From issue: Impact Investing: Profit Meets Purpose (Fall 2011)
Not So Fast: The Realities of Impact Investing
The ups and downs of microfinance offer some cautionary lessons to champions of socially concious investing.
At the beginning of 2010, the Indian microfinance sector was a hotspot for impact investors. The promise of impact investing could be seen in the number of investors lining up to participate in the initial public offering (IPO) of SKS Microfinance.
SKS had ballooned from 603,000 borrowers in fiscal year 2007 to 6.8 million in fiscal year 2010. Most were women in South Indian villages. The founder of SKS, Vikram Akula, had been saluted by TIME and the World Economic Forum, and his Harvard-published memoir told the story of an “unexpected quest to end poverty through profitability.”
But by 2011, the Indian microfinance sector was mired in bad press and political controversy. Newspapers accused lenders of putting poor villagers in debt and causing suicides. State-level legislation in late 2010 capped interest rates and scared away equity investors. Borrowers ceased to repay, and SKS’s share price plummeted, dipping below 200 rupees ($4) in late August 2011 (from an IPO price of 985 rupees, $20, in August 2010). As summer 2011 ended, BASIX—a pioneering competitor of SKS—very publicly searched for funding to stay afloat.
Both the achievements and challenges in India hold lessons for impact investors, no matter what country they’re from.
Impact investing has been widely touted, with microfinance as a leading example. The temptation to attract capital by promising macro-impact at a micro-cost is difficult to resist—and India continues to be one of the most important and innovative microfinance markets. But getting the equation right is more complicated than most advocates admit.
Here are seven lessons on challenges, risks and realities drawn from three decades of microfinance ups and downs.
Win-Win Possibilities are Enticing but Exaggerated
The early rhetoric around microfinance was heavy on win-win. Investors would earn a profit, and poor customers would gain access to opportunities that were previously limited to richer folk.
Today, that rhetoric has been toned down in microfinance, and experts carefully note that for all its possibilities, microfinance is not a silver bullet. That’s a start at realism, but a larger point is still under-
appreciated: data fail to confirm that win-win investments are always most appropriate or most powerful. It may be necessary to accept bigger costs in order to generate bigger benefits. The impact investment proposition is based on achieving massive scale and multiplying the power of philanthropy through financial leverage. All the same, often the optimal proposition for someone interested in creating social change is not win-win. Instead it may be lose-win; i.e., tolerating a financial loss may be the best way to create the most meaningful social benefit.
In this light, it’s notable that Muhammad Yunus has been leading the opposition to commercial microfinance in India. The Grameen Bank founder accused investors in SKS of being more interested in profit than social change.
“Poverty should be eradicated, not seen as a money-making opportunity,” Yunus wrote in an op ed for The New York Times in January 2011. “Commercialization has been a terrible wrong turn for microfinance.” He went on to observe that it indicates a “worrying ‘mission drift’ in the motivation of those lending to the poor.”
Yunus’ motivation is partly to distance Grameen Bank from the public relations disaster in India, particularly given Grameen’s own political troubles in Bangladesh. But his barbs reflect a longer legacy of concern that microfinance is abandoning the truly poor families that had been Grameen Bank’s core focus. In keeping with Yunus’ vision, Grameen looks more like a nonprofit cooperative than a traditional bank—and as such doesn’t present much opportunity for a financial “win” by outside impact investors, regardless of how impact is assessed.
For-Profit Efforts Seldom Target the Poorest
Most microfinance customers, especially those served by commercially oriented players in Latin America and Eastern Europe, are not rich, but neither are they poor as measured by the global extreme poverty line of $1.25 a day. The typical commercial players do not focus heavily on women or on the poorest borrowers, leaving low-profit segments of the markets to the NGOs. If the aim is to help meet the United Nations Millennium Development Goals through impact investing, microfinance yields few investments in the win-win sweet spot, especially outside of South Asia.
Benchmark data from the Microfinance Information Exchange, a donor-supported information clearinghouse, suggest that microfinance NGOs serve very different communities than do commercial microfinance banks.
We can get a rough measurement of customers’ income by dividing an institution’s average loan size by the gross national income per capita in the country. It’s not a perfect measure, but it is indicative. Lower percentages mean that loan sizes are smaller and suggest that the institution serves poorer customers on average. This proxy measure registers at 16 percent for NGOs, 32 percent for nonbank financial institutions and 111 percent for commercial microfinance banks.
In other words, the typical institutions most open to impact investors (the commercial microfinance banks and nonbank financial institutions) look very different from the typical institutions (NGOs) that are most focused on poor communities. You can’t count on investing in the former and reaching the customers of the latter.
It's Not So East to Find Investment Opportunities
Even when going “upmarket,” it may be hard to find appealing deals from a financial standpoint. The microfinance rating agency MicroRate conducts an annual survey of microfinance investment vehicles, finding $4.7 billion invested in microfinance by 80 funds in 2010. About three-quarters of this amount is concentrated in Latin America and Eastern Europe. But the survey also revealed another $1.7 billion held by the funds but not invested in microfinance, presumably waiting for investment opportunities.
“Quite frankly, impact investors are sitting at the end of an oil pipeline, waiting for the riches to gush out, but they are finding few deals,” said Felix Oldenberg, Ashoka’s Europe and Germany director, in a conversation with Nilima Achwal on NextBillion.net. “The most common complaint from impact investors is the low deal flow in their industry, since there are so few social enterprises that meet their (often narrow) requirements for investment.” Experience suggests that part of the problem is the win-win assertion that you can expect to achieve meaningful social impact for next to nothing in foregone income.
Impact Investment Doesn't Banish the Need for Subsidy (It Often Requires It)
It’s natural to imagine that social enterprises get funded solely by social investors, just as commercial enterprises get funded by commercial investors. The reality, however, is more complicated.
Most microfinance institutions are funded by a range of different kinds of investors. Some funding comes from foundations; others from government grants. Some comes from social investors happy with below-market financial returns. And, on the margin, some funding originates from commercial funders simply seeking profits. Financial statements reveal business models built on funds from multiple sources, together with revenues earned from doing business with customers.
Since money is fungible, some of the grant funding and some of the social investment necessarily is used to attract (and pay for) the commercial funding. Some social investors, seeking to attract commercial capital, are aware of and perfectly happy with this arrangement. Others, however, may not be so happy to think that their social investments are subsidizing the returns of commercial investors. But that is the reality, whether they realize it or not. While the commercially minded wing of the microfinance sector has at times been fiercely antisubsidy in its rhetoric, this misses the point. First, social investments usually entail opportunity costs—that is, they generate lower financial returns than comparable investments with no social component. This amounts to an implicit subsidy that is just as real as a traditional philanthropic grant. Second, social enterprises in microfinance often get subsidies from governments and foundations in addition to commercially oriented social investment. It is those subsidies that allow social enterprises to generate the returns (and lower the risks) for commercial and “near-commercial” investors.
This isn’t a criticism of microfinance and its funding. Instead, it’s simply a recognition of how hybrid business models have helped build the sector and how prevalent they remain.