Microfinance: Impact Investing, Philanthropy, and You
KEY POINTS
Microfinance provides an opportunity to invest in the lives of real people and support sustainable community change
Women are the primary participants and their strength, determination, and persistence are a major success story of the microfinance movement
Microfinance extends far beyond money and can provide childhood access to education, improved healthcare, personal empowerment, clean energy, clean water, and so much more
Microfinance is Exciting
It is not often that you can get excited about discussing saving, borrowing, investing, insuring, or anything else finance related.
Microfinance is your chance to get excited.
In its purest form, it is a win-win. Yes, it has its share of detractors, and rightfully so. We will address the pros and cons below. But at a high level, it is hard not to get excited when exploring microfinance and all its possibilities.
It has seen a substantial evolution and growth over the last 30 years. Governments, organizations, wealthy family offices, and individuals have raised the capital and created the infrastructure necessary to provide financial services to a targeted global population.
This form of impact investing has the potential to earn a return on investment while providing the catalyst to create impactful and sustainable change.
Access to financial services can provide the ability to borrow, save, start a business, grow an existing business, earn income, hire staff, and more. The results of someone gaining access to such services for the first time in their life can be profound.
It is the unlocking of untapped human potential.
The economic impact has a ripple effect starting from the individual and flowing through their family and community. The educational and medical impact are measurable as such basic human rights become attainable. The psychological, emotional, and overall social well-being of the individual and community is immeasurable.
What is Impact Investing?
The Global Impact Investment Network defines impact investing as investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return.
Impact investing differs from socially responsible investing (“SRI”).
SRI’s investments are aimed at avoiding a certain negative impact without the requirement to make a positive impact. For example, a company may be considered an SRI if it avoids selling products associated with alcohol, tobacco, or gambling.
Impact investments are intentional in their pursuit of measurable social and environmental impact. For example, a microfinance company or organization may be considered an impact investment if it lends money to impoverished individuals while earning a return on such loan portfolio.
Can you invest and be philanthropic at the same time?
Impact investing and philanthropy both address social and environmental issues.
Most companies and organizations involved in impact investing aim to generate sustainable profitability. Although these entities possess a strong philanthropic element, their profitability objective precludes them from being classified as purely philanthropic endeavors.
There are some non-profit organizations that are focused on impact investing through microfinance. Such would be considered philanthropic in nature as their financial goal is breakeven profitability as opposed to sustained profitability. Donations from individuals to such entities would be philanthropic in nature.
What is Microfinance?
It is the provision of financial services to individuals, groups, or small businesses that do not have access to traditional banking.
Individuals or groups may exhibit one or more of the following traits; extremely poor, socially marginalized, or geographically isolated. Prior to the introduction of microfinance, they may have transacted through a barter system instead of using currency as a medium of exchange.
Financial services initially focused primarily on providing access to credit. The services offered has grown and now includes savings accounts, checking accounts, insurance, leasing, and more.
10 Types of Services
The following are examples of the services that may be offered.
Credit
This is what most people think of when someone mentions microfinance. It is the process of providing small/extremely small loans to individuals in poor populations that are often marginalized or geographically isolated.
Savings
Individual and group programs exist to encourage consistent savings. The purpose of such savings can vary like a traditional savings account (e.g., emergency funds, wedding, housing, transportation).
Insurance
Institutions may provide coverage for health, crops, livestock, theft, fire, life, natural disaster, property, disability, etc. The ability to insure against potential losses for the first time can be a powerful financial tool.
Electronic Funds Transfer
For some individuals, participating in microfinance will provide them with their first experience utilizing currency as a medium of exchange. The ability to open an account and send / receive funds, in a safe and affordable manner, from friends and family in the community or from afar can be profound.
Peer-to-Peer Lending
This provides an opportunity for you to become directly involved in the process as the service connects individual lenders directly with potential borrowers. Therefore, you can evaluate the intended use of funds and choose to lend at your discretion. Theoretically, this platform should reduce transaction costs and increase efficiency. It also has the potential to create a more personalized experience for the lender.
Village Banking
This consists of low-income entrepreneurs (often family, friends, neighbors) that form a financially interdependent financial group. Each member guarantees the loans of all members of the group. The benefits often extend beyond financial as the members tend to provide non-financial support to each other.
Leasing
This involves the leasing of machinery and equipment to small businesses. Such is a critical service due to the prohibitive cost of ownership. These leasing arrangements are often farm related as agriculture is a dominant industry in many communities reliant on microfinancing.
Housing
These loans provide for the purchase of a new home, renovation or expansion of an existing home, and land. The home can provide the following benefits: shelter, safety, investment, and a productive asset for business purposes.
Franchising
This business model shares elements of the traditional franchise model. The model may extend to franchises that deliver their services from an individual’s home or car.
Energy Loans
These loans provide the opportunity to access clean energy for a home or small business. Such can improve health and safety as it reduces or eliminates the use of kerosene and charcoal.
Microfinance – Some Examples
An individual may borrow $200.00 to purchase tools and seeds to increase the harvest, income, and profitability. The income provides food, clothing, shelter, education, and more for the borrower’s family. Profits, if any, may be used to hire additional employees and grow the business. The related economic spin-offs can be impactful throughout the community.
Microfinance has expanded beyond credit.
A group may form to achieve a specific savings goal per person. For example, 10 people may each contribute $5 per day. Each day, one individual is paid $50 (assuming no fees or interest earned). Such daily payment is made in sequential order until everyone has received their $50 payment. This program can be modified to incorporate over contributions, borrowing, and more.
Pros and Cons
Microfinance is intentional in its direct engagement of individuals and their small businesses. Its impact can have a profound impact on the local community. However, critics have wisely highlighted potential negative consequences stemming from such initiatives.
The following list of pros and cons highlights some key observations, many of which continue to be intensely debated amongst investors, donors, governments, participants, economists, and critics.
The internet is full of real-life stories of individuals, families, and communities that have engaged in microfinance. We encourage you to embrace these stories before getting involved.
The success stories can be extremely inspirational as they recount female financial independence and empowerment (females often represent >80% of borrowers), consistent attainment of necessities (food, clothing, and shelter), increased childhood education, improved access to healthcare, all combining to send a ripple effect through the local communities.
Not all participants have had a positive experience. Borrowers often lack a robust financial education, face complicated financial options, and can be forced to pay very high interest rates. This foundation may lead to poor financial management and the desire/need to obtain additional financing. Such can create an inescapable debt trap. The related stress can have a detrimental impact on the individual’s well-being (psychological, emotional, physical). In extreme cases, the journey ends in suicide.
The irony of trying to help communities facing extreme poverty while charging extremely high interest rates is not lost on anyone.
The good news is that the industry is evolving and embracing a more regulated and integrated approach. Technology continues to innovate, increase efficiencies, and decrease costs. The financial product offering continues to expand while financial providers are partnering with established organizations providing complimentary non-financial services (e.g., healthcare).
It is imperative for the industry to operate within a regulatory framework that protects all participants. Such becomes critical due to the predisposed vulnerability of such participants. A sustained reduction in poverty and inequality can only be maximized if the service offering is tailored and integrated into the community’s broader development strategies.
Global Reach
Grameen Bank of Bangladesh was a key catalyst in propelling microfinance through a period a rapid evolution to the present day. The financial services offered have expanded and such services are now offered around the globe by NGOs, formal and informal financial institutions, and member-owned organizations.
The following 2018 regional statistics provide a global overview of microfinance as it pertains to borrowing¹.
The above table provides the following high-level insights:
South Asia represents approximately 60% of all borrowers and 30% of all money borrowed. Such includes the largest markets consisting of India, Bangladesh, and Vietnam.
Latin America & Caribbean represent approximately 16% of all borrowers and 39% of all money borrowed.
The average dollars loaned per borrower varies dramatically across regions.
The following table illustrates the composition of the number of borrowers by region in 2018¹:
How to Invest in Microfinance
We always recommend that you obtain advice from a financial advisor prior to making any investment decisions. We consider this increasingly important in this case as Impact Investing can be emotional and such may cloud your judgement.
There are several ways to invest.
You can lend money directly to a Microfinance Institution (“MFI”) and even select the borrower you lend to. You may also consider investing in a microfinance fund, a publicly traded microfinance company, or a through a microfinance exchange-traded fund. It is worth noting the funds and ETFs may potentially invest in securities that are not in the microfinance sector: be sure to research the respective investment mandate and review the most recent portfolio holdings report.
You and your financial advisor will need to assess if this asset class provides the appropriate risk / return profile in relation to your short-term and long-term goals. These investments may have a higher default risk and currency risk than your current portfolio mix. Such investments may have an overall higher than average risk profile but may not offer the potentially higher commensurate returns expected.
Wealthy Families Embrace Microfinance
Some of the wealthiest and most influential families have embraced microfinance.
Bill & Melinda Gates Foundation
“Our mission is to create a world where every person has the opportunity to live a healthy, productive life.”
Ford Foundation
“We believe in the inherent dignity of all people. But around the world, too many people are excluded from the political, economic, and social institutions that shape their lives.”
“Our mission has been to reduce poverty and injustice, strengthen democratic values, promote international cooperation, and advance human achievement.”
Soros Economic Development Fund
“The Fund uses investment capital to support the rights and opportunities of marginalized people and communities, often in ways and places that entail significant financial risk. We look to catalyze positive social and economic change, by acting in alignment with allies and partners, reinforced by the strengths and capacities of the Open Society Foundations.”
The Rockefeller Foundation
“We improve lives and the planet, and unleash human potential, through innovation. We are dedicated to the principle that all individuals – dignified and resilient as they are – have the right to health, food, power, and economic mobility. We seek to advance those goals with a better use of science and data and through collaboration with broad and diverse partners and grantees. By pursuing the big bets humanity needs. The Rockefeller Foundation is making opportunity universal and sustainable.”
Bottom Line
Microfinance has come a long way in the last 30 years. It still faces challenges delivering a comprehensive and affordable service offering while simultaneously providing a return on investment to investors. However, there are many types of microfinance entities that have partnered with non-financial organizations to provide sustainable impact on a global scale.
We encourage you to access the following third-party links to learn more.
REFERENCES
¹Convergence.org: Microfinance Barometer 2019
