livelihoods first and build the capacity of their clients through livelihood initiatives which have long gestation periods. Other MFIs seeking high investor returns may offer bare bones client products and may free ride on the capacity building done by these outstanding organizations.

   Unfortunately the livelihood generation capacity of the clients often does not keep pace with the rate at which their total borrowing is growing every year.

   This could lead to overindebtedness and the eventual financial exclusion. See figure 1 in Ramesh Arunachalam’s blog – http://microfinance-in-india.b.....adigm.html.

   In the long run the investor owned for-profit model may work for the clients in cases when there are outstanding leaders of the MFI and the investors are true social investors who are going to be invested in the MFI forever and are seeking social returns ( Bank deposit rate + a few basis points i.e. no leverage gains) or ideally just capital preservation. But both of these may not always come together.

   One could also argue what is so unique about microfinance. If investor profit is such a bad thing why do we have investor owned banks all over the world. The reason is perhaps because banks predominantly lend based on quantifiable collateral and cash flow. Thus in the vast majority of the cases their borrowers will not get overindebted. Microloans are collateral free income generating loans. There are only limited ways of knowing the exact capacity of the borrower to borrow other than using the savings amount as a proxy. While outstanding leaders like Mr. Vijay Mahajan and Mr. P.N.Vasudevan may overcome the inherent complexity in the structure of for-profit microfinance and do it right, many others may find it too hard to handle. Thus I believe there are real risks to commercialization not done the right way in microfinance.

   In the larger context of microfinance to my knowledge Prof. Yunus has always spoken of microfinance as a social business ( member owned organization or as an external investor owned organization where investors get no financial returns). In both these cases the clients are the primary stakeholders.

   He has also spoken of interest rate spreads and their importance. Depositor protection is also important. We can cavil on his views on each of these points but then let us not miss the forest for the trees.

   Best Regards

   Bhalchander Vishwanath
   UnitedProsperity.org

7. Bhagwan Chowdhry Says:
   January 17th, 2011 at 12:00 am

   David, you say, “the problem is not barriers to entry but, if anything, the opposite.” Yes, I understand that you, and others, have written a lot about problems caused by “excessive” borrowing. The question one has to answer is why a profit-maximizing lender would not guard against excessive borrowings? Perhaps, the lenders do not face full consequences of their imprudent lending practices because they might be lending “other people’s money.” We know the solution to that problem – make sure they are not too big to fail.

   How would profit-maximizing lenders, who would not be bailed out, ensure against excessive borrowing and sequential defaults? Some forms of informal or formal information sharing mechanisms might help. I have written about this in a paper with Amit Bubna http://bit.ly/fmpaper

8. Vivian Norris Says:
   January 17th, 2011 at 5:11 am

   I think one thing which really needs to be discussed is that as investors, money goes looking for new places to make profits, especially during a time of financial crisis in the US and Europe, the “Bottom of the Pyramid” billions of poor represent a possibility for more profit. Add to this loan shark type interest rates and next to no ownership by the borrowers and you have a return to a feudalistic system of elites making profits off the backs of what could almost be termed “share-croppers”.
   There has to be a shift in thinking and this is what Dr Yunus has done through his own example (he himself makes a very low salary-people would be amazed and often are, that he is not rich-”I could have been,” he often replies). Grameen workers do not even accept a cup of water from the poor. These are the poorest of the poor, and Yunus argues they are poor because the system is broken. We need to fix the system NOT think about how to profit off of them. He argues that all humans have a for profit selfish part of themselves and a not for profit selfless part. It is the latter which should be involved with microcredit. If this is followed, then microlending can be brought to scale in a morally respectable way.

9. gaddeswarup Says:
   January 17th, 2011 at 6:29 am

   As far as I can see, the main objection to Professor Younus’ view seems to be “So if all the microcreditors could raise all their capital from their clients then, I agree, that is the way to go.
   But almost none has—not even the Grameen Bank.”. Vijay Mahajan said in 2005, without specific reference to outside ownership
   http://base.d-p-h.info/en/fich.....-7541.html
   “Thus the dual promise that microcredit is able to serve the very poor, and in a financially sustainable manner, is not borne out in practice. Experience shows that either one of these two mutually contradictory goals can be achieved, but not both together.”
   These seem to suggest that outside inputs are needed and ousiders, if they go in to help, should do so with minimal expectation of profits.

10. Scott Gaul Says:
    January 17th, 2011 at 11:43 pm

    I’d be skeptical that targeting return levels will be able to create the right incentives. Returns embed a lot of information, so their interpretation can be ambiguous and institutions would have many degrees of freedom when trying to hit a threshold.

    For instance, if an institution has ‘too high’ returns and wants to decrease the margin between revenues and expenses, they could lower costs to clients (revenues). Or they could raise their expenses – increasing executive compensation would have the same net effect as lowering interest rates. Maybe that is unlikely, but it would at least meet the ‘letter of the law’.

    On the other hand, MFIs have revenues from more than just loans. Gains (or losses) from currency exposure are one example – for some MFIs these can be between 10 – 20% of total revenue (see for instance: http://www.mixmarket.org/node/.....it_or_loss). In these cases, returns would be higher, but not because the institution is engaging in excessive profit-taking – they’re just located in a country where the local currency appreciated. (N.B. This particular example wouldn’t be an issue in India and Bangladesh, where most funding is in local currency.)

    I’m also not sure that the relationship between growth and returns is that strong (high returns -> rapid growth). Many profitable institutions don’t grow rapidly. Even if this were the case, it does not then imply that low returns -> slower growth. While retained earnings is one way to finance growth, it is not the only one, and it wasn’t the primary mechanism for (most) Indian MFIs (see: http://www.themix.org/publicat.....een-funded).

    All in all, I would imagine there’s little harm if individual institutions implement this as a policy, but as a broad-based principle it seems too indirect. Are we concerned about profits in and of themselves or other behavior that (we think) is associated with high profits?

11. ali rahmat shah Says:
    January 18th, 2011 at 12:19 pm

    i like the job of such people who helps the needy people around the worid. God bless u all….

12. Peter Wall Says:
    January 24th, 2011 at 12:00 pm

    In regard to the discussions, of the crisis for MFIs in India, I am surprised at the absence of explicit linkages made between a real source of Indian MFIs’ profit margins – access to loans at below-commercial rates due to Gov’t-mandated priority sector credits through the banking system – and the lack of a clear definition of what constituted an eligible MFI for such credits, or conditionality on the loans’ use/onward pricing. The recent Malegam Committee recommendations address the critical questions of what constitutes microcredit, and what makes a provider of microcredits an MFI (and not a loan shark or simple finance company). It seems to me that in return for subsidized credits, recipients must demonstrate that they are on-lending as intended and be willing to accept a cap or range on profit margins.

    More broadly for MFIs, for Socially-Responsible Investors, and for governments/regulators, the Indian Crisis demonstrates how defining microfinance and measuring the social contribution attributes of individual MFIs is critical to achieving desired outcomes. There doesn’t need to be a one-definition fits all approach, but all the parties should have clear and publicly-stated policy goals, and metrics for measuring whether a company providing financial services to the poor or underserved is actually providing ‘mission-led microfinance’.

13. ALEX NGOWI Says:
    November 17th, 2011 at 3:57 pm

    Dear brother,what Yunus has argud is true for sure,if you want to prove it,just come and make a simple research in Tanzania,by making comperative study of 1990′s microfinance and the current one. SACCOS were performing better because of the nature of ownership. “BORROWERS HAS TO OWN THE LENDERS”